How to analyze a stock – the ultimate guide
Whether you’re an experienced investor or completely new to the field of investing, the most important thing to know is how to analyze a stock.
That’s why we at Equito have decided to put together the most comprehensive guide on the topic, covering as many relevant aspects of stock analysis as possible, without limiting ourselves to just one technique.
With this guide you can choose, based on your character, your investing style and analytical strengths (numbers, charts, macro trends, …), along with which data points to consider and when.
In other words, this guide can help you build your own effective system for analyzing and picking the winning stocks. And if you already have your own system, we’re sure you’ll find many ideas on how to improve it.
So, here’s how to analyze a stock like a professional investor.
The best data sources for stock analysis
An important leg up in investing is having an informational advantage over others. An informational advantage is about having the right data, at the right time, from the right source and, of course, having that data be accurate. Thus, the first step when analyzing a stock is always to collect the relevant data.
An informational advantage is not decisive in itself, since the data you’re using when you’re not a professional investor is publicly accessible to everyone else as well.
Thus, the informational advantage is more about choosing the right combination of datapoints and putting them in the right context to make the best investing decisions. At the end of the day, you have little chance of succeeding as an investor if you don’t have data infrastructure at least as good as other investors, as well as a system for how to process the data and act on it.
There are five different types of data to consider when analyzing a stock:
- Qualitative fundamentals – Know the company
- Quantitative fundamentals – The company’s financials
- Valuation and investment attractiveness – Valuation metrics
- Market sentiment and news
- Technical analysis – Stock chart with signals
Several sites such as investing.com aggregate many different types of data and we recommend using them. Nevertheless, you usually have to browse through several different sources to get the whole picture regarding a specific company.
Picking a winning stock is not an easy job and takes some analytical effort. Here are the recommended data sources for each category of data to help you analyze a stock as comprehensively as possible:
|Data category||Where to find the data?||Recommended websites|
|Knowing the company||Annual reports Quarterly reports Company website Industry reports||EDGAR – SEC filings |
Investing’s earnings calendar
Fidelity Q Sector report
|Financials||Balance sheet Profit & loss statement Cashflows||Investing.com |
|Valuation||Financial ratios and statistics||Uncle Stock |
|Market sentiment and news||Financial news sites||Investing.com |
|Stock chart and signals||Financial visualization platforms||Trading view Tradingeconomics|
For additional help, we’ve also prepared a huge list of websites for investors (100+ sites), where you can find all the additional resources you need, if the sites listed above aren’t enough.
An additional tip: Besides researching recommended sites for investors, we also advise that you gather niche intelligence by entering the relevant keywords in a search engine. Examples of such keyword searches are:
- [industry] trends report
- [company] stock analysis report
- [company] stock news
- [company] main competitors, etc.
Never limit yourself exclusively to data that is easily accessible to all investors. If your goal is really to outperform the market, you have to put some additional effort into researching a particular stock.
Now that we know where and how to gather data, let’s look at how to analyze each of the data categories.
Qualitative fundamentals – Know the company
One of Warren Buffet’s famous quotes is: “Never invest in a business you cannot understand”. A big investment risk comes from not knowing exactly what you’re doing.
This can be true for the different classes of assets (stocks, bonds, options…), as well as not studying specific industries or individual companies enough, prior to making an investment decision.
Yes, you might get lucky from time to time by investing in something you have no clue about, but in the long run to be a successful investor you have to constantly study new trends, specific industries, businesses, their annual reports, and their competitors.
These habits have many additional benefits, also. Most investors state that they have become much better businessmen in general after studying different businesses and investment strategies.
“Other guys read Playboy. I read annual reports.” Warren Buffet
Thus, the first step we recommend when analyzing a stock is to get to know the company, at least to a certain extent. The best way to do so is to read their annual and quarterly reports, their industry and competition reports, interviews with their CEO and board members, and so on.
When you buy a stock, you become a shareholder of that company. You own part of the business. It’s only logical to know and understand what you own.
If you are a regular customer of the businesses you tend to invest in, that’s even better. Using the product is one of the best ways of understanding what a company does. That’s why at Equito we offer a special kind of crowdfunding service called “customer crowdfunding”, where businesses raise money directly from their customers.
