How To Research Stocks: A Beginner’s Guide

The stock market is one of the greatest wealth-building vehicles ever created by the U.S. economy. Since the S&P 500’s inception, annual returns have averaged 10.7%. A simple investment in the S&P 500 index has paid off well for long-term investors. Nonetheless, a large contingent of investors have been able to outperform the broader market by picking individual stocks. Choosing which stocks to invest in over an index fund can expose investors to more risk, but the returns to the upside are exponentially more attractive. In order to beat the market, however, investors will need to learn how to research stocks; for most, that means conducting a fundamental analysis of individual equities.

How To Analyze Stocks

Stock prices are directly correlated to the global economy and its impact on investor sentiment. In other words, stock prices usually fluctuate based on how investors feel about a certain company and the macroeconomic conditions most likely to impact its future. That said, there are seemingly infinite factors that can impact the trajectory of a stock. Whether it is an accounting error on the company’s behalf or a multi-year pandemic, stock prices will move in the direction investors are convinced they belong.

Unfortunately, there are simply too many factors that can influence a stock price to account for them all. As a result, investors have developed several ways to research stocks in an attempt to uncover their true value. Despite their flaws, however, two strategies have risen to prominence. Any investor who wants to learn how to research stocks should attempt one of the following strategies:

• Fundamental Analysis: As its name suggests, a fundamental analysis attempts to assume an equity’s true value based on fundamental indicators. Instead of assuming that a stock’s price is directly correlated to the intrinsic value of the underlying business, an in-depth fundamental analysis will determine the closest thing to a stock’s true value by looking at anything and everything that can affect its future share price. A thorough fundamental analysis will account for everything, from secular economic trends and the state of the economy to the number of outstanding shares and the quality of the management team. A number of valuation metrics have been created to assist investors in conducting a fundamental analysis, but the goal is always the same: to provide investors with a share price they can use to determine whether or not the equity is valued fairly relative to its peers.

• Technical Analysis: Contradictory to its fundamental counterpart, a technical analysis ignores fundamental indicators. Instead of determining an equity’s fair value by assessing economic and financial indicators in relation to the company’s products or service, a technical analysis seeks to predict a stock’s price by referencing historical market performance. In other words, a technical analysis uses past performance to try and predict where a stock’s price will be in the near future. In studying the convergence of several statistical trends, like price and trading volume, a technical analysis will theoretically be able to tell investors where a stock price is going based on past performance.

To be perfectly clear, it is not possible to analyze a stock without an inherent degree of error; even these two stock research tools have their flaws. There is no way to predict the stock market or the direction individual equities will trend, but there is a way to place time on your side. With a sound stock analysis process, investors can increase their odds of beating the market over the long term and finding the best stocks to buy now.

How To Research Stocks In 4 Steps

In the event investors want to forego the technical analysis process and focus on researching an individual stock, they will be confronted with several options. Every investor and outlet, for that matter, probably has their own way to research stocks. That’s not to say one way is better than the other, or that there is only one way of analyzing equities, but rather that there are some universal rules that tend to apply to each technique.

Anyone who wants to learn how to research stocks should apply the following steps to their own process:

1. Start With Company Financials

2. Focus On Key Information

3. Conduct Qualitative Research

4. Decide If The Company Is Right For You

Start With Company Financials

The first step in a fundamental analysis involves quantitative research; that is to say, investors need to dig into the financial data of a respective company. Fortunately for anyone who wants to learn how to research stocks, the U.S. Securities and Exchange Commission (SEC) requires public companies to disclose many of their financial documents on a regular basis. In doing so, the SEC is able to protect investors, maintain a fair market, and facilitate capital formation. At the same time, investors may use the financial statements to gain a better understanding of a company’s performance.

Not surprisingly, financial statements can reveal a lot about a company’s financial position. Most notably, financial statements can tell investors a number of important facts, not the least of which include:

• how money is made

• whether or not revenue is growing

• the total value of assets held

• how much debt the company currently has

• which direction cash is flowing

Financial statements can tell investors a lot about a respective company. However, the information necessary to research stocks isn’t relegated to a single financial statement; it is spread across several different statements. As a result, investors learning how to research stocks will also need to learn how to find and read the following financial statements:

• Form 10-K: Filed once a year with the SEC, the 10-K is a collection of financial statements that have been audited by an independent third party. The 10-K is comprehensive and extensive and contains just about everything an investor learning how to research stocks needs. This particular form holds the company’s income statement, balance sheet, and cash flow statement. The 10-K reveals how the business makes money, the risks it is exposed to, revenues and expenses, and insights offered by management.

• Form 10-Q: Though not as popular as the 10-K for stocks research, the 10-Q is a quarterly report of unaudited financials. While less comprehensive, the 10-Q can still reveal a lot of information about a company and teach investors how to research stocks. A lot of the information found in a 10-Q can be found in a 10-K but on a quarterly basis.

