Wealthsimple provides an easy-to-learn primer on how to analyze stocks
Wealthsimple | February 24, 2020 | SmallCapPower: There are basically two ways to analyze stocks. These are fundamental analysis and technical analysis.
In fundamental stock market analysis, you use concrete data about a company to calculate the true value of its stock. You’re looking at the company’s financial health across a broad spectrum. In contrast, technical analysis factors in how the market impacts a stock price. Both are great ways to evaluate investment opportunities.
Many people choose fundamental analysis because it focuses in on the company itself. However, the market has such an important impact on the stock price that it’s important to pay attention to those elements as well.
Technical Analysis
To conduct a technical stock market analysis, check the supply and demand on the market. This technique emphasizes the stock’s historical performance and bases projections of future performance on it. The true value of the company is largely ignored. Instead, there’s a heavy concentration on stock trends and charts.
Price-to-Earnings Ratio
You can also compare the price-to-earnings of the stock you’re analyzing. Calculate P/E by taking the share price and dividing it by the earnings per share. Compare this to other stocks to determine if one is a good value. Lower P/E stocks often make great investments as they may represent undervalued stock.
Earnings Per Share
Earnings per share represent the revenue flowing through to investors. The higher the EPS, the more confident investors feel in the stock. According to NASDAQ, a higher EPS increases the number of shares you’re worth.
PEG Ratio
Price-to-earnings growth metrics add growth projections to the P/E. To calculate PEG, divide the price-to-earnings ratio by the company growth rate for the last 12 months. Future growth is estimated based on historical growth. A stock with a PEG lower than 1 is considered valuable.
Book Value
The price-to-book ratio is a way for investors to detect undervalued, high-growth companies. To calculate P/B ratios, take the market price and divided it by the book value of equity. To get the book value of equity, you subtract liabilities from assets. Low P/ B means a stock could be undervalued.
Return on Equity
Investors using ROE divide net income by the typical shareholder’s equity. A trend of growing ROE indicates the company does a good job producing returns for shareholders. Use this metric to determine companies that generate profit.
What About Professional Analysts?
Investors analyze stocks and rely on professional analysts to help them choose which stocks to buy. Analysts perform both technical and fundamental analysis to reach their conclusions, resulting in sell or buy recommendations for different companies. Some investors use professional analysis and investigate the company’s historical performance before buying.
Stock Analysis Mistakes
If you don’t understand a company, it may be best to not invest in its stock. Taking the time to get to know companies that you wish to buy stock from gives you added insight when it comes time to sell it. It also makes it easier to understand when rapid growth may be slowing down.
Keep an eye on revenue trends. Earnings growth is essential to a healthy company with a valuable stock. If profits aren’t on the rise, there’s little chance that your stock value will go up. That’s why it’s so important to look at sales growth as well as earnings. Companies only continue to grow by increasing sales or cutting costs. Expanding sales is the most viable way to continue increasing profits.
Exercise Caution
Remember that there are pros and cons to every investment. Use caution when accepting advice from friends and professionals alike. Whether you take advantage of an opportunity also depends on your risk tolerance. If you are willing to lose a little more money, your profit will be greater if things work out. Just ensure that you are also prepared for the opposite.
Retirement Funds
Retirement funds are another option for self-directed investors that enjoy investing in the market. Roth IRA funds in the United States and Tax-Free Savings Accounts (TFSAs) in Canada. These “savings” accounts can include stocks, bonds, investment certificates, exchange-traded funds and cash. You already paid taxes on the money you invest, so you don’t pay taxes when you withdraw money.
Keep in mind that, no matter how careful you are, stocks go up and down in value. Exercise caution when dealing with stocks and other investment assets that make up your retirement fund.
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