Time to get your scalpels out and scrutinise
your stocks minutely. Yes, almost like a professional analyst would do.
Just a recap: A stock is a unit of ownership
of a company that the public can own and trade. A stock’s value is dependent
on many things. Among many things, the value could depend on how the company’s
business is faring. It could also depend on how the stock is traded on
the stock exchange. Analysing stocks, or assessing their value, hence
takes two widely followed methods of analysis, the fundamental and the
A fundamental analysis looks at all things that could possibly affect
the business of a company.
Some of these things looked at are:
the company’s sales and earnings, the operating margins, the balance sheet,
the composition of the top brass, the company’s clientele, the prospects
of the industry it is in, competition it faces and so on.
You need to know how much has the company
sold and how much are its profits. Investors always go for a company with
high sales and good profits. Companies with sales and profit figures more
than the industry average are generally preferred.
Operating margin and net operating margins
tell us about the profitability of a company. In mathematical terms they
are ratios expressed in percentages of the company's gross profit and
net profit to the sales, respectively. A debt-to-equity ratio is a measure
of a company's leverage, calculated by dividing long-term debt by common
shareholders' equity. The ratio for a company depends on the industry
it functions in. A high ratio indicates a good chance that the company
won't be able to service its debt in the future. However, the company's
debt/equity ratio should generally be below the industry average.
Just impressive sales and profit figures
don't impress many investors. They also judge a company by its growth
rate i.e., rate of growth in sales as well as profits. A fast growing
company has good capital appreciation. Good growth is also a reflection
of quality management. One also checks for growth rate figures to be consistently
above the industry average.
In a fundamental analysis one would
not make an analysis of the stock market or the stock’s behaviour. With
a fundamental analysis you might find companies that are fundamentally
strong i.e., have an excellent business performance, but whose stocks
are currently undervalued by the market.
A technical analyst, on the other hand,
sits on a lot of charts to infer patterns on how a stock is being traded.
He employs complex statistical tools to study the graph of a stock’s price
and its quantity traded over time. Out of all his efforts he expects the
shape of the graph to tell us whether the stock price will rise or fall.
Such an analysis also looks for certain
price levels in a stock’s performance in the past e.g., 52-week high and
the 52-week low. These levels tell the highest and lowest price of the
security for the past one year. The 52-week low is also called the support
level because it is commonly believed to be the 'support' level below
which the stock's price shouldn’t fall unless there is something fundamentally
wrong with the company. But if it does, watch out, it can become worse.
In a technical analysis, analysts also
look out for the average price of a stock which gives a good picture of
the price trend minus fluctuations. A moving average of a stock is the
average price of a stock over the past few days or months. Moving average
prices, one for a short period and another for a long period, set the
resistance levels or support levels for a stock. The first resistance
or support level is the average price of the stock over a short period,
say for the past 50 days. The second level is the average for a longer
period, say for the past 200 days. The commonplace idea is that the resistance
level resists the stock's or the market's efforts to go up for the time
being and support resists the price from falling any further from what
it already has.
If the current stock price is the same
as the 52-week high, then obviously you should avoid buying the share
at that price unless of course, you have inside information that it will
go even higher! In case the stock breaks its resistance level with huge
volumes, one might consider a buy after observing the stock movement for
a day or two. The stock price ideally should increase steadily and positively.
It should not fluctuate to a huge extent. A good stock should outperform
the industry. Generally you should attempt to hold the market's top-performing
securities -- those that have done better over the past year than the
majority of stocks and expected to outperform even in the near future.
The basics of technical analysis are
not too complicated for individual investors to try out themselves. Common
market wisdom is that the stock market moves in discernible patterns and
hence, technical analysis comes in handy by plotting graphs of recent
and historic price movements and analysing them for trends.