Investment professionals don’t just wake up and decide to buy a specific stock — a lot of research is involved beforehand. With the right analysis, investors can decide whether a company is undervalued or overvalued, or they can find the right price at which a company is worth buying. Luckily, anyone can analyze when to buy in. Here’s how:
Step 1: Understand the different types of analysis
There are three types of analysis: fundamental, technical and quantitative. The difference between these types is based on the information you use about the company and its stock price to make an investment or a trading decision. Despite each having its perks and flaws, successful investors and companies use a combination of two or all three of these techniques.
Fundamental
Fundamental analysis aims to determine a company’s fair value. This is a more common type of analysis because it uses freely-available information like price-to-earnings ratio, cash flow, earnings per share, etc. Typically, fundamental analysis is used by growth investors and value investors who are looking to get a great company at a fair price.
Pros
Easy to learn
Provides valuable company information
Helps you find excellent companies at a discount
Cons
May take a lot of time to find the right company
It may take months or years for the investment to pay off
It’s not foolproof — economic factors may change and negatively affect the company in multiple ways
Technical
Technical analysis uses charts with historical price movements of company shares to predict future price movements. Day traders and swing traders often use this type of analysis to help them find a good entry and exit price.
Pros
Helps you identify support and resistance levels, i.e. which price point is likely to be a good buy or sell
Highly customizable for your trading goals and strategies
Cons
All technical indicators are lagging behind the price
Can often give false signals
Doesn’t care about the company fundamentals, it only focuses on the share price
Quantitative
Quantitative analysis uses mathematical and statistical data to determine the value of a company’s share price and to predict future moves. Typically, “quants”, as these analysts are more commonly known, don’t concern themselves with the company’s fundamentals. Instead, quants make computer models and base their trades on that. Quantitative analysis is often used by high-frequency traders and hedge funds and rarely by long-term investors.
Pros
Completely removes emotion and personal bias toward share trading
Quant strategies can be automated, further removing human interaction
Cons
Can’t predict macroeconomic changes
A computer algorithm doesn’t understand news and events like a human does, which can impact the share price
Step 2: Learn how to interpret key company metrics
We’ll start off with some of the most popular metrics used in fundamental analysis.
Market capitalization
Market capitalization — often called “market cap” — is the total dollar market value of the company’s shares. Market cap is used to determine the company’s size. Typically, the bigger the market cap, the safer the company and the investment. Smaller cap companies, on the other hand, are riskier but they can have a bigger upside. Also, chances are higher that small-cap companies could be acquired by larger companies, which could quickly drive the share price higher. Based on market cap, companies can be:
Micro-cap (less than $30 million)
Small-cap ($300 million to $2 billion)
Mid-cap ($2 billion to $10 billion)
Large-cap ($10 billion or more)
Companies with a market cap of over $200 billion are often referred to as mega-cap. Blue chip companies, like Apple and Amazon, are mega-cap. How it’s calculated: Current market price x the total number of shares.
Price-to-earnings (P/E) ratio
Price-to-earnings ratio compares the share price to its earnings per share (EPS). This is a metric used to determine the value of the company stock. A high P/E ratio often means the company’s shares are overvalued or that investors expect increased growth. If the company has no earnings or is losing money, then the P/E ratio can be negative. How it’s calculated: Current share market price / Company’s EPS.
PEG ratio
PEG ratio — price/earnings-to-growth — is used to determine a company’s value by factoring in the earnings growth. This is supposed to provide more detailed information than simply using the P/E ratio. Many investors use the PEG ratio to show the stock’s true value. The idea behind this is that investors are looking for companies with low PEG ratios, meaning the company is undervalued. How it’s calculated: Price/EPS / EPS growth.
EBITDA
Earnings before interest, taxes, depreciation and amortization (EBITDA) is a measure of profitability. A negative EBITDA shows that a business has problems with profitability, while a positive EBITDA typically shows the company generates cash. How it’s calculated: Net income + interest + taxes + depreciation + amortization.
Step 3: Learn the difference between a “good” stock and a “bad stock”
In addition to the most widely used valuation metrics, there are other factors — including profitability, competitive moat and leadership — you should consider when researching stocks.
