Learn How to Buy Stocks
There are currently two main strategies for researching and forecasting the future growth trends of stocks - fundamental analysis and technical analysis. They are used to know how to buy stocks.
Fundamental analysis refers to the evaluation of a stock based on factors that can affect the company’s current business and its future growth potential. These can include the overall economy, conditions/trends of a specific industry, financial condition and management of the company itself. To determine the current and future state of a company, analysts usually look at the following key indicators.
(i) Earnings per share (EPS) – Calculated by dividing the net earnings by the number of outstanding shares. The EPS is a useful benchmark to compare one company to another within the same industry.
(ii) Price to earnings ratio (P/E) – Calculated by dividing the stock price by the EPS. The P/E lets the investor know how much the market is willing to pay for the company’s earnings. A higher P/E usually means that the market is optimistic about the company’s growth prospects, though it could also mean that the stock is overpriced
(iii) Price to sales (P/S) – Calculated by dividing the stock price by the sales per share. This ratio is useful for evaluating young companies with no earnings. The conventional wisdom is that the lower the ratio, the better.
(iv) Price to book (P/B) – Calculated by dividing the current stock price by the book value per stock. The P/B allows investors to assess how much value the market places on the book value of the company. This is also useful for comparing companies within the same industry.
(v) Return on Equity (ROE) – Calculated by dividing net income by book value. The ROE, when considered over a period of time, allows investors to identify the better long-term investments (i.e. more competitive companies) in the industry, as the latter have shown their ability to achieve greater profits with their assets over time.
Other indicators used are projected earnings growth, dividend payout ratio, dividend yield, etc. Besides these quantitative fundamentals, there are also the qualitative fundamentals such as the management quality, brand name recognition and proprietary technology that can boost the company’s performance. In short, fundamental analysis, with its thorough understanding of a company’s business, helps investors identify sound long-term investments.
On the other hand, technical analysis looks at stock market statistics, such as past prices and trading volume. Stock charts are also used to identify patterns and trends to predict the stock’s future price movements. Technical analysis is based on two principles – (i) the stock price, at any given time, reflects all the factors that can affect the company; and (ii) stock price movements follow a trend, including historical ones.
According to technical analysis, it is important to understand and identify the trend (i.e. uptrends, downtrends and sideways) so that the investor trades with, and not against the trend. To get a better sense of a stock’s overall trend, analysts use the moving average, which is the average stock price over a period of time. By removing the daily fluctuations, analysts are better able to identify the true trend.
In addition, the stock usually trades within a range defined by the support and resistance levels. Once these levels are breached, it is said that the psychology behind the stock’s movement has shifted, in which new levels will be established. The analysis of these levels allows investors to identify when a trend is changing and adjust their trading decisions accordingly. Another important aspect of technical analysis is the trading volume which is used to confirm trends and chart patterns. (Any price movement with a relatively high volume is seen as a more relevant move than one with a low volume.)
Once you know what types of stocks you want to buy you must then use resources to find these stocks.
Here at WallStreetWindow we use a combination of both fundamental and technical analysis in our TwoFold Formula. To learn about it click here.