You may know that selecting a profitable investment, such as stocks, is challenging for many investors. However, investing in the stock market can also be rewarding and lucrative when you make the right choices in the long run. Fortunately, as an investor, you can use investment analysis in order to help you determine how your investment will perform.
As a new investor, it can be intimidating to venture into the stock market. While you may know that the main idea is to buy stocks at a low share price and sell them for a higher price later, when it comes time to purchase individual stocks, you might be at a loss.
Stock picking can seem challenging and confusing, but using investment analysis and ratios can help you find lucrative and long-term investing opportunities.
Investment analysis is a robust ongoing process that involves evaluating current as well as potential allocations of various financial assets, such as stocks and bonds, and then choosing those allocations that best fit your needs and goals.
How can you decide which stocks to purchase and when to buy them? Note that there are many factors you should consider before making the decision.
Price-Earnings Ratio
When conducting investment analysis, understanding and evaluating a price-earnings ratio is important. The ratio shows the vital correlation between the price of a single share of a stock and the earning-per-share that the firm or company reports over a specific period. Keep in mind that this period is usually one year.
The ratio illustrates the amount of money that each investor is putting into the company for every dollar of earnings or post-tax profits the company posts. It is best to look for companies that post yearly growth in earnings. However, it is worth noting that an occasional hiccup during, for example, recessions is acceptable.
While it isn’t a perfect metric, it is undoubtedly one you should consider. In many cases, investors will compare one stock’s P/E ratio to another stock’s P/E ratio in the same industry in order to determine the value of the stocks. Typically, investors and analysts consider lower P/E ratios more favorable.
Cash Flow
The second and important factor of investment analysis is free cash flows. Did you know that cash flows arise in many ways, such as dividend income from a publicly-traded stock or interest payments on a government bond? It is worth noting that a strong free cash flow is usually an important signal that the underlying company has a competitive advantage over its competitors.
You should know that an investor will like to evaluate cash flows in order to see if the cash flows repay the investment while also paying off the assumed value of the risk on the proposed investment.
You can use many methods, such as discounted cash flow, to evaluating cash flows. Some other techniques include the future value of cash flows.
Share Price and Intrinsic Value
You may know that famous and insightful investor Warren Buffett made billions of dollars by comparing the fair market value of stocks to their current market price. When Buffett finds a company that is trading lower than its stock price, he pounces and makes the most of the discount.
You should know that Buffett understands that in most cases, an undervalued stock will finally climb to reach its fair value or intrinsic value.
This process is known as value investing. It is a type of investing that places the utmost importance on a company’s valuation. Value investing uses various metrics in order to determine whether the stock valuation is high, low, or where it should be.
Excellent Current and Projected Profitability
When performing investment analysis and choosing stocks, you should consider a company’s financial fundamentals, such as operating margins, earnings, and cash flow. Together, all these factors can reasonably paint a realistic picture of the company’s existing financial health as well as how profitable the company is likely to be in the near future and long-term.
And on the earnings side, you should consider how stable the earnings are and how they are trending. Keep in mind that higher operating margins are usually more favorable compared to lower operating margins with regards to measuring how efficiently the company operates.
Dividend Yield
We can define the dividend yield as the relationship between a company’s stock price and its dividend payments. You can calculate the dividend yield by dividing the annual dividend by the company’s current stock price.
Note that if your main goal is to produce income through your investments, you should take the time to consider the dividend history and trends of the company you are interested in purchasing to make the best decision.
Ultimately, most income investors are usually looking for high dividend yields or a higher level of income in relation to the company stock’s price. It is best to look for a company’s dividend yield (or yearly dividend), expressed as a percentage.
Final Thoughts
Keep in mind that selecting the wrong or inappropriate investment opportunity may end up costing you your whole investment or more. On the other hand, choosing the right investment opportunity can help you achieve your investment goals. Using a suitable investment analysis method will help you make a better, more prudent, and educated decision.
It is no secret that making sound investment decisions requires thorough and comprehensive analysis and investigation. As an investor, you can use multiple investment analysis approaches to evaluate a proposed investment.