Here are all the datapoints to consider when doing a qualitative fundamental analysis:
1. The business model and products
The most fundamental qualitative data concerns the company’s product portfolio and their business model, namely what the company is selling and how they are making money.
You should analyze which products are their cash cows, which are their rising stars, which of the products are declining and what kind of innovations are planned for the future (for more information on analyzing a company’s product portfolio, refer to BCG Matrix).
You can also study their geographical expansion plans and similar topics. An important question in this regard is also how the company’s products are better than those of the competition. Each company you invest in should have some kind of a competitive advantage and something that differentiates them on the market.
2. Would you buy the product?
If the company you plan to invest in is offering a consumer product, it’s smart to ask yourself whether you would buy and use their product. For example, if you’re considering buying shares in Coca-Cola, ask yourself if you are a fan of their beverages or would rather drink a Pepsi.
It’s not always a relevant question (since there are many great businesses whose products you might not even like), but there’s no better feeling than owning shares in a company whose products you enjoy using.
One of the most successful investors, Peter Lynch, who averaged 29% per year between 1977 and 1990 (double the S&P500 return), suggests that investors should always “invest in what they know”.
3. A competitive advantage
The next important question is what the company’s competitive advantage is. Do they own intellectual property or enjoy first-mover advantage, marketing/branding superiority, or maybe cost-based or technology-based dominance?
Winning on the market is all about having a distinct advantage against the competition. An unfair advantage. As an investor, you invest in the future potential of a business, which means that there must be a clear long-term competitive advantage.
4. Future growth plans
A competitive advantage is rarely enough on its own; management must also have a clear vision of how they will exploit this advantage. A good strategy is to apply the greatest strengths of a company to the biggest opportunities.
That’s what the future growth plans of a company should be based on. Since you are investing in the company’s future growth (and the growth of earnings for that matter), understanding the management’s vision and strategy can be extremely helpful prior to making an investment decision.
5. Weaknesses and threats
Every company deals with at least a few weaknesses and threats. Weaknesses are the internal shortcomings of a company, while threats refer to outside factors such as market changes, new competitors, new disruptive technologies, and substitute products.
An important part of the company’s strategy should be to overcome weaknesses and to avoid threats; or, even better, to turn the latter into opportunities.
As an investor, it’s beneficial to understand the cons of the company, and if it turns out the current strategy is not working to overcome them, to react before the company suffers greater losses and investors start dumping shares en masse.
6. CEO and Management (Board)
An important factor in how successful a company will be in the future is, of course, the management board itself, with the CEO at the top.
It’s not easy to analyze the quality of the management (since having firsthand experience with people is the best basis for those kinds of judgments), but there are some general rules to consider (and three different aspects to analyze) when it comes to the management of the company you plan to invest in:
Does the board have enough experience?
A board with a good track record usually means the company is in safe hands. That doesn’t mean new leaders with fresh management approaches can’t outsmart experienced management. Experienced managers sometimes don’t adapt to new changes fast enough.
On the other hand, managers with poor track records or even corrupt practices rarely show any improvements in their performance.
One of the best sources of information for analyzing the management is to read some interviews or CEO letters to shareholders, along with researching the endorsements and recommendations they receive from other successful businessmen and investors.
Public image of the CEO
Many CEOs want to also become public figures or even celebrities. – Take Elon Musk for example. But that often means their public actions (for example Tweets) can have a huge influence on what’s happening with the stock price – in a good and a bad sense.
Sometimes such actions also tread the line of what’s legal and what isn’t according to regulators. The company’s stock price growth can also be driven by a charismatic CEO’s persona and their great vision, but the vision must be backed by a solid strategy, actual disruptive products, sufficient funding, etc.
If there’s only hype behind a vision, it sooner or later ends up reflected in a stock price correction.
One important data point is whether the CEO, board members and other managers are buying or selling the company’s stock, but analyzing this is not that simple. First of all, there are legal and illegal types of insider trading.
- Insider trading is illegal when the trades are based on information that is still non-public but which can have a substantial impact on an investor’s decision to buy or sell the stocks.
- Legal insider trading is when company employees buy or sell stock without acting on confidential information and report these trades to the regulators in a timely manner.
The next factor to consider is whether the legal insider trades are based on management’s own assessment of the stock value, or if the transaction is based on exercising stock options as part of executive pay, or something similar.
