When we have a health issue, we visit the doctor. If our computer malfunctions, we contact a technician. Practically, for anything about which we lack knowledge, we seek professional assistance. The same holds true when selecting stocks to invest in. There are trained advisors, analysts, and other experts whose jobs are to help people make the best choices for their investments.
However, there are some, such as the famed investor Warren Buffett, who became one of the wealthiest people in the world by conducting extensive research on the firms he wanted to invest in. He has stated that he enjoys the process of creating investments, i.e., that this is the work he loves to do.
If you also want to pick stocks based on some prior knowledge about them and to be a self-reliant investor, then you should consider becoming your own analyst and do your own stock research.
The first step in thinking like an analyst
The first step in thinking like an analyst, whether you are a growth or value investor, is to cultivate a probing mind. You must decide whether to purchase or sell anything, and at what price. Analysts usually focus on a single industry or area. They focus on a few companies in the industry. An analyst’s purpose is to extensively study the activities of each firm on their list. They do it by going over the company’s financial statements as well as any other available information.
You should do your own research, as well, before putting money into anything. It is always best to look into more than one stock in the same industry so you can compare them. Most of the time, it’s not hard to get information. The most important thing you need is time to become your own stock analyst.
Retail investors may not be able to spend as much time as professional security analysts because they have other things to do. But you can definitely start with just one or two companies to see how well you can analyze them. That would help you figure out how things work. With more time and experience, you might want to look at more stocks.
Two primary methods of analyzing stocks
Fundamental analysis and technical analysis are the two most common ways to look into stocks and decide what to do with your money.
Fundamental analysis seeks to find stocks with high growth potential at a reasonable price by studying the underlying company’s operations as well as situations in its sector or the larger economy. Investors usually use fundamental research for longer-term trades. This research looks at things like earnings per share, price-to-earnings ratio, price-to-earnings growth, and dividend yield.
Technical analysis, on the other hand, ignores the fundamentals of the underlying firm in favor of looking for statistical patterns on stock charts that may predict future price and volume movements. The theory is that stock prices already represent all publicly accessible information about a firm, so there’s no need to go through a balance sheet. In the past, traders used technical analysis for short-term trades because it focused on how prices and volumes changed.
In technical analysis, the first step is to look at charts. In fundamental analysis, the first step is to look at the company’s financial statements.
Fundamental vs. technical analysis
In fundamental analysis, you must examine a company’s income statement, balance sheet, and cash flow statement to establish its intrinsic worth. A stock’s intrinsic value may be estimated by discounting its predicted future cash flows to their net present value. You can invest in the stock if it trades below the company’s intrinsic value. Technical analysts, on the other hand, say that the price of a stock already reflects all of the things that have or could affect a company.
In contrast to the short-term perspective of technical analysis, fundamental analysis frequently has a long-term viewpoint. According to fundamental research, it will take a long time for the stock market to reflect a company’s true worth. Stock charts in technical analysis might be bounded by weeks, days, or even minutes.
Technical analysts and fundamental analysts have widely distinct objectives. Technical analysis requires you to find several profitable short- to medium-term trades, but fundamental analysis requires you to make long-term investments.
Three more important pieces of advice
And remember the great investors’ piece of advice: it is far more essential to invest in a good firm than a cheap stock.
With that in mind, here are three more important aspects of stock analysis to keep an eye on:
Long-term competitive advantages
As long-term investors, we want to know that a firm will be able to maintain (and preferably enhance) its market share over time. When researching potential companies, it’s critical to look for a long-term competitive advantage, also known as an economic moat, in the company’s business strategy. This can show up in many different ways. A trusted brand name, for example, might provide a corporation with pricing power. Patents can shield it from competition. Its broad distribution network may allow it to have a better net margin than competitors.
Excellent leadership
It makes no difference how wonderful a company’s product is or how much growth an industry is seeing if the wrong individuals are making important choices. Ideally, a company’s CEO and other key executives would have successful and significant business expertise as well as financial interests that correspond with shareholder interests.
Industry trends
Investors should concentrate their efforts on industries with promising long-term development potential. For example, during the last decade or so, the proportion of retail transactions conducted online has increased from less than 5% to more than 12% today. As a result, e-commerce is an example of a growing sector. Other businesses that are expected to develop considerably in the next few years include cloud computing, payments technology, and healthcare.
