Last Updated on Aug 26, 2021 by Aradhana Gotur
When you buy any product, you analyse its features, quality, worth, price of peers, and other aspects. Only when you are satisfied that you are buying the best, you make the purchase. Investing in stocks should be no different. You need to analyse different stocks on their potential to create a quality portfolio. This is where stock analysis comes into the picture. In this article, we dive into what stock analysis is and how it works.
This article covers:
- What is stock analysis?
- How does stock analysis work?
- Types of stock analysis
- Tools of stock analysis
- Benefits of stock analysis
Table of Contents
What is stock analysis?
Stock analysis is the process through which investors or analysts examine a particular stock, stocks of a particular sector, or the stock market as a whole. This analysis, then, helps investors and traders make the right trading decisions, that is, which stocks to buy and which to sell, the worth of the stock in the portfolio, and the possible levels to watch for to effect a trade in the chosen stock.
How does stock analysis work?
The workings of stock analysis is a bit technical. Investors, traders, and analysts peruse the past and current data of stocks and the market as a whole. This data is collated and arranged in decipherable charts and figures. Thereafter, the charts and statistical figures are studied to assess which stocks to buy and sell.
Types of stock analysis
There are two main types of stock analysis processes. Each of these processes is quite different from the other in terms of the data used and the parameters used for analysis. Let’s understand.
Fundamental analysis means analysing the fundamental basis of a company. If the company is fundamentally strong and stable, it is expected to reflect the same in its stock price. Moreover, a stable stock is expected to have a good profit-generating potential and the ability to weather out volatility risks. This is done by assessing the company’s financial position, its management, and micro and macroeconomic trends and their possible impact, among others.
Compared to fundamental analysis, technical analysis studies the past performance of the stock to predict future performance. Technical analysis tracks stock price movements in the past to estimate how the prices could move in the future. It is a purely mathematical and statistical calculation done using charts and numbers that helps avoid emotional decision-making.
Tools of stock analysis
Both fundamental and technical analysis tools are used for analysing stocks. Some of the main tools used for stock market analysis include the following:
Earnings per share (EPS)
It is the net profit of the company expressed per unit of its outstanding shares. Companies with a higher EPS are said to be more profitable than those with a lower value. You can, thus, compare the EPS of companies in the same sector to assess which stocks are worth buying.
Price to earnings ratio (P/E ratio)
P/E ratio is one of the most commonly used measures in stock analysis. The ratio shows how much investors are willing to invest to avail the profits earned by the company. A high P/E ratio shows either a high demand for the stock or its overvaluation. On the other hand, a low P/E ratio depicts negative market sentiments towards the stock.
Return on equity (ROE)
Return on equity measures how effectively the company uses its assets to generate a profit. A high ROE means the company generates higher profits with its assets. Thus, a high ROE is favourable for investors. This is an important tool in stock analysis that helps investors understand the value a company can add to their portfolio.Return on equity (ROE) measures how effectively a company uses its assets to generate profit. A high ROE means the company generates higher profits with its assets and thus is favourable. Click To Tweet
Dividend payout ratio
This ratio measures the proportion of the company’s profits which is distributed as dividends. A company might retain a part of its profits for internal growth, paying off liabilities, or creating a reserve. Thus, the ratio indicates the part of the profit distributed vis-a-vis the part retained.
Candlestick charts are technical analysis tools that help in assessing the market trend. They consist of a candle body and a wick, hence their name. Each candlestick tells you the opening price, closing price, highest price, and the lowest price of the stock. When the candlesticks are plotted together, they form patterns that help you determine possible times to buy or sell a stock for maximum gains or trim losses.
Benefits of stock analysis
Stock analysis has several benefits, which is why it is preferred by investors and traders alike. Here’s a look at some of its benefits:
- It helps you pick stocks that have good profit potential.
- It allows you to create a quality portfolio and get attractive returns on your investment.
- If you analyse the overall market, you can spot trends and trend reversals.
- As such, stock market analysis helps you time the market for maximising gains and minimising losses.
- Stock analysis also helps you review your portfolio so that you can reshuffle it and weed out non-performing investments.
It is important to assess each stock that you buy and this assessment is made possible with stock analysis. Therefore, analyse the stocks before you invest in them so that you pick those which have a better potential of giving you good returns on your investment. Use Tickertape’s Screener and Stock Pages to discover and analyse your favourite stocks.