It’s also worth noting that legal insider buying is a better signal to consider compared to legal insider selling. The latter might be based only on the insiders’ need for money because of personal reasons (like buying a flat, etc.).
Finally, where can you access data about insider trading? By going on Yahoo Finance’s Insider Transactions, you can see information on all insider trades.
7. Corporate governance
According to the definition, corporate governance is a set of policies and practices that a company follows to provide organizational transparency, accountability, fairness, responsibility, and security. The central feature of corporate governance is to involve and protect shareholders, and for the organization to be socially and regulatorily compliant.
Good corporate governance by itself is, of course, not enough to justify an investment, but it is certainly an important factor to consider when the company meets all the other investment criteria.
Poor corporate governance, on the other hand, can definitely be a deal breaker, even if the company is otherwise considered a good investment. When analyzing corporate governance, you should consider the two following aspects in particular:
- (mandatory) Management not having any history of fraud, corruption, or lack of integrity, and having a system in place to prevent any poor ethical leadership.
- (welcomed) That the company follows the best sustainability, carbon neutrality, diversity, and inclusiveness policies, among others. Not following these practices is a deal breaker for some investors, while for others it’s just a bonus. That’s up to you to decide.
8. Market cap
Market capitalization or ‘market cap’ is the financial size of a company; namely how much the whole company is worth on the stock market.
It’s calculated by multiplying the number of outstanding shares by the share price. For trivia, here’s a list of the biggest US companies ordered by their market cap. There are at least three main reasons why market capitalization is important:
- Company size category – Based on its size, a company can be categorized as a large business (large-cap) or as a small/medium enterprise (small-cap). Larger, more well-established businesses usually mean a safer, less volatile investment. On the other hand, a smaller company usually means a more aggressive and volatile investment.
Large-cap companies are considered those with a $10 billion or more valuation, mid-cap between $3 to $10 billion, while all companies under $3 billion are considered small-cap. Mid and small-cap companies are often listed together.
There are also two different indices for both categories on the US market. The S&P 500 index generally includes large and well-established companies (blue chips) while the Russell 2000 Index follows the performance of smaller cap businesses.
- Market cap benchmark – It can be valuable to analyze how market capitalization of the company has grown over the years. In addition, it’s recommended to analyze the company’s market capitalization in comparison with its competitors. If there are competitors with a significantly bigger market cap, the company will usually need an even stronger competitive edge.
- Market cap vs. market valuation – Market capitalization and market value are not exactly the same, but they are sometimes mixed up. Market capitalization considers only the current price of stockholder’s equity on the market. Market valuation, on the other hand, considers much more financial data and many other ratios, such as price-to-earnings (P/E), price-to-sales (P/S), enterprise value-to-EBITDA, debt, taxes etc.
An important aspect of analyzing a stock is to estimate if the current market cap is realistic considering the revenues, earnings, book value and other fundamental data.
9. Earnings date
Last but not least, you should know the data for earnings releases of the company you plan to invest in. Unfortunately, not all companies publish their quarterly earnings reports on the same date, but all public companies release reports for the previous fiscal quarter (they are obligated to) soon after the quarter ends.
You can use the Earnings calendar so that you don’t miss the earnings date of the companies you own, especially if you have several investments. The reason it’s important to know whether a company has surpassed or fallen short of its expected earnings will be covered later in the market sentiment chapter.
Having the earnings dates in mind, let’s move on to analyzing the quantitative fundamentals of a company or, in other words, the financial reports.
Quantitative fundamentals – Financials
Now that you understand the business model of the company you plan to invest in, it’s time to take a deep dive into their financials and valuation. This is called the fundamental analysis.
In fundamental analysis, you’re looking to make sure that the company is profitable and growing, has good liquidity, that operations are efficiently run, and that the company leverages the right use of financing. With all those qualities, the stock is an attractive investment.
When you are analyzing financial statements and valuation metrics, you must always consider the numbers within a certain context. These contexts usually are:
- The company’s financial history – You’re analyzing how the company’s business is improving over time and becoming more and more profitable, with a stronger position in the market.
- Industry averages – You compare financial data in relation to industry averages and how the company is under- or over-performing in the industry.
- A competitor’s benchmark – You should also compare one competitor’s financial health to another, or several companies that are working in the same or similar industry. Sometimes it also makes sense to analyze and compare companies in different sectors, but you must be careful not to compare apples to oranges.
