The Fundamentals Of Stock Analysis And Why It Is Important For Investors
Stock analysis is the most crucial step every investor needs to take before making any investment. It allows investors to gain an in-depth insight into the stock market, trading instruments and even the economy of the country. The process usually involves learning about the past, present and future performance of a trading instrument and devising a strategy to select the most profitable stocks for trading. If you’re planning to invest your money in the share market, then this stock analysis guide is going to be very useful for you. Here, we will discuss the fundamentals, importance and tools for stock analysis. So, if you want to learn more, keep reading!
Investors perform stock analysis to find out the most profitable stocks.
Fundamentals of stock analysis
As discussed above, stock market analysis is the process of examining the stocks or other trading entities such as funds, indexes, etc. to check whether they are good for making an investment or not. There are mainly two types of stock analysis: fundamental stock analysis and technical stock analysis. Both types of analysis include different factors and methodologies based on which a stock is evaluated.
Let’s discuss both types of stock analysis in detail:
- Fundamental Analysis
The fundamental stock analysis process involves the evaluation of a company or stock with regard to its basic financial level. The main reason for performing this type of analysis is to determine whether or not the current price of a stock is reflecting the future worth of the company.
Fundamental analysis uses multiple factors like the current financial performance of the company to predict the price of its stock. Besides, the process also uses different metrics in order to determine the financial health of the company. Some of these metrics are as follows :
Earnings per share (EPS)
This metric is useful when you need to compare different companies operating within the same industry. The EPS of a company reflects its profitability. Therefore, a higher EPS is considered as a good sign. The higher the EPS, the better is to invest in the shares of that company.
Price to Earnings ratio (P/E)
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The Price-to-Earnings ratio shows how much traders are willing to pay for a company’s earnings. The higher P/E ratio means that the shares are overvalued. Further, it can also mean that the company is expected to perform extremely well in the near future. In contrast, a lower P/E value means that the stock/company is not favored by the market.
Price to Earnings to Growth ratio (PEG)
This metric helps investors to learn about the value of a company’s stock with regard to the growth of its earnings. When used alongside the P/E ratio, the PEG ratio can help you obtain a big picture of where a company is standing at present and how it is likely to perform in the future.
Price to Book ratio (P/B)
The price to Book ratio is used to compare the book value of a company to its market value. It uses the value that the stock market puts on a stock with respect to the book value of the same company. Note that, a financially sound company will trade for a price higher than its book value.
Return on Equity (ROE)
ROE is a measure to determine how efficiently a company uses its assets to generate earnings. A higher ROE value implies that the company makes higher profits with its assets. Therefore, investors should prefer investing in companies with a higher ROE.
Dividend Payout Ratio
Dividend Payout Ratio is used to calculate the percentage of earnings a company has paid to its shareholders. Further, the earnings that aren’t shared by the company’s stakeholders, are used to clear off the debts and for reinvestment purposes.
- Technical Analysis
The method of technical analysis involves evaluating the stock market data generated on the basis of factors such as trading volume and price. Investors following this type of stock analysis approach use multiple technical indicators like oscillators and charts to find out the patterns that can help in forecasting the price movement of the stocks.
Analysts usually examine the historical trading data of a company and predict its future movement. The technical stock analysis is based on the following assumptions:
The market knows everything
The technical analyst assumes that the market value of a stock hints towards the present and future performance of the company.
Stock Price follows a specific trend
This assumption states that once a price trend has been set up, the future price is likely to follow this trend. This kind of assumption lays the basis of many technical trading strategies.
History repeats itself
This assumption implies that the price movement tends to repeat over time. This happens due to the market psychology that causes stock prices to follow the historical direction.
Why Stock Analysis Is Important For Investors?
We have discussed what share market analysis is, and what are its types. Now, let’s discuss why it is important for the investors!
Stock analysis saves you from making poor investment decisions.
Below are the reasons for which every investor is suggested to perform stock analysis :
