Stock Analysis
It is the method of assessing which stocks to invest in and/or which stock to buy and sell and when it should be done.
Stock analysis is a method to study or examine the trends of a company's stock and monitor it over time to ascertain if it's suitable to meet the needs of the investor and/or the analyst.
The main objective of performing the analysis of a company's stock is to predict the future movements of the stock and keep yourself shielded from any possible losses that may occur in the approaching period for which the analysis has been done.
What do we mean by a stock for absolute beginners in finance?
It is a piece or share of ownership of a firm, an entity, or a business that a group of shareholders shares and/or stakeholders of that particular business. We are not talking about the institutional and private investors who buy a stake in the company in bulk.
We are referring to the part of the capital employed by the company that is being funded through equity shares traded publicly by the various market players.
Let us move on further and understand it through various upcoming sections that will help you understand the topic more deeply.
Key Takeaways
- Stock analysis assesses which stocks to invest in and/or which stock to buy and sell and when it should be done.
- Stock analysis can be done in two broad ways: fundamental and technical.
- Fundamental analysis analyzes stocks through company financials like income statements, profit and loss statements, and cash flows.
- Technical analysis utilizes historical and present data to derive the stock's future activities.
- However helpful Stock analysis may prove to be, it also has some limitations. One of the key limitations and factors to remember about stock analysis is that you can never predict the future accurately.
Understanding Stock Analysis
Before we proceed, we hope you will take a moment to review our stock article.
As we discussed earlier, It is usually performed by investors, brokers, and any other market player to make buying and selling decisions regarding that stock.
The analysis is usually done by deploying any or every information available about the recent or immediate past of the stock's performance and anything that is possibly an indication of its future behavior.
The doctrine behind performing such an analysis is that all the information available in the market about that stock will help us determine the intrinsic value of the company's share value.
The intrinsic value of a stock is the measure that helps us know the assets' real worth. This value is arrived at after a few fundamental calculations, which we will discuss later, and is compared with the stock's current market value.
NOTE
Using the knowledge of analysis of the stocks helps one make a much better and more informed judgment about the stock.
If the intrinsic value is greater than the current market value of the share, then the share is currently undervalued. If it is less than the share's current market value, then the share's current market price is overvalued.
Only rarely does the intrinsic value and the market price of a share be equal, considering there are behavioral biases while calculating the same. We have two basic methods to analyze a stock. These are fundamental analysis and technical analysis.
Fundamental Analysis
The fundamental analysis of a company or its stock is a way to determine how to deal with its stock.
It is achieved through various bases such as income statements, profit and loss statements, balance sheets, annual reports, company assets, market share and competitiveness in the industry, and many more.
Analysts can also make use of financial statements to calculate a plethora of ratios under the quantitative analysis of a stock.
These consist of some of the most important ratios, including current and quick ratios. These ratios are used to determine the state of the company's current assets and gain insight into its efficiency in the cash flows.
NOTE
This is only quantitative analysis of a stock's value. Investors and analysts also render equal importance to the qualitative analysis of a company as it speaks about the company's ethics and core beliefs which makes a business better than its competitors.
One can also determine the debt and equity ratios to know the financial leverage that the company currently holds and what it says about its functioning. Operating profit margins could also be used to compare companies' operating profits.
Technical Analysis
Under technical analysis, the stock is judged based on its course of action in the past and present and to forecast what will happen in the future using that information.
Technical analysis is relatively more complicated than fundamental analysis, and thus, this is done by technical analysts who specialize in this field.
These analysts are more concerned about the market as a whole and the company's role and standing in the market concerning the volume and liquidity of the company.
NOTE
You can read about the volume and liquidity of a firm in our articles.
In this kind of analysis, visual representations play a crucial role, and graphical charts are used to conclude. It also summarizes the opening and closing prices of the stock and the price levels over a month, quarter, and/or year.
It lets us know whether there is a bearish or bullish trend in the stock compared with the industry or if the industry suffers from the same hindrances.
Stock Analysis for Beginners
A beginner can analyze their stock without it being a tricky process. To research your first stock, you need to gather as much public information about the stock that you feel may have even a slight impact on the performance of the stock.
This may contain newspaper information, any recent news on your television about the company's significant actions regarding anything, and also reading the articles available on the internet.
Next, you need to gather the most recent financial statements of the company, and you can also go back two to three years in time, depending on the utility of the stock to you.
- If you intend to invest in it for a longer period, you must regularly analyze the company to know deeper about it and how it will be in the long run.
- If you are an arbitrageur or an active trader who is only seeking to gain short-term profits by buying and selling stocks, then only the most recent news can be of greater use to you.
Those investing in a company and thinking of holding the stock for the long term must compare the business with its counterparts and look out for any risks associated with the company and its market share and sales growth within the industry.
Moreover, they should also watch out for any potential business fallout due to unexpected circumstances by being risk averse.
Limitations of Stock Analysis
However attractive and easy this may seem, it comes with a disadvantage you cannot evade.
These are inevitable, and thus, one can only try to avoid such things from happening. Let us look into certain limitations that stock analysis incorporates in it.
1. It is only a prediction
Most investors consider stock analysis the last resort to save them from any possible risks. However, this is not always true. In the end, it is the future that you are predicting, and you can never predict what will eventually happen in the upcoming times.
2. The research is never exhaustive
Including all and every piece of information about the stock in your analysis is nearly impossible. You miss one or more information. That could lead to a few risks that may come unannounced to you.
NOTE
There is also certain confidential information the company is unwilling to disclose. That may have a significant impact on stock performance.
3. There are always biases
While drilling into the information about the companies, certain inherent biases may be inevitable and tend to impact our final decisions in most cases.
4. Stock analysis is a complex process
It could be very complex to perform as the fundamental analysis could only get you to invest in it for some time as it is mainly based on historical data.
Benefits of Stock Analysis
However, it is the best possible way for an investor to secure their possible profits in the future. It is obvious that as an investor, one would only aspire to stay in a profitable position all the time.
This is the prime reason that the analysis of the stocks in an investor's portfolio is so significant.
With the world becoming increasingly data-driven, it is necessary to stay updated with all the new information at all moments to incorporate them into your analysis, which makes stock analysis all the more crucial.
In short, it defines the immune system of your portfolio; you must know what could lead to the drop in the value of your portfolio and what your portfolio is immune to.
In such cases, technical analysis is of the best use regarding such decisions. But sadly enough, technical analysis is not everybody's cup of tea!
To analyze your first stock, check out our Valuation Modelling Course!
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