Stock Market Analysis : Meaning, Importance and more

Stock market analysis is used to gain knowledge of the equity market to arrive at true value of a stock. It involves fundamental and technical research as its main tools.

What is Stock Market Analysis?

Stock market analysis enables investors to identify the intrinsic worth of a security even before investing in it. All stock market tips are formulated after thorough research by experts. Stock analysts try to find out activity of an instrument/sector/market in future.

By using stock analysis, investors and traders arrive at equity buying and selling decisions. Studying and evaluating past and current data helps investors and traders to gain an edge in the markets to make informed decisions. Fundamental Research and Technical Research are two types of research used to first analyze and then value a security.

Why is Stock Market Analysis important?

Performing a research before making an investment is a must. It is only after a thorough research that you can make some assumptions into the value and future performance of an investment. Even if you are following stock trading tips, it ideal to do some research, just to ensure that you are making an investment that’s expected to get you maximum returns.

When you invest in equity, you purchase some portions of a business expecting to make money upon increase in the value of the business. Before buying anything, be it a car or phone, you do some degree of research about its performance and quality. An investment is no different. It is your hard earned money that you are about to invest, so you must have a fair knowledge of what you are investing in.

What is Fundamental Research?

In fundamental research, you try to find out value of an equity share using the information provided in the financial statements of the company. The investor tries to analyse various aspects of the business like competitive advantage, financial soundness, quality of management and competition.

The main aim is to ascertain the relative attractiveness of the underlying business. Here, it is assumed that the market price doesn’t reflect the true value of the company due to some uncontrollable external factors like investor sentiments. As the market will attain equilibrium, the real value will be equal to its market price in the long run. It believes that paying a higher price for a stock will affect return on investment adversely.

Thus, by means of financial ratios, investors try to arrive at the true value at which a stock should ideally trade in the market.

Which key indicators are used in Fundamental Research?

Financial ratios form the pillars of fundamental research. Some of them are as follows:

• Return On Equity (ROE)

Return On Equity tells you about how much does a company earns on shareholders’ equity. It gives you information apart from a simple profit figure. It shows whether the operation of the company are efficient or not.

Return On Equity = [(Income – Preference Dividend)/ (Average Shareholders’ Equity)]*100While looking for this metric, an ideal ROE is one which is consistent, high and increasing. ROE of one company can be compared with its own past performance and with performance of other companies within the same industry. You may use it irrespective of the type of industry.

• Debt-Equity Ratio (DER)

Debt-Equity Ratio shows the proportion of assets which is being used to finance the assets of the company. It indicates how much funds have been provided by the borrowers and owners of the company. This ratio can be expressed in numbers and in percentage.

Debt-Equity (D/E) Ratio = Total Debt/Total EquityWhile looking for a debt-equity ratio, go for the ones which are lower than others and are decreasing in a consistent manner. You can compare D/E of one company with its own past performance and with performance of other companies within the same industry. You may use it to analyse performance of capital intensive industries like capital goods, metals, oil and gas.

• Earning Per Share (EPS)

Earning Per Share is one such useful measure which the investors look for all the time. It shows the amount of money which the company is earning on every share. EPS of a company needs to increase in a consistent manner to show superior management performance.

Earning Per Share = (Net Income – Preference Dividend)/Weighted Average Number of Shares OutstandingEPS of one company can be compared with its past performance and with that of other companies in the same industry. It can be used to ascertain what portion of profit is the company allocating to each outstanding share. Investors usually go for companies which have steadily increasing earnings per share. It can be easily used to compare performance across industries.

• Price to Earning Ratio (PER)

Price to Earning Ratio compares the current market price of the share with the earnings per share. It tells you the price which the investors are willing to pay for the share depending on the current earnings.

Price to Earning Ratio = Current Share Price/Earning Per ShareThis ratio also indicates the number of years that will be required to get back the initial invested capital by way of returns. You need to look for stocks which have a low price to earnings ratio. You can easily compare P/E ratio of a company with its past performance and also with other companies operational in the same industry. Ideally, this ratio is suitable to analyse performance of companies present in FMCG, pharmaceutical and technology sector.

What is Technical Research?

Technical research relates to the study of past stock prices to predict the trend of prices in future. It shows you the direction of movement of the share prices. With the help of technical research, you can identify whether there will be sharp rise or fall in the price of share. It is not dependent on recent news or events which has already been incorporated in the price of the share.

As the stock prices are dependent on investor psychology which keeps changing according to news and events, technical research emphasises the use of Stop-losses. It will save investors from suffering a big loss in future. Technical research gives meaningful results only for stocks which are high in demand and traded in huge volumes.

Technical research uses different types of charts like bar chart, candlestick chart; to understand the pattern of stock prices. Daily charts are used by short term traders to examine the immediate movement in the stock prices. Weekly / monthly charts are used by medium/long term traders to ascertain the probability to earn higher more in the long run.

How to invest in Equities?

While venturing into stocks, don’t blindly believe on anyone else’s advice. Conduct a thorough analysis before buying any stock. Do not invest more than 10% in any single company. Many a time investing in equity becomes complex.

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