How to start analysing a stock

13 August 2020 | Posted by Hannah Duncan
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Why should you care?

Analysing a share in a business, also known as a “stock”, can help you to figure out whether or not it’s a good investment. Knowing what to look for, and where to find it, can help you in your decision-making process.

Remember, when investing your capital is at risk and you may recover less than the original investment amount.

What will you learn?

The tools and methods you can use to analyse a stock and what to look out for.

There’s no set formula for researching stocks, but there are tools you can use to make an informed decision. If you’re passionate about an industry or company and think you’d like to invest, here are some general tips to get you started.

Give yourself time

Jumping on “hot stocks” without taking time to research them is not an investment strategy.

Before you begin, make sure you’re free to dedicate some serious ongoing time to study your stock. It is typically stated to stick with your investments for at least five years, however, this is dependent on your investments so always keep a lookout for what’s going on.

In the infamous words of Warren Buffet, “If you are not willing to own a stock for ten years, don’t even think about owning it for ten minutes”.

Research the industry of the stocks

You could begin your process by looking at the industry and then filtering your way down to the stock you like, known as the Top/Down approach.

Or you could start with the stock and work upwards, following the Bottom/Up method.

Either way, researching the industry is essential. Whether it’s tech, energy, health, or something else, really dig deep and get a feel for where it’s headed now and in the future.

Often the Annual Reports of dominant companies will have some pages about this – try reading a few to get a general view. You can usually find these on the company’s corporate website.

Stay up to date with the latest news and magazines, following how world events and policies might impact the sector

Many trading platforms and market data sites offer a kind of filtering platform, known as a stock screener. If you’ve ever used an app like Skyscanner or Zoopla, you’ll know what we mean. It’s basically an online tool where you can narrow down what you’re looking for in a stock. This handy screener could be useful as you explore your options!

Explore the business model

You probably have a few companies in mind, or perhaps you want to focus on your favourite.

Start with brand identity, products, and competitors. This means going beyond the marketing and pouring over the Annual Report in detail.

Look at the types of customers they appeal to, and why. If you think that this group of customers are likely to continue growing, that could be a good sign.

See what news comes up about the company. All news, good and bad, needs to be uncovered. Try to be as objective as possible when doing this.

A good reference point is usually the “Notes” section of an Annual report. This is normally where you can get a good flavour of what is currently happening with the company, and what lies ahead for it and the industry. 

Get to know the management team

Do you have faith in the people running the company? Have they bought shares themselves, and do they use their own products? Is the stock a subsidiary of a larger parent company, and would that influence it’s autonomy? Research the management team and make a note of new appointments to get a feel for the priorities and direction of the board.

See what other analysts think

No, it’s not cheating! It’s likely that an experienced investment analyst or two has beaten you to it and researched the stock you’re interested in. Take full advantage of that by reading what they have to say and look closely at their valuations.

Often professional investment teams have sophisticated equipment which helps them track and calculate the value of a stock. Benefit as much as you can from the information that they’re sharing. Ideally, read as many as possible. See if you agree with their reasoning and conclusions. 

Tracking down analysts’ reports can be tricky, especially if you’re not spending money. It depends a lot on the stock, but some good starting places are financial data and commentary sites such as Zacks, MarketWatch, MorningStar or Seeking Alpha. Often investment houses and banks will publish their analysis for blue chip stocks as well.

Dig into the financials of stocks

Spend time understanding the company’s most updated financial statements. These include the: 

  • Balance sheet: This is a summary of a company’s financial position at a point in time. It will list the assets, liabilities, and shareholders’ ownership.
  • Income statement: This document reports how much money a company is bringing in.
  • Cash flow statement: This document records the cash which flows in an out of a company as it makes and spends money.

Look at the company valuations

One of the most popular formulas is the Price to Earnings (P/E) Ratio. This measures how much the share costs compared to how much income it brings in. The formula is quite simple: 

P / E Ratio =

Market value per share

Earnings per share

There are two types of P/E ratio. One looks over the past performance, known as a Trailing P/E ratio. You can usually find this on financial data sites, often you’ll see the ratio over the past twelve months, but it can be more.

A forward-looking ratio, known as the Forward P/E ratio, is obviously impossible to conclude. However, the company will often give it a good go, and present their projected Forward P/E ratio in their Annual Report. 

Other useful measurements include the price to earnings ratio, debt & earnings ratio, free cash flow ratio and price-to-book ratio. All of these valuations can be useful in your analysis. You could compare them to an industry benchmark, such as an index, to get an idea for how your stock is performing.

You could also go back over the past earnings, to see if your stock is doing better over time. Please remember that past performance is not a guarantee of future results and the value of stocks, like any other investment, can go down as well as up.

Keep researching

There are many more things you can cover, and every analyst is different. Some have become famous for creating their own methods of stock picking. However you develop your style, remember to give yourself lots of time and don’t panic if you find that you’re rejecting more stocks than you select. While you search for your dream stocks, it could be a good idea to stay diversified with a strong selection of investments.

While this article is intended to provide general tips, it is not advice.

Key takeaways

  • Analysing stocks takes time and commitment.
  • Researching the industry is essential – pay special attention to world events which could impact the sector in the coming years and decades.
  • Look at how other analysts have judged the stock. You may not agree with their findings, but it’s important to research a variety of opinions where possible.
  • You can get a lot of information from a company’s Annual Report and financial documents
  • No matter how good your stock is, it’s nearly always a good idea to spread your risk by investing in a diversified portfolio.

When investing, your capital is at risk.

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