Profitability
Cost of goods sold (COGS), also known as gross profit margin, is another metric that measures company profitability. This is the difference between revenue and the costs of production. Typically, the higher the number, the more profitable the company. However, some sectors are affected by seasonality where the profitability number varies throughout the year. Note, startups and growth companies may not be profitable for months or years while they are reinvesting in growth or expanding their operations.
Competitive moat
Also known as an economic moat, a competitive moat is an advantage the company has over its competitors. This could be either access to cheaper raw materials, a patent or technology that no one else has. Good companies typically have a stronger competitive moat, which makes them a good candidate to invest in. Bad companies often don’t have any advantage over their competitors, which makes the competition hard to beat.
Leadership
Having strong leadership with a proven track record is another indication of a good company. Some of the criteria you should look for are:
How much of the leadership team has their net worth tied up in the company stock.
Whether their vision is clearly communicated to their employees, customers and shareholders.
Their success in attracting and retaining talent.
Their track record. This is the most important.
Market trends
Market trends change often based on macroeconomic and geopolitical events. For example, during the pandemic, companies that made vaccines did great. With the rise in cryptocurrency prices in 2021, crypto mining that used computer hardware boomed. Combined with the work-from-home practice and the need for new computers and devices caused massive demand for computer hardware. This benefited chip companies like Nvidia and AMD. Keep an eye out for market trends when deciding on which company to invest in.
Step 4: Find the data
Now that you know what data you need to analyze a stock, you need to know where to find it. Company financial reports are available on the Securities and Exchange Commission (SEC) website. All you have to do is type the company name in the search tab and go through the reports. This will take you to the Electronic Data Gathering, Analysis, and Retrieval system (EDGAR), which holds all company information. Another alternative is to use your brokerage. Large brokerage companies like Interactive Brokers hold tons of useful information. What’s more, a lot of the info is often presented in a user-friendly way, and it’s easier to find than going through whole SEC reports.
Decide on your investment strategy
Once you’re done researching potential investment candidates, you must decide on your strategy. This includes factors such as how long you are willing to wait for your investment to become profitable, what is your risk tolerance and when to cash out.
Type of stocks. When you’re looking for long-term investments, value and growth stocks are typically the way to go. To ride out high-inflation periods or prolonged bear market, dividend stocks are often a good option. But if you’re not keen on choosing the stocks yourself, you can always invest in exchange-traded funds (ETFs), which are basically a basket of stocks in a particular sector, industry or theme.
Risk tolerance. Those who are nearing retirement are often investing in low-risk companies. That’s because there’s not much time to correct a mistake if you’re wrong. Investors who have a long time to go to retirement can go for riskier investments in growth stocks.
Minimum holding period. Similar to risk tolerance, this typically depends on how long you plan to hold onto your stock. Value stocks may need years to be profitable, while growth stocks and speculative stocks can become profitable in days or months. However, they can lose value quickly if something goes wrong either with the company or the broader economy.
Amount willing to invest. This depends on your investment and diversification goals. General consensus among experts is that you should invest between 10% and 20% of your monthly income. Of course, this is flexible and mostly depends on your financial situation.
Create your watchlist
Watchlists are useful if you have multiple companies on sight and you’re waiting for a good price to enter. Most watchlists, whether they be from your brokerage or dedicated apps and platforms, let you set alerts when specific criteria are met. Most brokerage platforms let you create a watchlist of stocks, but if your brokerage doesn’t offer this feature, you can create a watchlist for free on platforms such as Yahoo Finance, MarketWatch, StockCharts.com and finviz.
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Bottom line
Three types of analysis can help you find the right stock to invest in: fundamental, technical and quantitative.
Fundamental analysis is most common and uses company financial data that’s freely available online.
If you need help with your stock research you can use investing newsletters like Ticker Nerd that do the work for you.
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Finder is not an adviser or brokerage service. Information on this page is for educational purposes only and not a recommendation to invest with any one company, trade specific stocks or fund specific investments. All editorial opinions are our own.
Kliment Dukovski is a personal finance writer at Finder, specializing in investments and cryptocurrency. He's written more than 700 articles to help readers compare the best trading platforms, understand complex investment terms and find the best credit cards for their needs. His expert commentary has been featured in such digital publications as Fox Business, MSN Money and MediaFeed. He’s also well-versed in money transfers, home loans and more — breaking down these topics into simple concepts anyone can understand. In another life, Kliment ghostwrote guides and articles on foreign exchange, stock market trading and cryptocurrencies.
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