How Do Stockbrokers & Financial Analysts Determine What Stocks to Buy?

As the old saying goes, “Everybody has an opinion.” That’s especially true when you seek recommendations on buying stocks. Financial professionals such as stockbrokers and financial analysts can help you determine which stocks have the best upside. They use a variety of methods, including investment philosophy, investment objectives, fundamental analysis or technical indicators, to figure out the stocks that offer a buying opportunity. They also have various motivations -- ranging from the professional to the self-serving -- for wanting you to buy the stock they recommend. So it’s best to follow this sage advice from the Securities Industry Association: “Before you invest, investigate.”

Do the Research

Many competent stockbrokers and financial analysts base their buy recommendations on a tried-and-true investment philosophy. This philosophy informs their stock research as they examine key variables to determine if a stock is worthy of a “buy” recommendation. The analysts review financial statements and analyze the economic fundamentals of the company issuing the stock. This quantitative analysis looks at factors like a company’s revenues, expenses, assets and liabilities to predict how a company will perform in the future.

Analyze the Fundamentals

Brokers or analysts who use fundamental analysis find this information in a company’s financial statements -- including the balance sheet, the income statement, and the cash flow statement. By analyzing the statements, they seek to find if revenue is increasing or decreasing, and what percentage of the revenue is actually profit. The analysts may also compare their findings against industry benchmarks and competitors' financial statements to figure out the company’s competitive position. They also look to see if the company can pay its debts and if management is participating in any financial shenanigans, including adding earnings or other financial misrepresentations to the statements.

Assess Intrinsic Value

Fundamental analysis assumes that a stock market’s price and the real -- or intrinsic value -- of a share of stock differ. So the analyst researches to find an undervalued stock whose market price should eventually rise to its intrinsic value. In addition, some financial analysts and brokers analyze technical indicators. Instead of looking at the fundamentals of the company itself, they use charts and other tools to analyze the pattern of a stock’s price. They look at the past performance of the stock’s price trend for indications of future price action. These indicators can include signals like a stock’s moving average or relative strength index.

To Buy, Or Not

As with any financial or investment advice, it’s necessary to check your advisor’s background and do your own homework regarding the recommended investments. Many stockbrokers don’t do their own research, instead basing their recommendations on the information given to them by their firm’s financial analysts. The Financial Industry Regulatory Authority advises investors not to “rely solely on an analyst recommendation when making an investment decision.” Instead, FINRA encourages investors to look to other sources -- such as the SEC's EDGAR database at www.sec.gov/edgar.shtml and independent news reports to research the companies. Also, ask your broker if he has any conflicts of interest, and precede with caution if the analyst’s firm has a relationship with the recommended company or has underwritten the initial public offering he is advising you to buy.