Getting started as an investor is as exciting as it is intimidating. There is a lot of information and terminologies to come to grips with, along with trends you need to analyze and understand. Your prospects of succeeding as an investor will hinge on your ability to make heads or tails of this information. 

A wise man said that if you fail to plan, you plan to fail. To succeed as an investor, you need a plan, or a strategy, that will help you make a series of informed decisions. You cannot merely depend on your gut or luck. 

Stock Analysis Basics

A stock analysis attempts to decipher the future behavior of a given instrument, a financial sector, or the money markets as a whole. The attempts to decode this future activity is not guesswork—it is guided by both past and present data. The aim of attempting to establish an instrument’s future movements is to maximize the probability of purchase or sale of the instrument resulting in a gain. 

Also, read 8 Major Challenges in the Growth of the Indian Capital Market

But the key to making an investment that brings in good returns is to take time to analyze the available data closely. There are two types of analysis you’ll want to engage in, fundamental analysis and technical analysis.

Fundamental Analysis

In this form of analysis, analysts use information about an entity’s financial performance over time to establish its present and future financial status. Based on this, they decide whether it is a good idea to invest in its stock. 

This information can be gleaned from the company’s financial records, which are periodically released into the public domain to show its performance over a year, half, or quarter of a year. It will indicate how profitable the entity is and whether it will be able to pay its short and long-term debt.

Technical Analysis

In this form of analysis, you will rely on past and current price movements to try and predict how the value of a stock unit will move in the future. Besides price, analysts using this method will use parameters such as the volumes of units being traded and demand and supply factors to assess market activity. Technical analysts will usually be guided by charts depicting a particular instrument’s price trends over a given time.    

Useful Investment Metrics

For both forms of analysis to be beneficial, there are some key metrics you need to establish. This will help you determine how one stock measures up to another in the same category. It will also give you a clear idea of the value of that unit. Here are some ratios and why they will be useful to your analysis:

• Profit Margin Ratio– This metric establishes the ratio of a company’s profits to its total revenues. It is a good way of determining how well a company is handling its revenue.

• Price-to-earnings Ratio– This is the most commonly used metric by analysts using the fundamental analysis method to gauge a trading company’s financial health. It measures how the company’s earnings in a given period compared to its share price in the same period.

• Price-to-book Ratio– The book value is the net value of all a company’s assets. When you compare this to the company’s current stock price, you get the price-to-book ratio. Having this information about a company will be necessary to those who engage in fundamental analysis intending to invest. This is the strategy favored by stock market rock stars like Warren Buffet.

• Debt-to-equity Ratio– Analysts use this metric to gauge a company’s financial health by looking at the amount of debt it has vis-a-vis its revenue. You can derive the entity’s total debt by looking at its balance sheet, and its revenue can be retrieved from its most recently published financial statements.

• Free Cash Flow– Free cash flow, or FCF, refers to the revenue earned by a company after factoring out operational expenses paid in cash. It differs from profit in that it only factors in expenses paid for in cash, not those for which money is owed to suppliers. It also includes money spent on acquiring assets. FCF is, essentially, the money available to pay out dividends and interest to shareholders as well as settle any debts.

• Price/Earnings-to-Growth Ratio– This metric offers an effective means of determining if an entity’s stock is overvalued or undervalued.

• Dividend Payout Ratio– This is another vital tool used in fundamental analysis. It seeks to establish the ratio of the amount paid out as dividends to a company’s shareholders against its total profits. 

Research Tools and Resources

If keeping tabs on all these parameters is a bit too much for you, you can get help from professionals who do this for a living. Investment research companies collate up-to-date financial data from multiple sources and present it to you to help you capitalize on stock market trends and make sound investment decisions.  

Below are some of the resources they use:

• Company’s financial documents, including Form 10-K and Form 10-Q.
• Information on how a company makes its money and what sets it apart from its competitors.
• Company’s historical revenue and profit data.

If you prefer to manage your investments, you can use a stock screener to identify stocks that have good fundamentals, based on the criteria listed above.

Do Your Homework

Making your first personal investment shows that you’re serious about securing your financial future. But with so many potential avenues of investment, you may be overwhelmed and end up making a poor decision based on misleading information. Make sure you put any potential stock under the microscope before you take the leap, and it never hurts to get an expert opinion.