Basics of Stock Analysis

Bull and Bear Markets, and Short Selling

Two of the basic concepts of stock market trading are “bull” and “bear” markets.

The term bull market is used to refer to a stock market in which the price of stocks is generally rising. This is the type of market most investors prosper in, as the majority of stock investors are buyers, rather than short sellers, of stocks. A bear market exists when stock prices are overall declining in price.

Investors can still profit even in bear markets through short selling. Short selling is the practice of borrowing stock that the investor does not hold from a brokerage firm which does own shares of the stock. The investor then sells the borrowed stock shares in the secondary market and receives the money from that sale of stock. If the stock price declines as the investor hopes, then the investor can realize a profit by purchasing a sufficient number of shares to return to the broker the number of shares they borrowed at a total price less than what they received for selling shares of the stock earlier at a higher price.

For example, if an investor believes that the stock of company “A” is likely to decline from its current price of $20 a share, the investor can put down what is known as a margin deposit in order to borrow 100 shares of the stock from his broker. He then sells those shares for $20 each, the current price, which gives him $2,000. If the stock then falls to $10 a share, the investor can then buy 100 shares to return to his broker for only $1,000, leaving him with a $1,000 profit.

Analyzing Stocks – Market Cap, EPS, and Financial Ratios

Stock market analysts and investors may look at a variety of factors to indicate a stock’s probable future direction, up or down in price.

Here’s a rundown on some of the most commonly viewed variables for stock analysis.

A stock’s market capitalization, or market cap, is the total value of all the outstanding shares of the stock. A higher market capitalization usually indicates a company that is more well-established and financially sound.

Publicly traded companies are required by exchange regulatory bodies to regularly provide earnings reports. These reports, issued quarterly and annually, are carefully watched by market analysts as a good indicator of how well a company’s business is doing. Among the key factors analyzed from earnings reports are the company’s earnings per share (EPS), which reflects the company’s profits as divided among all of its outstanding shares of stock.

Analysts and investors also frequently examine any of a number of financial ratios that are intended to indicate the financial stability, profitability, and growth potential of a publicly traded company. Following are a few of the key financial ratios that investors and analysts consider:

Price to Earnings (P/E) Ratio

The ratio of a company’s stock price in relation to its EPS. A higher P/E ratio indicates that investors are willing to pay higher prices per share for the company’s stock because they expect the company to grow and the stock price to rise.

Debt to Equity Ratio

This is a fundamental metric of a company’s financial stability, as it shows what percentage of company’s operations are being funded by debt as compared to what percentage are being funded by equity investors. A lower debt to equity ratio, indicating primary funding from investors, is preferable.

Return on Equity (ROE) Ratio: The return on equity (ROE) ratio is considered a good indicator of a company’s growth potential, as it shows the company’s net income relative to the total equity investment in the company.

Return on Equity (ROE) Ratio

The return on equity (ROE) ratio is considered a good indicator of a company’s growth potential, as it shows the company’s net income relative to the total equity investment in the company.

Profit Margin

There are several profit margin ratios that investors may consider, including operating profit margin and net profit margin. The advantage of looking at profit margin instead of just an absolute dollar profit figure is that it shows what a company’s percentage profitability is. For example, a company may show a profit of $2 million, but if that only translates to a 3% profit margin, then any significant decline in revenues may threaten the company’s profitability.

Other commonly used financial ratios include return on assets (ROA), dividend yield, price to book (P/B) ratio, current ratio, and the inventory turnover ratio.

Sources:
www.wikipedia.org / www.corporatefinanceinstitute.com / www.businessdictionary.com / www.readyratios.com / www.moneycrashers.com