Ever thought of taking control of your investments and becoming your own stock analyst? It may seem daunting, but it's not as complicated as you might think.
With the credibility of some analysts being called into question, it's becoming more important to learn the ropes of stock analysis yourself. After all, nobody asks you to perform surgery on yourself or represent yourself in court, so why not take charge of your own financial future?
At Wisesheets, we'll show you how to think like an analyst and conduct your own research, so you can confidently make informed investment decisions from the comfort of your own home. Time to become an expert in the stock market.
Step 1: Develop a probing mind
Developing a probing mind is the first step to thinking like an analyst. This means being inquisitive and curious when it comes to researching companies and industries. Analysts focus on specific industries and companies, analyzing their financial statements and all available information. They cross-check their findings by probing the affairs of a company's suppliers, customers, and competitors, giving them a more comprehensive understanding of the company and the industry.
To develop a probing mind,
- Start by choosing an industry or sector that interests you and researching several companies within that space. This approach helps you to identify the industry's top performers and undervalued stocks. It also allows you to understand trends in the industry and how a company's performance stacks up against its peers. Look beyond the financial statements and try to understand the broader market trends and competitive landscape.
- Ask questions and investigate further, not accepting information at face value. Learn to cross-check facts, verifying information with other sources. What is the company's business model, and how does it make money?
Practice this process with a few companies, comparing their strengths, weaknesses, and financials. With more experience, you can think of putting more stocks under your lens. And by honing your probing skills, you can gain a deeper understanding of companies and industries, identify potential risks and opportunities, and make more informed investment decisions.
The key is to remain curious, inquisitive, and detail-oriented when researching companies, and always strive to uncover new insights and information.
Step 2: Look over existing analyst reports
Instead of relying solely on your own research, consider reading analyst reports from research firms that provide detailed analyses of stocks and industries. These reports offer valuable insights into a company's business, including its financials, strengths and weaknesses, main competitors, industry outlook, future prospects, and growth potential, so investors can act on informed opinions about a stock.
But, it's important not to blindly follow buy or sell recommendations made by analysts. Instead, use the reports to identify the common thread in the information provided by different analysts. By reading a wide range of reports, you gain a more comprehensive understanding of the company and the industry.
Furthermore, you should pay close attention to the earnings forecasts of different analysts, as they ultimately determine their buy or sell recommendations. Different analysts may set different target prices for the same stock, so it's essential to understand their reasoning.
Step 3: Master the six stages of stock analysis
When it comes to analyzing stocks, it's important to have a clear understanding of the process. By breaking it down into smaller steps, you can arrive at a reliable conclusion about a stock and make better investment decisions. Let's take a look at the key steps involved in stock analysis.
Top-Down vs. Bottom-Up Approaches
There are two different approaches to stock analysis: top-down and bottom-up.
The top-down analysis starts with analyzing the industry and then finding a company that fits the criteria.
- Start with a broad macroeconomic outlook, then narrow down to specific industries and companies that fit that outlook.
- For example, if you believe the global economy is in a period of growth, you might analyze the automotive industry as a whole and then narrow it down to specific companies like Tesla or Ford.
Bottom-up analysis, on the other hand, starts by analyzing a specific company and then learning about the industry outlook.
- Start with a specific company and then work up to analyzing the industry as a whole.
- For example, you might start by analyzing the financial statements and business model of a company like Apple, then move on to compare it to its competitors in the tech industry.
Both approaches can be effective, and many analysts use a combination of the two to form a comprehensive analysis of a company or industry. But any process of analyzing a stock involves the following steps.
1. Peeking under the hood: What makes an industry tick?
When conducting an industry analysis, it's important to understand the industry's growth prospects and identify the major players. Here are some tips on how to conduct a thorough industry analysis:
- Gather information from various sources such as trade magazines, industry reports, and websites.
- Look for trends, growth prospects, and industry challenges. Identify the major drivers and barriers of the industry.
- Compare the company's performance with its peers in the same industry. Analyze key financial ratios such as P/E ratio, ROE, and D/E ratio.
- Study the impact of macroeconomic factors on the industry, such as interest rates and government policies.
For example, if you're analyzing the technology industry, you can look at trends in the adoption of new technologies, innovation, and competition. You can compare the company's performance with other companies in the same industry, such as Apple, Microsoft, and Amazon. By analyzing industry trends, you can get a better understanding of the company's growth prospects and risks.
2. Beyond the surface: Evaluating a company's inner workings
The next step is to evaluate the company's business model. This involves analyzing the company's strengths and weaknesses, such as its unique brand identity, products, customers, and suppliers. Here are some tips on how to conduct a thorough business model analysis:
- Gather information from the company's annual report, trade magazines, and websites.
- Identify the company's core competencies and competitive advantages. Analyze how the company creates value for its customers.
- Study the company's supply chain, including suppliers and distributors. Look for potential risks and vulnerabilities.
- Analyze the company's revenue streams and pricing strategies.
For example, if you're analyzing Apple's business model, you can study its ecosystem of products and services, its brand identity, and its supply chain. You can also look at the company's pricing strategy, such as its premium pricing for its products. By analyzing the company's business model, you can get a better understanding of its strengths and weaknesses.
3. Reading between the lines: Interpreting financial statements
Understanding a company's financial strength is crucial to stock analysis. You should be able to read and interpret the company's balance sheet, income statement, and cash flow statements. Here are some tips on how to conduct a thorough financial strength analysis:
- Analyze key financial ratios such as P/E ratio, ROE, and D/E ratio.