The financial data is based on the three basic financial statements that all publicly traded companies must issue on a quarterly and annual level. These three financial statements are:
- Balance sheet – A balance sheet shows the financial position of a company on the last day of the fiscal year or quarter. It shows the assets that a company owns, compared with their liabilities and shareholders’ equity.
- Income statement – An income statement shows the financial performance of a company during a certain time period, usually quarterly or annually. It shows revenues, expenses and net profit.
- Cash flow – A cash flow statement shows cash transactions over a certain time period, again usually on a quarterly or annual basis. It consists of five parts: cash flow from operations, cash flow from investing, cash flow from financing, closing cash balance, and net change in cash.
In this article we won’t take a deep dive into each statement, but only consider a few specific items or ratios when analyzing a stock. Nevertheless, we encourage you to study more extensively what each statement shows, how it’s accounted together, and why they are important from an investing perspective.
When you are analyzing financial data, you’re interested in five main aspects of the company:
- Profitability – Is the company making a profit?
- Liquidity – Can the company meet their short-term obligations?
- Efficiency – Are the company’s operations efficient?
- Financial leverage – How much debt is the company using? Too much, and its solvency is at risk; too little, and its return on equity is not as high as it could be.
- Growth – How quickly are the company’s revenue and profit growing?
Now let’s look at the 15 most frequent metrics investors look at when analyzing financial statements:
1. Current ratio
Current ratio, also known as Working capital ratio, is a liquidity ratio that measures whether the company is able to pay their short-term obligations (these are obligations that are due within one year) with their current (short term) assets.
It’s calculated as current assets divided by current liabilities. If the ratio is greater than 1, it means the company has enough short-term resources to cover their short-term obligations. A good current ratio is considered above 1.2.
2. Quick ratio
Quick ratio or an “acid test” shows if the company is able to meet their short-term obligations with cash, cash equivalents, accounts receivables and marketable securities.
All these are considered quick assets, since they are cash or can be quickly converted to cash. To get the quick ratio, you divide quick assets with all current liabilities. A good quick ratio is any number greater than 1.0. Of course, the greater the number, the better the position a company is in.
3. Long-term debt
Long Term Debt is all outstanding debt the company holds which has a maturity of 12 months or more.
Long-term debt is important because it shows the company’s solvency and their leverage ratio, meaning whether the company is able to meet its long-term debt obligations based on its overall debt level and earnings capacity. The long-term debt should not be too high (see debt to equity ratio below).
4. Debt to equity ratio (D/E)
Debt to equity ratio compares all the liabilities to shareholder’s equity. It shows the financial leverage the company is using, or in other words the relative contribution of the capital employed from the creditors compared to capital employed from the shareholders.
In a practical sense, it shows how much debt there is for every dollar of capital. A good D/E varies from industry to industry, but it generally shouldn’t be above 2 as a rule of thumb.
5. Interest coverage ratio (ICR)
The interest coverage ratio shows whether the company can easily pay interest on the outstanding debt in a timely manner.
Usually it’s calculated as EBIT (Earnings before interest and taxed) divided by interest expenses in a certain period. ICR should be above 2, but ideally 3 or even higher.
6. Asset turnover
The asset turnover ratio measures the efficiency of how well a company is using its assets to generate sales. It’s calculated as total sales divided by average assets. The higher the ratio, the more efficient a company is.
For example, if the ratio is 2, it means the company generates $2 of sales for every dollar of assets. The ratio varies from industry to industry, so it should only really be used to compare companies in the same industry.
7. Return on assets (ROA)
ROA shows how profitable a company is in relation to their total assets. In other words, it shows how efficiently the company uses assets to generate profit. It’s calculated as net income divided by average assets.
A higher ROA indicates that the company is more efficient with their assets to generate profit. An ROA above 15 % is considered good.
8. Return on equity (ROE)
ROE shows how profitable a company is relative to equity (net assets, not considering debt). It’s calculated as net income divided by average shareholder equity, and it measures how much profit the company generates on each dollar contributed from the shareholders.
An increasing ROE is usually a sign the company is generating value for shareholders. There’s also a more detailed analysis of ROE called Du-Pont analysis. An ROE above 25 % is considered good.
