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.
Table of contents
- Stock analysis is when investors assess a particular financial instrument, company, securities sector, or stock market to make informed purchasing or selling decisions.
- It includes researching the company and its stock and calculating its long-term growth potential based on past and current market performance.
- The fundamental stock analysis reviews the company’s financial position using its financial statements, while technical stock analysis forecasts stock price movements using charts and oscillators.
- Investment banks and research firms usually recruit analysts to perform stock analysis. Individual investors can do it on their own, but they may not be able to go too far.
Stock Analysis Explained
Stock analysis fundamentals helps traders and investors assess the stock market situation in a way that helps them make maximum profit. Before investing in a stock, they need to do their due diligence and learn what makes a company unique and why they should invest in it. It is never good to buy a stock because “everyone else is doing it” or “someone told to do so.” It is where stock analysis comes in. This phenomenon, also known as equity or market analysis, can be performed using either fundamental or technical stock analysis tools.
Thus, through this technique, an investor can assess the current financial condition and the future activity, plans and growth potential of a business, a particular sector or the market as a whole. It uses past and present financial data to forecast the future, which is the best way to make any investment decision. If the company has limited information or its business is of a unique type, then it is difficult to obtain stock analysis data to analyse stocks. However, in that case investors should follow the performance of peer companies, the sector and the economy trends to understand the stock’s future prospects.
Stock analysis fundamentals can be an investor’s best guide while venturing into securities markets. The company’s past and present financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. and their comparison with competitors can tell a great deal about how well the company is doing. Metrics like operating profit marginOperating Profit MarginOperating Profit Margin is the profitability ratio which is used to determine the percentage of the profit which the company generates from its operations before deducting the taxes and the interest and is calculated by dividing the operating profit of the company by its net sales. can also help analysts estimate the company’s revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions., operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit., operating incomeOperating IncomeOperating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business. It doesn’t take into consideration non-operating gains or losses suffered by businesses, the impact of financial leverage, and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business., etc.
Investment banksInvestment BanksInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc. and research companies typically use similar stock analysis tools. Although individual investors can do it on their own, they may not be able to go too deep. In that case, they can monitor stock trading platforms and other financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc. resources to study factors like price targetsPrice TargetsPrice Target in the context of stock markets, means the expected valuation of a stock in the coming future and the valuation may be done either by the stock analysts or by the investors themselves. For an investor, price target reflects the price at which he will be willing to buy or sell the stock at a particular period of time or mark an exit from their current position., earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments., and potential revenue. Thus, it will help them make near-accurate predictions or recommendations about buying, selling, or holding stocks.
The two primary approaches to sector wise stock analysis include:
- Fundamental AnalysisFundamental AnalysisFundamental analysis refers to the analysis of financial aspects of business like financial statements and financial ratios and other factors like economic and others affecting the business to analyze the fair market value of its share/security whereas technical analysis refers to the analysis of share/security fair price by examining and analyzing the past trends and changes in price of shares and by studying historical information of business.
- Technical AnalysisTechnical AnalysisFundamental analysis refers to the analysis of financial aspects of business like financial statements and financial ratios and other factors like economic and others affecting the business to analyze the fair market value of its share/security whereas technical analysis refers to the analysis of share/security fair price by examining and analyzing the past trends and changes in price of shares and by studying historical information of business.
Both techniques are vital to understanding the stock, including its value and growth potential. They can be either performed separately or in tandem.
#1 – Fundamental Analysis
Investors apply fundamental analysis when reviewing a company’s financial positioning, such as evaluating its cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. , balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company., and earnings or income statement. The stock analysis report can reveal a company’s operating expenses, profits, and distribution of its revenue.
Furthermore, investors prepare ratios and valuation metrics to determine the company’s potential value. It involves looking into its financial records, stock price, market shareMarket ShareMarket share determines the company's contribution in percentage to the total revenue generated within an industry or market in a certain period. It depicts the company's market position when compared to that of its competitors., and overall assets. This way, it helps investors make long-term investment decisions.
Investors compare the previous and current financial statements to complete a thorough fundamental analysis of a stock, company, industry, or market. These statements are made public by the United States Securities and Exchange Commission and provide the answers to the following questions:
- Is the company growing?
