Researching stocks can give you a long-term advantage as an investor.
Investors are able to locate the most lucrative investment possibilities by doing stock analysis. When analyzing companies, using analytical methodologies allows us the opportunity to research Stocks that are now selling at a discount to their intrinsic worth. This may put you in a wonderful position to earn gains that are far higher than those of the market in the future.
1. Understand the two types of stock analysis
The fundamental analysis and the technical analysis are the two primary approaches that may be used while doing research stock.
This study is predicated on the notion that the price of a stock does not necessarily represent the true worth of the underlying firm, and it does so only to a limited extent. This is the primary instrument that value investors use in their search for the most lucrative business prospects. To assess whether or not a company is trading at an appealing price, fundamental analysts examine a variety of variables related to value in addition to other information. Investors that are interested in maximizing their profits over the long run may consider using fundamental analysis.
In general, the practice of technical analysis begins with the presumption that the price of stock already represents all of the information that is currently accessible and that prices tend to follow patterns. In other words, by evaluating the price history of a stock, one may be able to forecast the price behavior of the stock in the future. If you’ve ever seen anyone looking for patterns in stock charts or having a conversation about moving averages, you’ve witnessed a kind of analysis known as technical analysis.
The difference lies in the fact that fundamental analysis looks for possibilities to make long-term investments. This is an essential distinction. In general, the emphasis of technical analysis is on the most recent variations in price.
To a large extent, the staff here at The Motley Fool is in favor of basic analysis. We think that investors may outperform the market over the long term if they concentrate on buying shares of exceptional companies trading at reasonable prices.
2. Learn some important investing metrics
Keeping this in mind, let’s take a look at four of the most significant measures that every investor should have in their analytic toolset so that they can analyze the financial statements of a company:
- Price-to-earnings (P/E) ratio: Earnings per share, abbreviated EPS, is the method through which businesses present their financial results to shareholders. The share price of a firm is divided by its yearly earnings per share to get its price-to-earnings ratio, also known as the P/E ratio. For instance, if a share of stock is trading for $30, and the company’s profits over the course of the previous year were $2 per share, we would say that the stock sold for a P/E ratio of 15, often known as “15 times earnings.” This is the most frequent valuation indicator used in fundamental research, and it is beneficial for comparing businesses operating in the same sector as one another that have comparable growth potential.
- Price-to-earnings-growth (PEG) ratio: There is a wide range of growth rates across various firms. To create a level playing field, the PEG ratio takes the price-to-earnings ratio of a company and divides it by the rate at which annualized earnings are predicted to rise over the next several years. A company that has a P/E ratio of 20, as well as an estimated earnings growth of 10% over the course of the next five years, would have a PEG ratio of 2, as an example. The concept here is that a corporation with rapid expansion might be “cheaper” to operate than one with slower expansion.
- Price-to-book (P/B) ratio: Book value is the same as the total worth of all of an organization’s assets. Think of a firm’s book value as the amount of money it would hypothetically have if it shut down its operation and sold everything it held. This is the amount of money a company is considered to be worth. The price-to-book ratio, often known as the P/B ratio, is a comparison of the book value of a firm to its current stock price.
- Debt-to-EBITDA ratio: Examining a company’s level of debt may be a useful indicator of how healthy its finances are. There are a number of measures that pertain to debt, but the debt-to-EBITDA ratio is one that is recommended for novices to master. On a company’s balance sheet, you can discover the total amount of its loans, and on its income statement, you can find its EBITDA (earnings before interest, taxes, depreciation, and amortization), which stands for profits before these four expenses are taken into account. After that, create a ratio using the two numbers. It is possible that a high debt-to-EBITDA ratio indicates an investment with a greater risk, and this is particularly true during recessions and other difficult periods.
3. Look beyond the numbers to analyze stocks
This might very well be the most significant phase in the whole process of analysis. There is more to doing research and analysis on stocks than just looking at valuation indicators, as much as we all appreciate a good deal when we find one.