9. Revenue growth rate
Revenue growth simply means an increase in revenue over a period of time, usually quarterly or annually. It shows how fast the business is expanding, and is often used to forecast future revenues.
It’s calculated as the Current Revenue Period minus the Previous Revenue Period, divided by the Previous Revenue Period and multiplied by 100.
It depends on industry and company maturity, but 10 % – 15 % sustainable annual growth over several years is considered very good. For larger companies, 5 % – 10 % of annual revenue growth is already excellent.
10. Net Income growth rate
Net Income growth shows the increase in income over a particular period of time. Just like with revenue, you can analyze whether a company’s net income (earnings) is speeding up or slowing down over the years.
More importantly, you can compare net income growth to revenue growth, to see whether the company is efficient at translating increased revenues into increased profit.
11. Gross profit margin
Gross margin is calculated as net sales minus cost of goods sold (COGS) divided by net sales. It shows the company’s profitability after subtracting direct material and labor costs.
The higher the gross margin, the better, since the company is left with more money to cover other indirect costs (sales, general, administrative), while more money is potentially left over for profit.
A company can increase their gross margin by buying cheaper inventory or selling goods at a higher price. Gross margin varies by industry, but generally a gross profit margin of between 30% to 70% can be considered healthy.
12. Net profit margin
Calculated as net income divided by net sales. It shows how much net profit the company obtains for each dollar of sales generated. A higher net profit margin is better, of course.
Net profit margin varies by industry, but in general a 5 % net margin is considered low, 10 % is a healthy one, and anything above 20% is considered an excellent net margin.
CASH FLOW STATEMENT
13. Operating cash flow (OCF)
This is the part of the cash flow statement which shows how much net cash the company makes from their core business operations within a specific timeframe (sales of goods and services, payments made to suppliers, taxes etc.).
It shows whether the company is generating enough cash flow to maintain and expand their business operations. A positive operating cash flow shows that the company can meet its obligations using only its operating revenue, without taking on any additional debt.
The other two types of cash flows in the statement are:
- cash flow from investing activities and
- cash flow from financing activities.
Cash flow from investing shows how much money the company has generated or spent by making investments (buying or selling assets such as facilities and equipment, mergers and acquisitions etc.)
Cash flow from financing, on the other hand, shows how much money the company has generated or spent through financing activities, such as taking or repaying loans, paying out dividends, etc.
15. Operating cash flow > Net Income
When cash flow from operations exceeds net income, it can be a sign that the company is in a healthier financial situation than the net income suggests.
Net income is an accounting term that can be slightly adjusted, but cash flow is real since it shows movement of cash in a company and is therefore significantly harder to manipulate.
Valuation & Investment attractiveness
When considering valuation, the key question being addressed is whether a stock is an attractive investment. There are several valuation metrics that give us a sense of an investment’s attractiveness.
Below you can find the most popular ones, but keep in mind that these metrics must be compared to something, such as:
- The company’s history
- Other industries
- The market in general
1. P/E Ratio
The Price to Earnings Ratio (sometimes called price multiple) is probably the most familiar valuation metric.
It’s calculated as the Stock price divided by Earnings per share (or by the company’s market capitalization divided by its net earnings), and shows how many years it would take for the company to pay back the amount paid for a share, assuming the company doesn’t grow and fully pays out the net profits to investors.
In other words, it’s how much an investor must invest to receive a dollar of the company’s earnings. The P/E Ratio is one of the most popular indicators that shows whether a company is undervalued or overvalued.
The long-term P/E market average for S&P 500 companies is around 14 – 16. The P/E ratio can fluctuate between 5x to 120x (or even higher), depending on the market cycles.
- High P/E stocks can be considered as growth stocks, meaning investors are expecting high growth rates and profitability in the future and thus are prepared to pay more for the stock; it could also be an indicator that the stock is overvalued.
- Low P/E stocks can be considered as value stocks, if other criteria for a good value stock are also met (more about these criteria later, when we introduce the Piotroski analysis). Low P/E can also indicate that the company is doing remarkably well relative to its previous performance.
If a company is not making any profit, the P/E is usually shown as N/A.
We’ve also got a trailing P/E (using earning periods of the past 12 months) and forward P/E ratio (using future estimates of earnings), but more about that in another article.