- Look for trends in the company's financial statements, such as revenue growth, profit margins, and cash flow.
- Study the company's liquidity, solvency, and profitability.
- Analyze the company's capital structure and debt maturity.
If you're analyzing Coca-Cola's financial strength, you can study its revenue growth, profit margins, and debt maturity. You can also look at its key financial ratios, such as P/E ratio and ROE, and compare them with other companies in the same industry.
You can use a stock data tool to dump years of financial statements or live stock data on a simple excel or Google sheet. This makes it way easier to assess a company's financial strength, so you can get a better understanding of its ability to generate profits and manage risks.
4. Leadership matters: Evaluating Strategy, management, and board quality
A company's management quality is an important factor to consider when analyzing stocks. You should do some research on the Internet to assess the quality of the company's management and board.
- Look for the management's track record, experience, and education.
- Study the management's communication style and transparency.
- Analyze the company's corporate governance structure and board composition.
- Look for any red flags, such as conflicts of interest, scandals, or lawsuits.
So if you're analyzing Tesla's management quality, you can study Elon Musk's track record and communication style. You can also look at the company's board composition and corporate governance structure.
5. Growth potential: Making realistic earnings forecasts
Assessing a company's growth potential is a vital part of stock analysis. Here are some tips on how to analyze a company's growth potential:
- Analyze past earnings, sales growth, and profitability trends to evaluate the company's historical performance.
- Identify key growth drivers, such as new product releases, acquisitions, or expansion into new markets.
- Assess the company's R&D spending to determine its future growth potential.
- Determine if the company's earnings growth potential is realistic.
For example, if you're analyzing a tech company, you might look at its research and development spending to assess its ability to innovate and develop new products. You can also look at the company's past earnings and sales growth to determine its historical performance. By identifying the key drivers of growth, you can better understand the company's future potential and make more informed investment decisions.
6. Putting a price on it: Determining a company's worth
Valuation is a crucial aspect of stock analysis that helps you determine a stock's worth. Here are some methods that investors use to value a company:
- Value investors look at a company's intrinsic worth based on its assets, liabilities, and cash flows.
- Growth investors focus on the company's future earnings potential.
- Other investors may use a combination of methods, such as discounted cash flow analysis, price-to-earnings ratio, or price-to-book ratio, to determine a company's valuation.
Setting target prices
Once you have evaluated a company's financial strength, management quality, industry position, and growth potential, you can set a target price for the stock. Here's how to set a target price:
- Multiply the estimated earnings per share (EPS) with the estimated high and low P/E ratio.
- The high P/E ratio is the price at which you expect the stock to trade in a bull market, while the low P/E ratio is the price at which you expect the stock to trade in a bear market.
For example, if a company's estimated EPS is $2.50 and its estimated high and low P/E ratio are 20 and 15, respectively, then the high target price would be $50 ($2.50 x 20), and the low target price would be $37.50 ($2.50 x 15). By setting a target price, you can have a better idea of when to buy or sell a stock.
Step 5: Practice trading with virtual money
Practicing trading with virtual money has many benefits, such as:
- You can gain hands-on experience without risking real money.
- You can experiment with different investment strategies and see the results.
- You can improve your analytical skills and make better investment decisions.
To calculate a hypothetical investment and its current worth, you can follow these steps:
- Choose a stock and determine how much you would have invested.
- Look up the historical stock price for the time frame in which you would have made the investment.
- Calculate the returns, factoring in any dividends or stock splits.
- Use a compound interest calculator to determine the investment's current value.
Step 6: Don't follow other stock analysts blindly
It's important to understand that stock analysts are not infallible and their recommendations are not always accurate. Therefore, it's crucial to never blindly accept what they have to say and do your own research to improve your analytical skills.
Blindly following analysts' recommendations can lead to poor investment decisions, as their interests may not align with your own. They may have biases or conflicts of interest, or they may not have all the necessary information about the company. By doing your own research, you can gain a better understanding of the company's financials, industry position, and growth prospects.
Step 7: Avoid being a slave to your emotions
It's easy to get caught up in the excitement of the stock market and take risks that you wouldn't otherwise take. This can lead to rash decisions, such as buying too much of an individual stock or selling too soon.
To avoid making these mistakes, it's important to understand stock market psychology, remain disciplined, and stick to your trading plan.
When emotions like fear, greed, or excitement start to take over, it's important to step back and reassess the situation. Make sure you don't let your short-term emotions dictate your long-term decisions. And if you do make a mistake, remember to learn from it and move on.
Step 8: Stay informed & monitor your investments
The stock market is constantly changing, so it's important to stay up-to-date with developments in the industry. This means reading financial news, listening to podcasts, watching educational videos, or attending seminars on investing.
By staying informed, you'll have a better understanding of the markets and be able to make more informed decisions.
And once you make an investment, it's important to monitor it regularly. This doesn't mean checking the stock price every day—it means evaluating the performance of your investments on a regular basis and making adjustments as necessary.
Become a true expert in the stock market with Wisesheets
All in all, becoming your own stock analyst is a challenging yet rewarding process that can help you make more informed investment decisions. By following the steps outlined in this article, you can learn to think like an analyst, understand the key elements of stock analysis, and make better investment choices. With time mastering this process will allow you to become an expert in the stock market.
As a final note, you can use tools like Wisesheets to make the process of stock analysis easier and more efficient. Wisesheets is an online platform that provides comprehensive financial analysis and valuation for public companies, helping you quickly assess a company's financial health and growth potential. By combining your analytical skills with the resources available on Wisesheets, you can become a more confident and successful investor.