- Is it profitable?
- What is it doing with the profits?
- Is the growth sustainable?
- Can the macro-environment support growth?
Moreover, this comprehensive analysis measures a company’s growth, profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance., creditworthinessCreditworthinessCreditworthiness is a measure of judging the loan repayment history of borrowers to ascertain their worth as a debtor who should be extended a future credit or not. For instance, a defaulter’s creditworthiness is not very promising, so the lenders may avoid such a debtor out of the fear of losing their money. Creditworthiness applies to people, sovereign states, securities, and other entities whereby the creditors will analyze your creditworthiness before getting a new loan., liquidityLiquidityLiquidity is the ease of converting assets or securities into cash., etc. The current ratioCurrent RatioThe current ratio is a liquidity ratio that measures how efficiently a company can repay it' short-term loans within a year. Current ratio = current assets/current liabilities and quick ratioQuick RatioThe quick ratio, also known as the acid test ratio, measures the ability of the company to repay the short-term debts with the help of the most liquid assets. It is calculated by adding total cash and equivalents, accounts receivable, and the marketable investments of the company, then dividing it by its total current liabilities. are two metrics used to determine if a company’s short-term or current obligations can be met using available assets.
Current ratio = Short-term liabilities/Current assets
In ideal conditions, the ratio should be 1. A ratio of less than 1 implies that the company is experiencing financial difficulties.
- Balance Sheet
It provides information about its total assetsTotal AssetsTotal Assets is the sum of a company's current and noncurrent assets. Total assets also equals to the sum of total liabilities and total shareholder funds. Total Assets = Liabilities + Shareholder Equity, liabilities, and shareholder equityShareholder EquityShareholder’s equity is the residual interest of the shareholders in the company and is calculated as the difference between Assets and Liabilities. The Shareholders' Equity Statement on the balance sheet details the change in the value of shareholder's equity from the beginning to the end of an accounting period..
- Income Statement
It shows how much money the company makes and at what cost. Its components include the cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. , gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services., total expenses, net incomeNet IncomeNet Income formula is calculated by deducting direct and indirect expenses from the total revenue of a business.. It is the most important number for the Company, analysts, investors, and shareholders of the Company as it measures the profit earned by the Company over a period of time., and earnings per shareEarnings Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is. (EPS). ). A higher EPS means the stock is worth purchasing.
- Cash Flow Statement
Statement of Cash FlowStatement Of Cash FlowA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business. provides information on the money flowing in and out from operations, investments, and financing. It also indicates if the company has enough cash to pay its expenses.
Other Helpful Fundamental Tools
Besides financial statements, here are some additional tools used in sector wise stock analysis to understand a company’s financial positioning:
- Price to Earnings (P/E) Ratio – Reflects a company’s value by dividing the share price by the EPS and then comparing it with competitors. A higher PE ratioPE RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. shows that investors are willing to pay a premium to invest in the company (it also means the firm is overvalued) and vice versa.
- Price to Book (P/B) Ratio – Price to Book ValuePrice To Book ValuePrice to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share compares a company’s market values to its fundamental book valueBook ValueBook Value of Assets is the asset's value in the books of records of a company or an institution at any given instance. Assets Book Value Formula = Total Value of an Asset – Depreciation – Other Expenses Directly Related to it or the net value.
- Return on Equity (RoE) – ROEROEReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit. shows a company’s profitability from investments made by investors.
- Price to Earnings to Growth (PEG) Ratio – The expected annualized earnings growth of a company, determining the stock value. It results from dividing the stock’s P/E ratio by the income growth rate.
- Dividend Payout Ratio – The dividend payout ratioDividend Payout RatioThe dividend payout ratio is the ratio between the total amount of dividends paid (preferred and normal dividend) to the company's net income. Formula = Dividends/Net Income refers to the percentage of the company’s earnings given to its shareholders.
- Debt-to-EBITDA Ratio – It is the ratio of total debts and EBITDAEBITDAEBITDA refers to earnings of the business before deducting interest expense, tax expense, depreciation and amortization expenses, and is used to see the actual business earnings and performance-based only from the core operations of the business, as well as to compare the business's performance with that of its competitors.. A high ratio indicates a riskier investment.
