There are many people who are keen on investing in the stock market, but who are not necessarily confident, or comfortable about making those all-important investment decisions. No matter what level of investment, large or small, it’s important to know something about what you’re putting your money into. So, if you are an investor and are prepared to be self-reliant, then you need to think about how to research stocks and basically become your own stock analyst. This article is aimed at giving the less experienced investor a helping hand in terms of providing some useful guidance on to how to research stocks on your own.
Where Is The Information?
The first step is to begin thinking like an analyst – develop an enquiring mind. You need to find out what to buy or sell and at what price. Analysts usually focus on one particular industry or sector. If it’s a sector then they’ll focus on certain companies. An analyst’s aim is to probe into the businesses of the companies on their list. They do this by analysing financial reports and as much other available information as possible about the company. To cross-check the facts, analysts also dig into the dealings between the company and its suppliers, customers and competitors. Some analysts also visit the company, engaging with its management in order to gain a first-hand understanding of the workings of the company, and so over time they connect all the pieces of information together to get the full picture.
Before making any investment, you should do your own research. It is always better to research several stocks in the same industry so that you have a comparative analysis. However, the biggest constraint in doing your own research will probably be time. Retail investors who have many other things to do may not be able to devote as much time to research as professional analysts. However, you can surely take up just one or two firms in the beginning and test how well you can analyze them. That would help you in understanding the process and with further experience and time, you can add more stocks for analysis into your portfolio.
Can Analysts Help?
Getting your hands on anlaysts’ research reports can be a great way to start your own analysis. That way, you save a lot of time and learn much about your selected company simply by reading these reports. You may not necessarily want to follow their sell or buy recommendations, but you can get a great overview of the company, including its strengths and weaknesses, main competitors, industry outlook and future prospects. Analysts’ reports are loaded with information, and reading reports by different analysts simultaneously would help you in identifying a common thread. Opinions may differ, but basic facts in all reports are usually very common.
In addition it would be wise to take a close look at various analysts’ earnings forecasts, which ultimately determine their buy or sell recommendations. Different analysts may set different target prices for the same stock. Always look for the reasons while reading analysts’ reports. What would have been your opinion about the present stock, given the same information? No clue? Then move on to the next step.
What To Look For?
Let’s take the analysts approach in learning how to research stocks on your own. Firstly, try to understand the various steps involved in analysing a stock. Some analysts follow a “top-down” strategy, starting with an industry and then locating a well-performing company, while others take a “bottom-up” approach, starting with a particular company and then learning about the outlook for the industry. Either way is good, but try to take account to the following:
analyze the industry – there are publicly available sources of information for pretty much any industry. Often, the annual report of a company will give a good overview of the industry, along with its future growth outlook. Annual reports will often also provide information about the company’s competitors in their industry. Simultaneously reading the annual reports of two or three companies should give a clearer picture. You can also subscribe to trade magazines and websites that cater to a particular industry for monitoring the latest industry happenings;
business model – take a look at the company’s strengths and weaknesses. Is it a strong company in a weak industry, or weak company in a strong industry? The strengths of a company are often reflected in things such as its unique brand, products, customers and suppliers. You can learn about a company’s business model from its annual report, trade magazines and websites too;
financial strength – this is arguably the most important element of all when analyzing a company. You need to take a look at a company’s balance sheet, income statement and cash flow statements. Often, the numbers in the financial statements offer more information than the words in the annual report. In case you are not comfortable with numbers, no need to hesitate, just start learning as early as possible;
management – have you ever heard the expression there are no good or bad companies, only good or bad managers? Senior executives are responsible for the management and future of any company, so assess company management and board quality by doing some research on the internet;
growth outlook – it’s well-known that stock prices track earnings, the higher the earnings then, typically, the higher the stock price. Try to find out what you can about where future earnings are predicted to be. This is not too easy and analysts tend to make their own estimates by looking at past figures of sales growth and profit margins, along with profitability trends in that particular industry. It’s basically connecting what has happened in the past to what’s expected to happen in the future. Making accurate enough earnings forecasts is the ultimate test of your stock analysis capabilities, because it’s a good indication of how well you understand those industries and companies;
valuation – if you are able to establish indications about future earnings, the next step is to know about the value, or worth of a company. Analysts need to find out how much the current market price of the stocks is justified relative to the company’s value. There is no “correct” value and different analysts will use different parameters. For example, “value” investors look at intrinsic worth, whereas “growth” investors look at future earnings potential;
target price – try to establish a target price. Once you have established future earnings potential, calculate high and low target prices by multiplying estimated earnings per share (EPS) with the estimated high and low P/E Ratio. The high and low target prices represent the price band within which the future stock price is likely to move in response to the expected future earnings.
A lot of what is outlined above is really useful in showing you how to research stocks on your own. Ultimately you want to make a profit, and one of the best ways to give yourself the best chance of doing that, and avoid paying someone else to do it for you, is to do your own research. It can be fun, interesting and will certainly increase your understanding not only of the stock market more generally, but also, of those particular stocks and companies that you have an interest in.