How to Analyze Stocks and Make Informed Investment Decisions

On a beautiful sunny day, as you joyfully cruise towards your office, the radio fills your car with your favourite song, bringing a smile to your face. The perfect weather and melodious tunes create a harmonious atmosphere. But as the song ends, a commercial break interrupts the momentary bliss.

The first ad promotes a new real estate project in Noida, enticing you with the idea of a dream home. Then, another ad highlights the benefits of a cooking oil, tempting your taste buds. Finally, a mutual fund ad takes the stage, introducing a new equity mutual fund. However, as the ad concludes, the narrator’s voice suddenly accelerates, cautioning you with a reminder that “mutual fund investments are subject to market risks, read all scheme related documents carefully”.

You always listen to this disclaimer and smile, understanding the importance of the message that should be conveyed before pitching the ad. However, you notice that it is often overlooked, likely due to the fear of discouraging potential investors in equity markets. Nevertheless, you choose to overlook this omission and continue driving smoothly to your office, keeping in mind the timeless advice of Warren Buffett, who famously said, “Risk comes from not knowing what you’re doing.

Investing in markets can be a treacherous task, requiring a careful balance of numbers and emotions. Many individuals begin investing with the intention of making quick and easy money, only to discover that they are the ones who learn the hardest lessons. The market favours those who are well-informed about the risks they are undertaking and are prepared to navigate them wisely.

We will guide our readers on stock analysis and how they can embark on their own investing journey. Stock analysis involves evaluating a stock to determine whether it is worth buying and at what price.
There are two primary methods of stock analysis: Fundamental Analysis and Technical Analysis.

• Fundamental analysis: Itis a method that concentrates on evaluating the financial well-being of a company. It involves scrutinizing the company’s balance sheet, profit and loss statement, and conducting a comprehensive study of the industry and economy in which the company operates. Several financial ratios play a crucial role in comprehending the overall state of the company. Let’s delve into a few of them:
  1. Earnings per Share (EPS): EPS measures the company’s profitability. For instance, consider two companies, A and B, both with revenues of 500 Cr. Company A has a net income of 100 Cr, while Company B has a net income of 50 Cr. At first glance, it seems Company A is the better choice.

     Let’s explore the example you provided to illustrate how EPS can offer a different perspective:

     EPS= Net Income/ Average Outstanding Shares

     Company	A	B
     Net Income (In Rs.)	100 Cr	50 Cr
     Average Outstanding shares	20 Cr	5 Cr
     EPS	5	10

     In this case, despite having a higher net income, Company A has an EPS of 5, whereas Company B has an EPS of 10. This means that Company B is generating higher earnings per share compared to Company A, indicating that it may be more efficient in utilizing its shares to generate profits for shareholders.

  2. Return on Equity (ROE): ROE is simply the return on net assets.

     ROE= Net Income / Shareholder’s Equity

     It indicates how efficiently a company is utilizing its equity to generate profits. A higher ROE signifies a more effective use of shareholder investments.

     Return on Capital Employed (ROCE) = ROCE = PBIT / Total capital employed

     ROCE is a useful metric for comparing profitability across companies based on the amount of capital they use – especially in capital-intensive sectors.Enhanced ROCE can potentially drive valuations and perception.

  3. Price to Earnings Ratio (P/E): As the name suggest, it is calculated as Price divided by earning of the company. It tells how much we have to pay to buy one share vs. the earning per share.

     P/E = Current Market Price of Share / EPS

     High P/E depicts an overvalued stock, or investors are expecting high growth in the future.Whereas a company with no P/E ratio means no earnings. P/E is usually seen as a comparison tool among the peer companies.

  4. Dividend Payout Ratio:  This ratio helps in understanding the dividend a company gives to it shareholder from its net earnings.

     Dividend Payout Ratio = Dividend Paid or Dividend Per Share / Net Earnings or EPS

     The most important aspect indicated by this ratio is the level of maturity and reinvestment opportunities for a company. Old or mature companies tend to pay higher dividends compared to new or young companies. This is because young companies prefer to use their net earnings to reinvest in the business rather than distributing it to shareholders.

• Technical Analysis : It involves studying charts derived from trading activities. Unlike fundamental analysis, which focuses on balance sheets and cash flow statements, technical analysis examines price and volume charts over various time horizons.The underlying principle of technical analysis is that past trading behaviour can serve as an indicator of future price movements. By analysing charts across different time periods such as 15 minutes, 30 minutes, or 1 day, analysts can identify patterns and predict trends.Charts can be presented in various forms, including bar, line, or the widely used candlestick chart. Chart analysts utilize multiple indicators, including momentum indicators, support and resistance levels, moving averages, and chart patterns, to determine the expected price movements.Let’s look at these indicators:
  1. Support and Resistance Levels: Prices fluctuate based on the interplay of demand and supply. During an uptrend, when demand exceeds supply, prices rise. At a certain point, supply and demand reach equilibrium, resulting in a price level that acts as resistance. Similarly, support represents a downside level where prices hold before further movement.
  2. Momentum Indicators: Momentum indicators such as RSI (Relative Strength Index) and MACD (Moving Average Convergence/ Divergence) measure the strength or weakness of the existing trend. They provide insights into the speed and magnitude of price movements.
  3. Chart Patterns: Chart patterns are distinct shapes that price charts form. Examples include Head & Shoulder, Cup & Handle, Double Top, and Double Bottom patterns. With practice, chart analysts can identify these patterns, and based on their significance, make predictions about future price movements.
  4. Moving Averages: Moving averages can be simple or exponential. They help smoothen data by calculating averages over a consistent period. Exponential averages assign greater weights to more recent prices, while simple averages maintain equal weights across the entire period.

Now that you understand both sides of the coin, we advise you to utilize them when buying your next stock and conduct diligent analysis instead of relying on stock recommendations from news anchors and Telegram groups.
At the end, it’s the investor who carries the risk, not the investment – as Robert Kiyosaki wisely said. Therefore, invest wisely!

To assist you in stock analysis, Globe Trade Pro provides users with access to analyse all listed companies on the stock exchange directly from their mobile screens. Click on the link below to download the app: Globe Trade Pro