Investors depend on stock analysis to find potentially profitable stocks. Common ways to analyze stock include technical and fundamental analysis. Several components fall under fundamental analysis, including examination of a company’s price-to-earnings ratio, earnings per share, book value and return on equity. Many investors also use the recommendations of financial analysts to analyze a stock. The type of stock analysis you implement is based on personal preference. Understand the different ways to analyze a stock to find the method that best fits your financial objectives.
Technical analysis studies the supply and demand of a stock within the market. Investors who use technical analysis believe that a stock’s historical performance indicates how the stock will perform in the future. Little attention is given to the value of the company. Technical analysis places heavy focus on the study of trends, charts and patterns.
A common method to analyzing a stock is studying its price-to-earnings ratio. You calculate the P/E ratio by dividing the stock’s market value per share by its earnings per share. To determine the value of a stock, investors compare a stock’s P/E ratio to those of its competitors and industry standards. Lower P/E ratios are seen as favorable by investors.
Earnings Per Share
A company’s earnings per share show how efficiently its revenue is flowing down to investors. An increasing EPS is taken as a good sign by investors. According to NASDAQ, the higher a company’s EPS, the more your shares are worth, because investors seek to purchase a company’s stock when earnings are high.
The price-to-earnings growth ratio takes the P/E ratio a step further by considering the growth of a company. To calculate the PEG, you divide the P/E ratio by the 12-month growth rate. You estimate the future growth rate by looking at the company’s historical growth rate. Investors typically consider a stock valuable if the PEG is lower than 1.
Another method used to analyze a stock is determining a company’s price-to-book ratio. Investors typically use this method to find high-growth companies that are undervalued. The formula for P/B ratio equals the market price of a company’s stock divided by its book value of equity. Book value of equity is derived by subtracting the book value of liabilities from the book value of assets. Investors view a low P/B ratio as a sign that the stock is potentially undervalued.
Return on Equity
Investors use return on equity to determine how well a company produces positive returns for its shareholders. Analyzing ROE can help you find companies that are profit generators. ROE is calculated by dividing net income by average shareholders’ equity. A continual increase in ROE is a good sign to investors.
Many investors use analyst recommendations to quickly size up a stock. Analysts perform extensive fundamental and technical research, and they issue buy or sell recommendations. Before deciding to buy or sell shares, investors typically use analyst recommendations in conjunction with a stock analysis technique.