It would be great to have a magic wand that would allow us to distinguish which stocks are good or bad when it comes to investing. Obviously, this does not exist; in fact, there is really no foolproof method that allows us to predict 100% of how an asset may behave.
However, there are different ways through which we can obtain sufficient elements of judgment to be able to make decisions. And this is really important: in investment, as in any order of life, well-founded decisions are usually more effective than impulsive or thoughtless decisions.
Formulas to analyze a stock market action to invest (or not)
There are many ways to select stocks based on different parameters or analysis elements.
If I had to make two large groups, to generalize, I would say that for the long-term investor, fundamental analysis tools are the ones that carry more weight, while for the short-term investor, the weight of the analysis can rest more on technical analysis.
Fundamental analysis focuses on assessing a company’s financial health, considering factors such as revenue, profits, and future growth. It’s like giving a company a medical checkup to decide if it’s a good long-term investment. It’s about understanding the real value of a stock, beyond its current market price.
Technical analysis, on the other hand, studies the price and volume patterns of stocks in the market. It’s like predicting the weather based on certain patterns, looking for signals on when to buy or sell. This method focuses more on “when” to invest rather than “what” to invest in, using charts and trends to make quick decisions.
Note! Both analytical models do not have to be mutually exclusive. Depending on the type of investor you are, you may give more or less weight to one of the models, but you may also use tools from the other to increase your information.
Stock analysis: main tools and models
Let’s take a quick look at the main ways we can analyze a stock and assess whether or not it is really interesting to invest in. We will go into more detail about some of them later, but for now, let’s get to know them.
Fundamental analysis
This type of analysis focuses on the financial health of the company and its growth potential.
- Financial Results : Review the company’s financial reports, including revenue, earnings, cash flow, and debt.
- Financial Ratios : Analyze key ratios such as price/earnings (P/E), return on equity (ROE) and debt.
- Growth : Evaluate the company’s growth potential, including expansion plans, new products and markets.
- Sector and industry : Understand the company’s position within its sector and the health of the sector itself.
- Dividends : If the company pays dividends, consider the regularity and growth of these payments.
Technical analysis
This analysis is based on the study of price and volume charts of the stock to predict future price movements.
Highlights:
- Price Trends : Identify patterns in the price chart that may indicate future trends.
- Technical Indicators : Use tools like moving averages, RSI (Relative Strength Index) and MACD (Moving Average Convergence/Divergence) to analyze price momentum and direction.
- Trading Volumes : Look at trading volumes to confirm identified trends.
Market sentiment
Market sentiment can influence the price of a stock regardless of the company’s fundamentals.
- News and Events: Stay up to date with relevant news, including regulatory, economic and political changes that may affect the company.
- Sentiment Analysis: Use sentiment analysis tools to measure market perception towards the stock.
risk assessment
- Market risk: Considers external factors such as the global economy, interest rates, and competition.
- Company-specific risk: Assesses internal risks, such as management changes, legal issues, or major project failures.
Analyzing a stock based on its profit
When you first dive into analyzing stocks on an earnings-per-share basis, the importance of financial performance as an indicator of how robust (or not) a company’s economics are becomes clear.
The benefits enable everything from increased liquidity to reduced financial obligations, including dividend distribution and capital reinvestment.
Initial analysis often focuses on a company’s financial results to assess the attractiveness of its stock, although this approach, while relevant, is not exclusive to determining its potential.
There are companies whose profits may be initially limited or non-existent, and despite carrying debt burdens, their shares may prove to be promising investments due to their potential for future growth. Therefore, reviewing profits should not be the only criterion; rather, it should be considered as the starting point of a broader analysis.
Earnings per share (PER) ratio
The earnings per share (PER) ratio is a key indicator in this analysis, as it provides an estimate of the years of profits required to recover the investment in the stock.
