What Is Stock Analysis?

Stock analysis is the process of institutional and individual investors evaluating a specific financial instrument, securities industry, or stock market to make informed buying or selling decisions. It entails researching the company and determining its long-term growth potential based on past and current market performance.

Investors consider several factors to predict a company’s earnings capability and stock price movement when conducting stock analysis. Investors can then utilize this knowledge to develop a trading strategy for their portfolio and select appropriate stocks.

Types of Stock Analysis

Stock analysis can be grouped into two broad categories:

1. Fundamental Analysis

The fundamental stock analysis method involves the evaluation of a business at a basic financial level. Investors use fundamental analysis to determine whether the current price of a company’s stock reflects the future value of the company.

Fundamental analysis uses different factors such as the current economic environment and finances of the company to estimate its stock value. Different key ratios are also used to determine the financial health and understand the true value of a company’s stock.

  • Earnings per share (EPS) – The EPS is useful when companies operating in the same industry need to be compared. A company’s EPS indicates its profitability; hence, traders consider an increasing EPS a good sign. The higher the value of EPS, the more the company shares are worth buying.
  • Price to Earnings ratio (P/E) – The P/E ratio indicates how much investors are willing to pay for the earnings of a company. A higher P/E value could mean an overvalued stock. Or, it could imply that the market is expecting the company to perform extremely well over time. On the other hand, a low P/E value is seen as unfavorable by the market.
  • Price to Earnings to Growth ratio (PEG) – The PEG ratio helps to determine the value of a company’s stock while considering the earnings growth of the company. The PEG ratio, along with the P/E ratio, can help obtain a clearer picture of a company’s stock than the P/E value alone.
  • Price to Book ratio (P/B) – The P/B ratio is used to compare the market value of a company with its book value. It seeks the value that the stock market places on a company’s stock relative to the book value of the company. A company with sound financial health will trade for more than its book value since investors will consider the company’s future growth while pricing the stocks.
  • Return on Equity (ROE) – It measures how effectively a company uses its assets for producing earnings. A high ROE implies that a company squeezes out greater profits with available assets. Hence, with all other things equal, it will be better to invest in high ROE companies in the long run.
  • Dividend Payout Ratio – It measures the percentage of the company’s earnings paid to shareholders or owners. The earnings of the company, which are not passed on to the shareholders, are used to pay off debts, reinvest in business operations, or are retained for future use

 2. Technical Analysis

The technical analysis method involves examining data generated through market activities, such as volume and prices. Analysts following such a type of stock analysis use technical indicators and tools like charts and oscillators to identify patterns that can indicate future price trends or direction.

Technical analysts examine the historical trading data of a security and estimate the future move of the security. It is frequently used for FOREX and commodities. The technical analysis is based on the following assumptions:

  • The market knows it all. Technical analysis assumes that the market price of a stock reflects all that has or can affect a company. Technical analysts consider that all the factors affecting the company are priced into the security.
  • Price follows a trend. It implies that once a trend is established, future prices tend to follow the direction of the trend. Such an assumption is the basis of many strategies for technical trading.
  • History is likely to be repeated. History repeats itself mainly concerning price movement. Market psychology causes price movements to repeat. Technical analysis involves using chart patterns to analyze the movements in the market and study trends. Charts that have been used for over 100 years are still relevant since price movement patterns are often repetitive.

Other Forms of Stock Analysis

Aside from fundamental analysis and technical analysis, analysts can leverage other less formal ways to analyze the price of a stock. With the inter-connectivity and complexity of social media, analysts can perform sentiment analysis by engaging with social media and news to gauge public perception of the company.

Quantitative analysis is similar to technical analysis in that it relies on complex financial calculations to determine future price projections. Quantitative analysis relies on mathematical and statistical modeling to review data; the goal of these models is to identify general trends based on what has happened in the past (not necessarily tied specifically to the stock price).

Analysts may also perform either a top-down analysis or bottom-up analysis. Top-down analysis requires an analysis of the overall economy, then narrows down to the specific performance of a company. On the other hand, bottom-up requires analyzing individual companies, then reviewing how the broader economy is performing. Both types of analysis are used to more generally understand factors that impact price such as broad market conditions.

Limitations of Stock Analysis

Many investors rely on stock analysis to deploy their best investment strategies. However, stock analysis may result in misplaced confidence or misguided strategies.

Stock analysis is often performed with limited information. This is due to a few reasons. First, public companies may not fully disclose all situations of their company to the general public. Second, stock analysis strives to project the future (in which the information is simply not available).

Because of this reliance on future events to occur, there is broad uncertainty around all stock analysis techniques. The stock market may rapidly change in either direction based on prevailing market conditions. For example, should political climates change rapidly and redefine political risk, there may be an unpredictable impact to investments no previously foreseen.

As analysis dig into stock data, there is always an inherent risk of bias. If the data being analyzed is not anonymous, analysts may find themselves favoring certain outcomes based on what they know about the investment options. In addition, analysts and investors may be lured into confirmation bias that steers decisions to match a desired outcome.

Last, stock analysis is often complex. It isn’t easy to pull together, and it requires a substantial amount of time. In addition, as variables change every day, stock analysis requires continual thoughtfulness and analysis to evaluate morphing conditions.

Which Stock Analysis Technique Is Best?

Investors may be best suited to use fundamental, technical, and quantitative analysis as one technique may not always be superior compared to other techniques. Based on the information available and objectives of the investors, it may be better to analyze the financial positioning, research the company’s industry, or devise complex financial models.

Conclusion Many people these days are looking forward to investing in the share market. For those with little expertise in this sector, keeping a careful eye on the share market could be a challenging endeavor. Finding the best stocks can take work through use of screeners, strict profitability and performance criteria, as well as projections for understanding where a stock might go.


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