There are no set ways to analyze a stock for investment. There are three types of analysis to be considered when deciding to invest in a particular stock -- technical analysis, financial analysis and analyzing the reports of securities analysts. Financial analysis generally covers five main points: price-earnings ratio, price-to-book ratio, debt-to-equity ratio, cash flow and price-earnings-growth or PEG ratio.
Technical analysis of stock price charts identifies trading ranges, price resistance and support. There are other indicators such as moving averages, relative strength, chart formations and various mathematical analysis tools that attempt to define buying interest and selling interest, and predict the price movement of the stock.
The price-earnings ratio attempts to discover whether the stock is trading cheap or rich. Find the P/E ratio by dividing the stock price by the earnings-per-share. Compare this to other stocks in that industry to determine if your stock is fairly priced. Most stock quote services indicate the P/E ratio.
The price-to-book ratio attempts to show whether a stock is over-priced. Take stockholders equity, which can be found in the company's balance sheet, and dividing that by the number of shares outstanding. The lower the number the better, but 1.5x is a good rule of thumb for fair value.
The debt-to-equity ratio indicates whether the company carries too much debt. Divide stockholders equity into total liabilities to find the debt-to-equity ratio. This is a number that must be compared to other companies in the same industry because different industries use different levels of leverage. The lower the number, in comparison with industry standards, the better.
Free Cash Flow
Find operating cash flow first by taking net income plus amortization and depreciation, minus capital expenditures and dividends. Free cash flow includes operating cash flow, plus or minus cash used or generated by investments and financing. This indicates whether a company generates plenty of money to operate and expand. Again, compare it to other companies in the industry.
Companies that have good financials but are not growing can result in a stock price that is not appreciating. To find the price-earnings-growth ratio, decide how many years of earnings growth you want to use, five for example, and average the EPS growth over those five years, then divide that into the P/E ratio. The lower the number the better, because it means the stock is undervalued.
Always look for analyst reports and recommendations for companies you are considering. If there are no analyst reports available, check the SEC's EDGAR database system and read the quarterly and annual filings by the company. These filings are an excellent source of the financial reports to use in your financial analysis.
- MSN Money: 5 Ways to Tell if a Stock is Cheap
- GuruFocus.com; Cash Flow: One of the Most Accurate Ways to Analyze a Stock’s Value; June 2010
- National Association of Online Investors; Investors: Analyze Financial Statements With a Critical Eye
- NYU Stern School of Business. "PE Ratio by Sector (US)." Accessed Oct. 4, 2020.
- multpl. "S&P 500 PE Ratio." Accessed Oct. 4, 2020.
- NYU Stern School of Business. "PEG Ratio," Page 3. Accessed Oct. 4, 2020.
- NYU Stern School of Business. "PEG Ratio," Page 6. Accessed Oct. 4, 2020.
Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.