Each of these reports can be found relatively easily. In fact, the first place to look for each report is on the company’s own website. Most publicly traded companies have dedicated “investor relations” pages to divulge the necessary financial information. In order to research stocks and their financials, simply navigate to the company’s investor relations page and look for the most recent report. While each website has their own way of doing things, the financial information most investors are after is usually under a “news,” “press releases,” or “financials” tab.

In addition to the company’s own website, financial statements may also be found on the SEC’s website. More specifically, the SEC’s Electronic Data Gathering, Analysis and Retrieval (EDGAR) website offers investors a searchable database to research stocks.

Last, but certainly not least, are the stock research tools provided by today’s many brokerages. Most online brokerages provide all of the financial information investors need to research stocks. The information available will vary from brokerage to brokerage, but is primarily found on each equity’s summary page.

Financial statements can be dry to read and intimidating for anyone trying to learn how to research stocks. Nonetheless, they are full of valuable information for those willing to put in the time. In order to make reading financial statements a little easier, investors should focus on the most important metrics outlined in the next section.

Focus On Key Information

Financial statements are full of numbers anyone learning how to research stocks may not understand. At the very least, the quantitative data required by the SEC is comprehensive and intimidating to anyone who doesn’t know what to look for. As a result, new investors should focus on the most important numbers. That’s not to say the rest of the reports should be ignored, but rather that new investors will probably get the most out of the following metrics:

• Revenue: Often referred to as “the top line,” revenue is the first line item on the income statement and denotes the total amount of income generated by the company. Revenue may be broken down into two metrics: operating and non-operating revenue streams. Operating revenue is generated from the company’s core business. Non-operating revenue identifies money brought in from a one-time business activity.

• Net Income: Net income is the last line item on the income statement and is also referred to as “the bottom line.” As its name suggests, net income represents the money a company has left over after operating expenses, taxes and other costs are subtracted from revenue.

• Earnings Per Share: When investors divide earnings by the number of outstanding shares, they reveal the earnings per share metric. The earnings per share suggests how profitable a business is on a per-share basis. While far from a perfect metric, earnings per share does give investors a good way to compare two stocks with different totals of outstanding shares.

• Price-To-Earnings Ratio: True to its name, the price-to-earnings ratio represents the ratio of a company’s share price to the company’s earnings per share. In doing so, investors may determine if a stock is overvalued or not.

• Price-To-Earnings Growth Ratio: The price-to-earnings growth ratio isn’t typically on financial statements, but investors may calculate it using metrics found on reports. Investors will first need to divide the company’s share price by its EPS (earnings per share). Next, take the resulting number and divide it by the earnings per share growth rate. The resulting PEG ratio will give investors a better idea of the company’s future profitability relative to each share.

• Price-To-Book Ratio: Otherwise known as the P/B ratio, the price-to-book ratio is a metric used to compare a stock’s current market value to its book value. A company’s book value is how much it is worth according to its balance sheet—less depreciation, amortization, and any other costs devaluing the assets. With the P/B ratio, investors may value a company’s equity relative to the assets it holds. For context, any company with a P/B ratio under one is generally considered a good value.

• Debt-To-EBITDA Ratio: EBITDA is an acronym for earnings before interest, taxes, depreciation, and amortization. Therefore, the debt-to-EBITDA ratio gives investors an idea of how much income a company has to pay down debt before accounting for interest, taxes, depreciation, and amortization. In other words, this ratio tells investors how capable a company is at paying off its known debts.

Conduct Qualitative Research

With most of the financial information accounted for, investors should turn to a more qualitative process. Instead of looking at numbers and data, investors need to take a closer look at the business itself and how it operates. Getting down to the basics of the business can tell investors a lot about a company, and can be as simple as answering the following questions:

• How does the business make money?: While it is usually obvious how a public company makes money, there are many exceptions. In fact, many up-and-coming tech companies aren’t even profitable at all. That said, it is important to not only know how a company makes money, but whether or not it is even profitable. Doing so will help analyze a stock at any cycle in the economy.

• How big is the company’s moat?: Not unlike the moat found around a medieval castle, a stock’s moat helps protect the business. More commonly referred to as a competitive advantage, a moat is something that helps differentiate the business from its competitors. The wider the moat, the more likely a business is able to maintain or grow its competitive advantage over time.

• How much experience does management have?: Management plays a pivotal role in the development and growth of a business. Great management is entirely capable of taking a company to the next level. Therefore, it is important to evaluate management’s experience and track record.

• What are the potential risks?: When evaluating a stock for its potential, it is also important to look at the risks which pose a threat to future growth. If for nothing else, knowing what can hurt the stock is just as important as knowing what can help it. Understanding risk helps put things into perspective and prevents overallocation into a single equity.

• What values does the company exercise?: When learning how to research stocks, investors should take a minute to evaluate the values each one exhibits. Values can play a big role in stock performance, and can even align with an individual investor’s own values. It is always important to invest in the stocks which support the future investors hope to see, so it is never a bad idea to invest in stocks that support your own values.