Keeping this in mind, the following are three other crucial components of stock analysis that you should keep an eye on:
- Durable competitive advantages: As investors looking to hold Durable competitive advantage: As investors looking to hold a business for the long term, one of our primary concerns is whether or not it will be able to maintain (and, ideally, enhance) its current market share. When doing research on possible stocks, it is essential to look for sustainable competitive advantage in the business model of the firm in question. This advantage is sometimes referred to as an economic moat. This may take on a few different guises. One example of anything that might provide a corporation with price power is a well-known and respected brand name. Patents provide a measure of protection from potential rivals. It is possible for it to have a bigger net margin than its rivals if it has a wide distribution network., one of our primary concerns is whether or not it will be able to maintain (and, ideally, enhance) its current market share. When doing Durable competitive advantages: As investors looking to hold a business for the long term, one of our primary concerns is whether or not it will be able to maintain (and, ideally, enhance) its current market share. When doing research on possible stocks, it is essential to look for sustainable competitive advantage in the business model of the firm in question. This advantage is sometimes referred to as an economic moat. This may take on a few different guises. One example of anything that might provide a corporation with price power is a well-known and respected brand name. Patents provide a measure of protection from potential rivals. It is possible for it to have a bigger net margin than its rivals if it has a wide distribution network., it is essential to look for a sustainable competitive advantage in the business model of the firm in question. This advantage is sometimes referred to as an economic moat. This may take on a few different guises. One example of anything that might provide a corporation with price power is a well-known and respected brand name. Patents provide a measure of protection from potential rivals. It is possible for it to have a bigger net margin than its rivals if it has a wide distribution network.
- Great management: If the incorrect individuals are in charge of making crucial choices for a business, it does not matter how impressive the product that the firm sells is or how rapidly the industry is expanding. In an ideal scenario, the chief executive officer (CEO) of a firm and other key executives will have a successful track record, substantial industry knowledge, and financial interests that are congruent with those of the company’s shareholders.
- Industry trends: The emphasis of investors should be on sectors that are anticipated to see healthy long-term expansion. For instance, throughout the course of the last ten years or so, the proportion of retail transactions that have taken place online has increased from less than five percent to more than eleven percent today. Therefore, one industry that is an example of one with a good development pattern is the e-commerce sector. Computing in the cloud, technological advancements in payment systems, and medical care are a few more examples of businesses that are anticipated to have considerable expansion in the years to come.
A basic example of stock analysis
Let’s take a look at a hypothetical situation, shall we? Let’s pretend that I’m looking to diversify my portfolio with a stock in the home improvement industry and that I’m torn between investing in Home Depot (NYSE: HD) and Lowe’s (NYSE: LOW).
To begin, I’d want to have a look at some of the figures. The following table compares the performance of these two firms according to some of the measures that we have been talking about:
|P/E ratio (past 12 months)||25.0||20.9|
|Projected earnings growth rate||14.4%||16.7%|
|Debt-to-EBITDA ratio (TTM)||1.46||1.73|
The most important thing to take away from these numbers is the following: According to both the price-to-earnings and the price-to-earnings-growth ratios, Lowe’s looks to be the more attractive investment option. The fact that Lowe’s has a larger debt-to-EBITDA multiple, on the other hand, suggests that it is the riskier of the two companies.
I wouldn’t argue that any of these companies has a significant edge over the other in terms of competition. It might be argued that Home Depot has a superior brand name and distribution network. However, the benefits it offers aren’t nearly as large as those offered by Lowe’s, which makes it even less likely that I’ll change my mind about investing in one of those companies. Both of the management teams have my support, and I believe that the home improvement business will continue to be one that is quite active. In addition, both of these enterprises are rather robust to economic downturns.
You are correct in your assumption that I am selecting just a few metrics to concentrate on and deriving my judgments from those numbers. The fact that there is no one method that is guaranteed to provide accurate results when researching stocks is one of the primary reasons why different investors choose various stocks.