The Price to Book ratio compares a company’s market capitalization to its book value. It’s calculated as Stock price / Book value per share (BVPS).
The book value shows the net difference between a company’s assets and liabilities, as well as the net assets of a company, namely how much shareholders would receive if a company was liquidated.
Traditionally a P/B ratio under 1 is considered a good investment (means a company is undervalued), but even a P/B ratio of up to 4 can be considered an acceptable investment, especially if the company is an “asset light” business like companies in the technology sector.
The Price to Sales ratio is calculated as the company’s market capitalization divided by total sales in the past 12 months. The ratio shows how the company is valued on the market for every dollar of the company’s sales. The lower the number, the better in general.
The ratio differs considerably among various industries and is most often used when benchmarking competitors. It’s also often used in cases when growth companies are not profitable yet.
The issue with this ratio are at a minimum that it doesn’t consider debt and that each company must sooner or later make profit out of sales.
4. Enterprise Value (EV)
Enterprise Value tells us how much money would be needed to buy the whole company and pay off all its debt. It’s calculated as market capitalization plus debt minus cash and cash equivalents (since they can be used to pay off part of the debt).
EV can be used as a better way to calculate the value of the company compared to market cap alone.
4.1. EV / EBIT
The EV / EBIT metric is sometimes also called the EV multiple and is an alternative valuation metric to P/E, but considers differences in debt structure, tax rates and larger amounts of cash on the books.
It neutralizes the capital structure and is calculated as Enterprise Value divided by a company’s operating profit or EBIT (earnings before interest and taxes).
For capital intensive companies, EBIDTA (earnings before interest, depreciation, taxes and amortization) can be considered instead of EBIT, also taking into account the impact of depreciation and amortization.
5. PEG Ratio
The purpose of the PEG Ratio is to take into account the expected growth rates of the company and is considered to be an improved P/E ratio. PEG ratio standardizes P/E ratio against expected growth rates.
It’s calculated as the P/E ratio divided by Expected Earnings per Share Growth Rate. A PEG ratio below 1 is considered “good”.
6. Dividend yield
The dividend yield is the percentage of the company’s share price that is paid out as a divided each year. It’s calculated as dividends per share paid out in a year divided by the price per share. Higher dividend yields are generally better. From 2 % to 6 % is considered a good dividend yield.
There are some exceptions of course, for example if company is paying out too many dividends instead of reinvesting in growth, or if it pays out too much in dividends when business is not going as expected and equity reserves become too small.
7. Dividend pay-out ratio (current, future)
Dividend pay-out ratio can help determine if the company is paying out a reasonable percentage of its earnings. The ratio is calculated as all dividends paid in a year divided by net income.
In other words, it shows us what percentage of net income was paid out as a dividend. A pay-out ratio between 30 % and 50 % is considered health. The same logic is applied to how much profit should be paid out as stated in the dividend yield section.
8. Number of shares / New Shares issued / Share buybacks
For investors it’s important to know how many shares are out there, or even more importantly; if new shares were issued.
Issuing new shares causes shareholder dilution, meaning the investor holding the same number of shares equal to a lower percentage of the company’s ownership after the issuance of new shares.
In addition, if too many shares are issued too quickly, the share price can drop because of greater supply. The opposite of issuing new shares and raising new capital are called share buybacks.
A company with extra cash can make new investments, cash out dividends, or repurchase their shares.
Share buybacks are a form of returning capital to shareholders, since these shares are taken off the market or kept as a treasury stocks. A buyback can also be a sign that management thinks the company is undervalued.
9. Float shares outstanding
Floating means the number of shares that are available for trading. Low float shares are usually riskier, having higher volatility and lower liquidity.
Floating shares are calculated as the outstanding shares minus restricted (locked-up shares) and closely held stocks (shares owned by the insiders and major shareholders). With popular stocks, floating is not that important, since these stocks are extremely liquid.
Piotroski F-score – a practical example how to analyze a stock using fundamentals
It’s time to put together everything that we’ve learned up to now. There are several popular methods combining different fundamental metrics into a methodology for assessing the company’s quality, and therefore its investment attractiveness.
Let’s start with the Piotroski F-score, since it’s one of the most popular methods used by value investors. The Piotrovski F-Score takes into account 9 fundamental metrics.