Decide If The Company Is Right For You

When learning how to research stocks, investors must also learn a little about themselves. In particular, it is always a good idea to make sure the company fits into an existing investment strategy. The strategy for investing is just as important as the stocks that make up a portfolio, if not more so. Therefore, investors need to make sure the stock is the right fit for them and their portfolio.

For starters, investors should prioritize stocks that complement their investment strategy. Those with long-term investing horizons will most likely favor growth stocks with a lot of potential upside. Younger investors, for example, tend to build portfolios out of stocks with more upside over the long run. It is worth noting, however, that growth stocks tend to expose investors to a little more risk. Typically, growth stocks are small, unproven companies with a lot of upside. That said, the unproven nature of growth stocks coincides with more risk, which is more acceptable for young investors with plenty of time to make up for any mistakes.

Those on the verge of retirement, however, may want to avoid growth stocks altogether. Shorter investing timelines don’t grant growth stocks the ability to compound over time and expose investors to more risk; something older investors can’t afford. As a result, those with fewer years to invest tend to focus on bluechip stocks with proven track records. The stable nature of bluechip companies limits upside, but can serve as a trustworthy source of income.

When all is said and done, there are countless inviting strategies. Still, not all stocks are created equal; some are inherently better for investment strategies than others. With that in mind, investors need to make sure the stocks they choose to invest in meet their unique needs.

Example Of Stock Research

Now that investors have a better idea of how to research stocks, it may be helpful to see the aforementioned information put to work. Let’s say, for example, there’s an investor who wants to start a position in the rapidly growing semiconductor industry. After careful deliberation, the investor has decided to choose one of two companies: Advanced Micro Devices, Inc. (NASDAQ: AMD) and NVIDIA Corporation (NASDAQ: NVDA). Both companies are industry leaders, but it is hard to tell how a company is doing based on price alone.

Upon a closer look at each company’s financials, investors will notice the following (figures as of August 4, 2022):

AMD

• P/E Ratio: 38.65

• P/S Ratio: 7.02

• P/B Ratio: 3.05

NVDA

• P/E Ratio: 51.52

• P/S Ratio: 16.51

• P/B Ratio: 18.25

When examining the two stocks, investors will notice NVIDIA has a higher price-to-earnings (P/E) ratio than AMD. While a high or low ratio isn’t necessarily indicative of a good or bad valuation, most investors will want to see the P/E of a respective stock somewhere around the neighborhood of 20 to 25. Since both of these companies are well over the 20 to 25 threshold, you could argue each company’s share prices are overvalued, relative to the earnings per share. However, with a lower P/E ratio, AMD currently looks like a better value.

Next, investors will notice AMD’s 7.02 price-to-sales (P/S) ratio is lower than NVIDIA’s 16.51. With a price-to-sales ratio that is less than half of NVIDIA’s, investors in AMD’s stock are theoretically paying less for every dollar of the company’s sales. As a result, AMD looks like a better value than NVIDIA on a price-to-sales basis.

The price-to-book (P/B) ratio will help investors compare each semiconductor company’s current market value to its book value. Traditionally, the lower the book value, the more a company can expect in return if it sold all of its assets at current market prices. Since AMD’s P/B ratio is lower than its competitor, it’s safe to assume it is a better value.

Looking at only the financial metrics would tell investors that AMD is a better valuation at its current price. As such, AMD should have a better opportunity to grow its share price. However, the market prices equities on more than just financials. It is at this point investors must conduct their own qualitative analysis and cross-reference their findings with the company’s financials.

For instance, while AMD may represent more of a value, NVIDIA is arguably the industry leader. Jensen Huang, NVIDIA’s CEO, is nothing short of a visionary and one of the primary reasons the company is doing so well. That’s not to say Lisa Su (AMD’s CEO) isn’t a brilliant manager, but rather that other factors need to come into play.

When learning how to research stocks: there’s one key takeaway for investors: there is no perfect way to research a stock. Different investors choose different reasons to invest in a variety of stocks, all with justifiable reasoning. That said, the stock research tools outlined above can give investors a better idea of which stocks will help portfolios the most.

Summary

Understanding how to research stocks is of the utmost importance to any investor who has made the decision to invest in individual equities. However, it is important to note that even the best research may be compromised. In fact, there is no universal strategy to research stocks that isn’t inherently flawed. If for nothing else, the macroeconomic environment by which Wall Street operates is too unpredictable for anyone to feel confident in. As a result, the best thing investors can do is work with the information they are given to give themselves the best chance of realizing success.

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FortuneBuilders is not registered as a securities broker-dealer or an investment adviser with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority (“FINRA”), or any state securities regulatory authority. The information presented is not intended to be used as the sole basis of any investment decisions, nor should it be construed as advice designed to meet the investment needs of any particular investor. Nothing provided shall constitute financial, tax, legal, or accounting advice or individually tailored investment advice. This information is for educational purposes only is not meant to be a solicitation or recommendation to buy, sell, or hold any securities mentioned.