- Debt Ratio – The debt ratioDebt RatioThe debt ratio is the division of total debt liabilities to the company's total assets. It represents a company's ability to hold and be in a position to repay the debt if necessary on an urgent basis. Formula = total liabilities/total assets shows how much debt is weighing on a company’s assets. If it is more than one, the corporation has more liabilities than assets.
Debt ratio= Total liabilities/Total assets
#2 – Technical Analysis
Investors and traders perform technical analysis by looking at past price and volume trends, demand and supply variables, etc., to determine where the stock price can go in the future. It is a way of forecasting stock price movements using various stock analysis tools and stock analysis chart. The analysis uses indicators like charts and oscillators to predict future trends. It benefits traders who seek profits from short-term price fluctuations. A few questions to keep in mind while performing technical analysis using stock analysis chart are:
- What trends are taking place?
- Is it a good time to enter/exit a trade?
- What are the price levels hit by stock?
- When the stock hits those levels, where does it tend to go afterward?
- Support – The price level shows previous declines marked well below the current price. The level followed by a break signals the start of a downtrend when the buyer enters the market and places a bid on a stock price.
- Resistance – The level at which the stock price starts to fall due to selling pressure. It shows the previous high points before the current stock price. Breaking through the level signals an optimistic outlook.
- Moving Averages (MA) – Moving averagesMoving AveragesMoving Average (MA), commonly used in capital markets, can be defined as a succession of mean that is derived from a successive period of numbers or values and the same would be calculated continually as the new data is available. This can be lagging or trend-following indicator as this would be based on previous numbers. reflect the average stock price over a specific period. Popular moving averages include the 200-day, 100-day, and 50-day averages.
- Trend Lines (TL) – These display price patterns that enable investors and traders to visualize support and resistance levels. One can create them by connecting the pivot points where the price has reversed during a specific period.
- Relative Strength Index (RSI) – This indicator measures the momentum of a stock price, indicating whether it is overbought or oversold.
- Pivot Points – The price levels in which the stock hits support or resistance.
Let us look at the Apple stock analysis to understand the concept:
- Fundamental Analysis of Apple Stock
It is a good idea to look at the company’s most current financial statements before analyzing a stock. In most circumstances, the earnings of a corporation can be seen on its website. For example, here is Apple’s Q4 2020 financial report:
Net sales = $111,439 vs $91,819*
Cost of goods and services sold = $67,111 vs $56,602*
Net Income = $28,755 vs $22,236*
Earnings per share (basic) =$1.70 vs $1.26
– * In millions
– The first number is the most recent quarter (Q4 2020) vs. the same quarter the previous year (Q4 2019)
The fundamental analysis shows that Apple has grown in various aspects, including sales, income, and EPS. It also means Apple is profitable with the investor capital, and investors are willing to pay a premium.
- Technical Analysis of Apple Stock
The above chart indicates that Apple’s stock has enjoyed a massive rally in Q1 2021. However, recently the stock has cooled off a bit (possibly due to macroeconomic factors) and is now seeking support near the 200-day moving average. If equity can find it in this area, it will be a bullish sign for the future.
Frequently Asked Questions (FAQs)
The stock analysis evaluates a financial instrument, company, the securities industry, or stock market to determine its long-term growth potential based on historical and current market performance. Investors can create a trading strategy, select appropriate stocks, and make an informed purchase or selling decisions using this information.
It requires investigating the company using numerous tools and resources, such as earnings reports, valuations, and historical price and volume levels. Also, it entails analyzing the company’s past and present financial statements and comparing them with its competitors. Finally, the stock analysis data can help estimate a firm’s earnings capabilities and its stock price movement in the future.
The two types of stock analysis are fundamental and technical. While the former examines a company’s financial status using its financial statements, the latter uses charts and oscillators to forecast stock price movements. Furthermore, fundamental analysis helps identify long-term investment opportunities, whereas technical research focuses on profiting from short-term market movements.
This has been a guide to what is Stock Analysis. We explain its various tools along with its types and examples to understand it in details. You can learn more from the following articles –