For each “yes” on a question below, the company gets 1 point. Companies with a score above 8 are considered fundamentally good, and companies between 5 and 8 can be considered good companies. If there are fewer than 5 points, it’s highly likely the stock is not a good value investment.
Here are the questions / criteria to determine the F-score:
- Is the net income positive?
- Is the Return on Assets (ROA) positive in the current year?
- Is the Operating Cash Flow positive in the current year?
- Is the Operating Cash Flow greater that Net income?
Leverage and liquidity
- Is the amount of long-term debt lower than in the previous year (decreased leverage)?
- Is the current ratio higher in the current year compared to the previous year?
- Did the company not issue new shares?
- Is the gross margin higher in the current year than the previous year?
- Is the Asset Turnover Ratio higher in the current year than the previous year?
In this chapter, we’ve looked at a few of the most common financial and valuation metrics. But there are hundreds more of them and the more experienced investor you become, the more you will add your own indicators.
For example, you simply enter “Piotroski” or any other set of criteria and get a list of the stocks that meet those selected criteria. It’s that simple.
Market sentiment and news
Now that we looked at the qualitative and quantitative fundamental data, let’s move on to the other forces that influence stock price – from market sentiment to hype, greed, and daily news.
In the next chapter we’ll look more closely at the basics of how to analyze a chart, but in this chapter we’ll first focus on some quantitative data that indicates the market sentiment.
1. Put/Call ratio
A put option gives investors the right to sell stocks at a predetermined (strike) price, and a call option gives investors the right to buy stocks at a predetermined price. The put to call ratio can be used as an indicator of overall market sentiment.
Buying more call options than put options can be an indicator of positive sentiment regarding the stock, since investors expect the price will rise and they can get a similar upside with a call option without using a lot of their capital, and vice versa.
An average put-call ratio is 0.7. If the put/call ratio exceeds this number significantly, investors are buying much more put than call options, indicating fear amongst them.
If the indicator is significantly lower than 0.5 investors are considered to be very optimistic. Extreme sentiment in either direction (optimistic or pessimistic) is usually a good contrarian indicator.
2. Institutional holdings
Institutional holdings show what amount of the company’s stock is owned by mutual and pension funds, insurance companies, investment banks and other institutional investors.
The company’s shares being owned by the institutional investors is considered a good thing (up to a point), since these institutions employ professional investment management and analysts to buy shares in perspective companies.
On the other hand, if something goes wrong with the company (a scandal for example) all institutional investors might sell their holdings quite quickly (known as a “sell-off”), which might greatly influence the stock price.
Too many institutional holdings might also indicate a low probability of the stock being significantly undervalued.
3. ETFs exposure
Similarly to institutional holdings, you can check ETFs (exchange-traded funds) exposure to a specific company’s stock. Exchange-traded funds trade on an exchange in the same way as a stock does, but follow a particular index, sector, commodity, or any other asset class.
Thus, an ETF can follow hundreds of stocks (for example all stocks that follow the Nasdaq Composite Index). It’s not such an important factor, but ETFs holding a company’s stock shows a certain level of stock popularity (the company being a blue-chip company).
4. Beating / Missing expected earnings
As we learned before, companies regularly report their quarterly and annual earnings, and you can see these dates on the Earnings Calendar. Before reports are publicly known, analysts (and the company’s management) set some expectations regarding the bottom-line results for the following quarter.
Logically, after publishing the reports investors are eager to know if the company beat, matched, or missed the forecasts.
There are many factors to consider when analyzing expected earnings versus actual earnings. It’s not always necessary that a stock will rise after beating market expectations or vice-versa. There might be unrealistic market expectations at play, investors buying on a rumor and selling the news and so on.
But in any case, right after publishing the earnings report there’s a new quarter to catch.
5. Analysts rating consensus / Analysts price targets
There are hundreds of financial institutions and websites with thousands of financial analytics analyzing specific stocks and giving buy or sell recommendations. In almost every trading app you have some kind of analyst rating consensus or their expected target price.
These apps aggregate the analysts’ opinions on whether the stock will move up or down. It’s not the only thing you should rely on, but definitely worth taking into consideration.
6. Social sentiment
Social sentiment shows how is the company performing in the eyes of their stakeholders, mainly customers and investors. Social sentiment usually consists of aggregate social media posts, especially on Twitter, Reddit, StockTwits and other social platforms.
