While investing in the stock market can be a rewarding pursuit, thorough research stocks a better understanding of the companies and markets in which you are putting your money is irrevocably necessary. Whether an investor new to this area or an experienced trader, for any type of decision, the process of researching is paramount. This guide walks one through all important steps and considerations involved in effectively researching stocks.
Basic Understanding
Before delving deep into the stock research, here are some basics to be known:
What is a Stock?
The stock represents ownership in a company. With the stock you buy, you are a shareholder and entitled to a portion of the profits and assets of the company. Stocks are bought and sold on stock exchanges, while their respective prices keep changing due to demand and the performance of the company, with some common trends in the market.
Type of Stock
There are primarily two types of stocks:
- Common Stock: Common stockholders are granted voting rights and may or may not receive dividends.
- Preferred Stock: The preferred shareholders usually get preferences with regards to the payment of dividends before equity shareholders but mostly without voting rights.
Why Research Stocks is Important
It is a way of turning up opportunities and risks in front of you, comprehending the financial health of a company, and determining whether a stock has a fair value. Proper research is essential to improving one’s investment strategy and increasing the chances of achieving financial goals.
Steps to Research Stocks
1. Define Your Investment Goals:
Before researching any stocks, you need to define your investment objectives. Are you looking for long-term growth, regular income in the form of dividends, or both? A set of goals will set a foundation as regards the kind of stocks to opt for and how to assess them.
2. Gather Information
Financial News and Reports
Start by collecting all the information you can from credible financial news sources like Bloomberg, CNBC, and The Wall Street Journal. Keep an eye on market trends, economic indicators, and major events that might move the stock market.
Company Filings
Companies must file periodic reports with the Securities and Exchange Commission when their stocks are listed on a public stock exchange. Reports include:
- 10-K Annual Report: It provides an extensive overview of the company’s business and its current financial condition.
- 10-Q Quarterly Report: Quarterly updates concerning the financial performance of the company are given through this medium.
- 8-K Current Report: Filed concerning significant events shareholders should be aware of.
All such reports can be accessed through the EDGAR database of the SEC or the investor relations section on the company’s website.
3. Financial Statement Analysis
The financial statements are the most important documents to develop an understanding of the performance and financial health of a company. There exist three principal financial statements to be considered while performing analysis, which comprise an:
Income Statement
An income statement keeps information about the revenues, expenses, and profits of a company over some duration. Key metrics to consider are:
- Revenue: The total sales or income earned.
- Net Income: Profit after subtracting all expenses from revenue.
- Earnings per Share (EPS): Net income divided by the number of outstanding shares.
- Balance Sheet: The balance sheet is an overview at any point in time of a company’s financial situation. It has three components, as a snapshot, which are:
- Assets: What the company owns.
- Liabilities: What the business owes.
- Shareholders’ Equity: Residual interest in the assets after deducting liabilities.
Some of the key ratios that can be derived from Balance Sheet are as follows:
- Current Ratio: The ratio of current assets to current liabilities.
- Debt-to-Equity Ratio: The ratio of total liabilities to shareholders’ equity.
Cash Flow Statement
The cash flow statement indicates the inflows and outflows of cash in the company. It is divided into three broad areas:
- Operational Activities: Cash generated from core business activities.
- Investing Activities: Cash used for or generated from investments.
- Financing Activities: Cash raised from or paid to investors and creditors.
4. Assess Company Performance
Profitability
Compute the company’s ability to earn money. This comprises the following, among many other measures:
- Gross Profit Margin: Gross profit as a percentage of revenues.
- Operating Margin: Operating income as a percentage of revenues.
- Return on Equity: Net income as a percentage of shareholders’ equity.
Growth
Establish the potential growth of the company. Consider the following:
- Revenue Growth: Year-over-year growth in revenues.
- Earnings Growth: Year-over-year net income growth.
Valuation
Assess if the stock is appropriately valued using valuation metrics that include:
- Price-to-Earnings Ratio: The stock price divided by EPS.
- Price-to-Sales Ratio: The stock price divided by the revenue per share.
- Price-to-Book Ratio: The stock price divided by the book value per share.
5. Understand the Industry
A company’s performance is often a function of its industry. Analyze the industry to understand:
- Industry Trends: Present and future trends affecting the industry.
- Competitive Landscape: Big competitors and market share.
- Regulatory Environment: Laws and regulations affecting the industry.
6. Evaluate Management and Corporate Governance
The efficiency of a company’s management team is a very vital factor for its success. Check on the:
- Management Experience: Background and experience of key executives.
- Corporate Governance: Board structure, independence, and shareholder rights.
7. Perform a SWOT Analysis
Use the SWOT analysis to analyze the company’s position based on:
- Strengths: Internal attributes that give the firm an advantageous position.
- Weaknesses: Internal attributes that are unfavorable.
- Opportunities: Those external factors that the company can exploit.
- Threats: Those external elements that may cause damage to the company.
8. Monitor Market Sentiment
The market sentiment is the general feeling of investors towards a security. Some indicators of measuring sentiment are as follows:
- Social Media: Sites like Twitter and StockTwits.
- Sell-side Analyst Ratings: Recommendations of financial analysts.
- News Headlines: Favourable or unfavourable media coverage.
9. Technical Analysis
Technical analysis is grounded on observing price charts and trading volumes with respect to the claimed asset, estimating its future price movements. Principal techniques include the following:
- Moving Averages: The average of the prices of a certain stock for some duration of time.
- Relative Strength Index: This measures the quickness and change of price movements.
- Bollinger Bands: These are volatility bands plotted above and below some moving average.
10. Diversify Your Portfolio
Diversification assumes investment in different sectors and asset classes to minimize the risk of loss. By diversifying, you reduce the impact of poor performance from any single stock.
Tools and Resources
Financial Websites and Platforms
- Yahoo Finance: Detailed coverage of financial news, data, and analysis.
- Google Finance: Stock market data and news.
- Morningstar: Independent research into investment, and analysis.
- Bloomberg: Business-related news and data.
Stock Screeners
Stock screeners help scan through stocks according to a set of specifications. Some of the popular screeners are:
- Finviz: Several screening criteria and various visualization facilities are available.
- Zacks: It offers screeners on Zacks Rank and several other metrics.
- MarketWatch: Comprehensive, with a lot of filters.
Investment Research Firms
Consider subscribing to the research from investment firms like:
- Morningstar: Detailed research and ratings
- Zacks Investment Research: Provides stock ratings and reports
- Value Line: Detailed data and analysis for stocks, mutual funds
Conclusion
It consumes much time, effort, and attention to detail. Informed decisions about investment can increase the likelihood of reaching your set targets. Keep in mind that investing in stocks is inherently risky, and no amount of research will ever help you eliminate risk totally. However, it will help you manage these risks more effectively and improve your overall investment strategy.
Happy investing!