Stock Analysis Basics

Before you invest in stocks, it’s sensible to do some research. The aim of stock research is to determine which stocks are worth buying and which stocks should be avoided.

There are two main forms of stock research.

Fundamental analysis

The first is what’s known as fundamental analysis. Fundamental analysis involves looking at all available information in relation to a company, including its financial performance, its financial strength, and the threat of competitors, to determine whether a stock is undervalued or overvalued.

In this form of analysis, investors analyse financial data and often use financial ratios to work out if a stock is worth buying.

Three popular ratios used in fundamental analysis

• Price-to-earnings (P/E) ratio:

This is the ratio of a company’s share price to its earnings per share.

The P/E ratio is useful because it can be used to compare the valuations of different stocks.

• Dividend yield:

This is the ratio of a company’s dividend per share to its share price.

It’s often expressed as a percentage. Dividend yield is useful because it enables an investor to compare the dividends offered by different companies.

• Return on equity (ROE):

This is the ratio of a company’s net income to the amount of equity (assets minus debt) on its balance sheet.

ROE is a measure of how profitable a company is.

Technical analysis

The second form of analysis is known as technical analysis.

In this type of analysis, investors examine stock charts and analyse trends, patterns, and indicators in an effort to predict a stock’s future movements.

Those who use technical analysis believe that historical price movements can be used to predict future price movements.

Three popular technical analysis strategies

• Trend trading:

This strategy aims to generate profits by analysing a stock’s trend.

A trend occurs when a stock moves in one direction for a long period of time. Once you have identified the trend, it may be possible to profit from it by trading in the same direction as the trend.

• Support and resistance trading:

This strategy aims to generate profits by identifying a stock’s support and resistance levels.

Support is the level on the chart where the stock’s price finds it difficult to fall below.

Resistance is the level where the stock’s price finds it difficult to go above.

Once these areas have been identified, it may be possible to profit by placing trades at the area where the stock’s price is likely to reverse.

• Breakout trading:

This strategy aims to generate profits by identifying stocks that have broken through established support or resistance levels.

Breakouts can be strong signals, especially when confirmed by other technical analysis indicators.

Fundamental analysis and technical analysis both have their advantages and disadvantages. For this reason, many investors use a combination of both when making investment decisions.
Reprinted from eToro, the copyright all reserved by the original author.