There are also specific tools available to monitor social sentiment on the internet. Social sentiment can include opinions on a company’s product, customer care, their business model, corporate governance, financial health and so on.
Social sentiment can also be valuable feedback for the company – where or how to improve or what they are doing right. However, it can also be a source of information to help investors react before the market based on negative or positive social sentiment.
7. Recent company news / Concerning recent events
Along with every quote on popular financial sites, there is a news section, showing the latest and greatest company info.
This news can have a positive or negative influence on a stock price, and can contain information about new product launches, announcements of dividends, management changes, employee layoffs, takeovers and mergers, accounting errors, new investment and expansions, strategic partnerships and so on.
8. Day’s Range / 52-Week Range
52 weeks is approximately one year. A 52-week range shows a stock’s volatility by showing the highest and the lowest stock price in the previous 52 weeks. When analyzing the stock, you should compare where the current stock price is compared to the past 52 weeks and calculate how much the stock price fluctuated.
That should give you a sense of expected volatility in the future and if such volatility is acceptable to you. Similarly, to the 52-week range you can also look at a day’s range if you are day trading.
Last but not least for this section, let’s mention beta. Beta is a measurement of stock volatility, calculated by using regression analysis. This measurement shows us how much a stock is expected to move relative to the market (for example the S&P 500 index), as well as a shows stock’s sensitivity compared to the movements on the market. Stocks that move more than the market have positive beta.
For example, a stock with beta of 1.1 is expected to move 10 % (higher or lower) than the market; or in other words a stock is 10 % more volatile than the market. If we look at a practical case, beta means if the market rises by 10 %, a stock with beta of 1.1 is expected to rise by 11 %.
The opposite also applies in cases where the beta is lower than 1. There are many downsides of beta, such as not considering new information about the company and as always, past performance is rarely an indicator of future performance.
Charts – Technical analysis
Besides fundamental analysis, which is focused on the business fundamentals (financial health and potential), the second most popular type of stock analysis is technical analysis.
This type of analysis is focused on analyzing the stock chart, and that’s why it’s often also called chart analysis. Same as the fundamental analysis, the technical analysis is a very complicated subject with many books written on how to master it.
It’s also worth mentioning that many investors are skeptical of it (since it’s more art than science), while other investors use it as a signal to buy a stock, when fundamental criteria are met. At the end of the day, it’s for you to decide if you’ll incorporate it into your “how to analyze a stock” strategy or not.
And as with fundamental analysis, metrics and indicators are rarely meant to be used alone, but rather in the right combination and context. We know the five main categories of indicators:
|Trend indicators||Simple Moving Average (SMA)|
Exponential Moving Average (EMA)
Moving Average Convergence Divergence (MACD)
Average Directional Index (ADX)
|Momentum indicators||Relative Strength Index (RSI)|
Commodity Channel Index (CCI)
Rate of Change (ROC)
|Volatility indicators||Bollinger Bands|
Average True Range (ATR)
|Volume indicators||On-balance Volume (OBV)|
Money Flow Index (MFI)
|Resistance and support Indicator||Fibonacci Retracements|
We won’t go into details in already long article. Nevertheless we plan to publish a separate article on technical analysis.
Other factors to consider when analyzing a stock
We’ve now covered a really broad range of ways to analyze a stock.
With all of us having a limited analytical capability, you can rarely look at all the indicators when making an investment decision, but simple select those that fit best your investment strategy, analytical forte, and other preferences.
That means the investment strategy you follow definitely has a great influence on which indicators to take into an account. A value investor will select a different set of criteria compared to a growth investor, momentum investor, or an investor that follows the global macro strategy.
So, a good starting point to select the right indicators might be to clearly shape your investing strategy.
The last thing to consider is the macroeconomic perspective. Macro trends (interest rates, GDP, inflation, employment etc.) have a great influence on overall market movements and investment class attractiveness.
In different time periods, different investment classes don’t have the same appeal. For example, in certain periods, stocks are a much more interesting investment class than in others, and so different investing strategies must be applied.
Thus, before analyzing a stock it is also worth considering whether stocks are the right asset class to invest in at a particular moment and if your investing strategy is aligned with the macro trends. But that’s already a different story.