What is Stock Research?
Stock research is a technique for evaluating equities based on aspects including the company’s finances, management, and competitors. Stock analysis aids investors in assessing a stock and determining whether it merits inclusion in their portfolio.
4 steps to research stocks
Before we get started, it’s important to keep in mind that stocks are long-term investments because they are quite risky; you need time to ride out any ups and downs and reap the rewards of long-term gains. For money you won’t need for at least the next five years, investing in equities is the greatest option.
1. Gather your stock research materials
Start by going over the business’s finances. Gathering the following documents, which businesses must submit to the U.S. Securities and Exchange Commission (SEC), is the first step in quantitative research.
- An annual report that includes significant financial statements that have undergone an independent audit is known as a Form 10-K. You can look at a company’s balance sheet, income sources, cash management practices, revenues, and expenses here.
- Form 10-Q: A quarterly report on business and financial performance.
2. Narrow your focus
There are many figures in these financial reports, making it simple to become overwhelmed. Focus on the following line items to learn about a company’s measurable internal operations:
Revenue:This is the total revenue a business generated throughout the time period. Because it appears first on the revenue statement, it is frequently referred to as the “top line.” Revenue can occasionally be divided into “operating revenue” and “nonoperating revenue.” The company’s operating revenue, which comes from its main line of activity, is the most revealing. Non-operating revenue is frequently generated by one-time company operations, such selling an asset.
Net income:The amount a firm makes overall after operating costs, taxes, and depreciation are removed from revenue is known as the “bottom line” amount since it is presented at the end of the income statement. Revenue is the same as your gross pay, and net income is the amount that is left over after covering your living expenditures and taxes.
Earnings and earnings per share (EPS):Earnings per share is calculated by dividing earnings by the total number of shares that are available for trading. This figure illustrates a company’s profitability on a per-share basis, making comparisons with other businesses simpler. If you see “(ttm)” after earnings per share, that stands for “trailing twelve months.”
Earnings are far from being an ideal financial metric because they do not reveal how effectively or how the company uses its cash. Some businesses use those profits to boost their operations. Others distribute them as dividends to shareholders.
Price-earnings ratio (P/E):The trailing P/E ratio of a corporation is calculated by dividing its current stock price by its earnings per share, which are typically over the last 12 months. The future P/E is calculated by dividing the company price by the expected earnings predicted by Wall Street analysts. This indicator of a stock’s value reveals how much investors are ready to spend to receive $1 in current earnings from the company.
Remember that the P/E ratio is derived from the potentially inaccurate calculation of earnings per share, and that analyst predictions are notoriously short-term oriented. As a result, it is not a valid stand-alone metric.
Return on equity (ROE) and return on assets (ROA):
Return on equity quantifies, in percentage terms, how much profit a business makes off each dollar invested by shareholders. Shareholder equity makes up the equity. Return on assets demonstrates how much profit a corporation makes for every dollar invested in assets. Each is calculated by dividing the annual net income of a corporation by one of those variables. These percentages also provide information about how effectively the business generates profits.
Again, watch out for gotchas. By repurchasing shares to lower the shareholder equity denominator, a business can raise return on equity artificially. The number of assets used to compute return on assets grows as more debt is taken on, such as loans to finance property purchases or to increase inventory.
3. Turn to qualitative stock research
Qualitative stock research offers the technicolor details that give you a more accurate image of a company’s operations and future, whereas quantitative stock research discloses the black-and-white financials of a company’s tale.
The famous quote from Warren Buffett goes, “Buy into a company because you want to own it, not because you want the stock to go up.” This is due to the fact that when you buy stocks, you buy a personal investment in a company.
You can use the following queries to assist you weed out possible business partners:
How does the business generate revenue? When it comes to a retailer whose primary activity is selling clothing, it can be quite clear. Sometimes it’s not, as in the case of a fast-food chain that makes the majority of its money through franchising deals or an electronics company that depends on consumer financing for expansion. Investing in firms that make sense and that you actually understand is a sound strategy that has worked well for Buffett.
Is there a competitive edge for this business? Look for a quality in the company that makes it challenging to duplicate, match, or surpass. This could be, among other things, its reputation, commercial strategy, capacity for innovation, research prowess, ownership of patents, operational competence, or superior distribution capacities. The strength of the competitive advantage increases with the difficulty of competitors breaching the company’s moat.
How effective is the management group? The ability of a company’s leaders to set direction and guide the business determines how successful it will be. Reading the transcripts of business conference calls and annual reports can reveal a lot about management. Do some study on the board of directors of the business, who sit in the boardroom as the shareholders’ representatives. Be aware of boards that are primarily made up of business insiders. You want to see a good mix of independent thinkers who can evaluate management’s activities with objectivity.
What might possibly fail? We’re not discussing events that can have a short-term impact on the stock price of the company, but rather fundamental shifts that have a long-term impact on a company’s capacity for expansion. Use hypothetical “what if” situations to spot potential red flags: A significant patent expires, the CEO’s replacement steers the company in a different path, a strong rival enters the market, or new technology displaces the company’s goods or services.
4. Put your stock research into context
As you can see, there are several measurements and ratios that investors may use to determine a company’s intrinsic worth and evaluate its overall financial health. However, focusing only on a company’s earnings from a single year or the most recent actions made by the management team would only provide you a partial view.
Build an informed narrative about the company and what characteristics make it deserving of a long-term relationship before you purchase any stock. Context is essential for doing it.
Pull back the scope of your investigation and examine previous data to gain a long-term perspective. You can learn more about the company’s ability to overcome obstacles, adapt to changing circumstances, and enhance performance over time by doing this.
Then, by comparing the figures and key ratios to industry averages and other businesses in the same or similar industries, consider how the company fits into the overall picture. On their websites, several brokers provide research resources. Using the educational resources provided by your broker, such as a stock screener, is the simplest way to make these comparisons.
Conclusion
A company’s performance can be compared to that of its competitors in its industry as well as to itself over the course of several years by gathering the right information from the right websites, looking at some key numbers, and asking some crucial questions.
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