What Is Stock Analysis?

What Is Stock Analysis?

Let me explain stock analysis directly: it's the evaluation of a particular trading instrument, an investment sector, or the market as a whole. As someone analyzing stocks, I attempt to determine the future activity of an instrument, sector, or market to guide your investment choices.

Key Takeaways

You should know that stock analysis is the practice of using information and analyzing data to make investment decisions. One popular form is fundamental analysis, where I use financial activity to forecast stock prices. Another is technical analysis, relying on historical stock price activity to predict future movements. There are also less common forms like sentiment analysis and quantitative analysis. Remember, investors often deal with unpredictable or limited information, which makes stock analysis challenging.

Understanding Stock Analysis

Stock analysis is a method you and I use as investors and traders to make buying and selling decisions. By studying and evaluating past and current data, we attempt to gain an edge in the markets through informed choices.

The core idea behind stock analysis is that available market information can help determine a stock's intrinsic value. In the main methods I'll discuss, you use financial statements, stock price movements, market indicators, or industry trends to decide on investments.

This strategy often leverages historical information. For example, I might analyze a company's stock based on its financial performance, looking at how similar companies performed in the past to estimate a fair price.

There are two basic types: fundamental analysis and technical analysis. I'll cover each in more depth below.

Fundamental Analysis

Fundamental analysis focuses on data from sources like financial records, economic reports, company assets, and market share. To conduct this on a public company or sector, you and I typically analyze metrics from the company’s financial statements – the balance sheet, income statement, cash flow statement, and footnotes.

These statements come out publicly via 10-Q or 10-K reports in the SEC's EDGAR database. We also look at earnings reports from quarterly press releases to see revenue, expenses, and profits.

Fundamental Analysis and Ratios

When I run stock analysis on financial statements, I'm checking for profitability, liquidity, solvency, efficiency, growth trajectory, and leverage. Different ratios help determine a company's health.

For instance, the current ratio and quick ratio estimate if a company can pay short-term liabilities with current assets. You calculate the current ratio by dividing current assets by current liabilities from the balance sheet. A ratio under 1 might indicate poor financial health, meaning the company could struggle with short-term debts.

On the balance sheet, I might also check debt levels using the debt ratio, which is total liabilities divided by total assets. A ratio over 1 means more debt than assets, and with high leverage, rising interest rates could push the company toward default.

Fundamental Analysis and Comparative Information

Stock analysis involves comparing a company’s current financials to previous years to see if it's growing, stable, or deteriorating. You can also compare it to other companies in the same industry.

For example, I might compare operating profit margins of two competitors from their income statements. This margin shows revenue left after operating expenses, calculated as operating income divided by revenue.

A company with a 0.30 margin looks better than one with 0.03, meaning it has 30 cents left per dollar of revenue after costs, using 70 cents for operating expenses.

Technical Analysis

The second method is technical analysis, which studies past and present price action to predict future movements. As technical analysts, we look at the financial market overall, focusing on price, volume, and supply-demand factors.

Charts are key tools here, showing a stock’s trend over time. For example, I might mark support levels at previous lows below the current price and resistance at previous highs above it. A break below support signals a bearish trend, while above resistance indicates bullish.

Technical Analysis and Comparability

Technical analysis works only when supply and demand influence the price trend. If outside factors interfere, it may not succeed. Like other analyses, it gets complicated with more variables.

Factors beyond supply and demand include stock splits, mergers, dividends, lawsuits, CEO deaths, terrorist attacks, scandals, management changes, or policy shifts – events that are hard to predict.

Other Forms of Stock Analysis

Beyond fundamental and technical, you can use less formal methods. With social media's role, I can perform sentiment analysis by checking public perception on news and social platforms.

Quantitative analysis uses complex calculations for price projections, relying on mathematical models to spot general trends from past data, not just stock prices.

Analysts might do top-down analysis, starting from the economy and narrowing to a company, or bottom-up, starting with companies and then the broader economy. Both help understand market conditions impacting prices.

Limitations of Stock Analysis

Many investors rely on stock analysis for strategies, but it can lead to overconfidence or errors.

It's often based on limited information because companies don't disclose everything, and it projects the future where data isn't available.

Uncertainty is high since markets can change rapidly from conditions like political shifts, impacting investments unpredictably.

There's risk of bias; if data isn't anonymous, we might favor outcomes based on what we know. Confirmation bias can steer decisions to match desires.

Finally, stock analysis is complex, time-consuming, and requires ongoing evaluation as variables change daily.

Which Stock Analysis Technique Is Best?

You might be best using fundamental, technical, and quantitative analysis together, as no single technique is always superior. It depends on available information and your objectives, like analyzing finances, industry research, or financial models.

How Do You Know If a Stock's Price Will Go Up?

Nobody truly knows if a stock's price will rise or fall, but you can use information to make strategic decisions. Generally, if a stock's fair value is below its current price, it might drop; if higher, it could rise.

How Can Beginners Start Analyzing Stocks?

Starting doesn't have to be hard. Gather public info like news articles and recent financial statements. Filter to the most relevant, use industry averages or competitor data for benchmarks, and decide if the company is outperforming or underperforming relative to prices and activity.

How Do I Research Stocks Before Buying Them?

As an investor, collect broad info: government filings, news, press releases, social media activity, and financial statements. Also, check other analysts' opinions to form your view on future price movement.

The Bottom Line

You can use fundamental and technical analysis independently or together. Some stick to one, but either way, stock analysis is crucial for vetting stocks, sectors, and markets to build your best investment strategy.