How to Analyze a Stock [Properly] Trading vs Investing

Knowing How To REALLY Analyze a Stock is Critical. Traders use Stock Charts, Price & Volume. Investors use Dividends, Profits, Cashflow & Value. Choose Wisely.

How to Analyze a Stock

There are two ways to analyze a stock. If you are a long-term value or income investor you will use fundamental analysis of a company’s financials, such as earnings, sales, dividends, and cash flow. If you are stock trading for short or medium-term profits then you will use the technical analysis of stock charts, prices, and volume indicators.

We will start by looking at fundamentally analyzing a stock, then we will move on to the technical analysis of stocks.

How to Analyze a Stock - Trading vs Investing Explained
How to Analyze a Stock – Trading vs Investing Explained

How to Analyze a Stock Using Fundamental Analysis

What is Fundamental Analysis of Stocks?

The fundamental analysis of stocks is an analysis of the foundation of a company’s financial operations.  Typically fundamental analysis helps you answer the following questions:

  • Is the company profitable?
  • Is the company growing sales?
  • Is the company paying dividends?
  • Is the company stock cheap or expensive?
  • Does the company have a healthy cash flow?
  • Is the company efficient?

Fundamental Analysis for Growth Stocks

Using a strategy of investing in growth stocks means you want to make profits from stock price growth over the medium to long-term.  What powers stock price growth, earnings, revenue & sales.

The most famous strategy for analyzing growth stocks is by using the CANSLIM method.

  • C – Current Earnings – Earnings per Share (EPS) quarterly growth > 18% compared to the same quarter last year
  • A – Annual Earnings – Annual Earnings per Share (EPS) 5-year average > 25%
  • N – New 52 Week Price High – within 15% of new high
  • S – Supply and Demand – Shares Available (Millions) > 9
  • L – Leaders – Relative Strength Index (RSI) > 69 compared to competitors
  • – Institutional Ownership – More than 35% of shares are owned by institutions
  • M – Market Direction – General market direction should in an uptrend

Wall Street analysts are primarily focused on these metrics as you can see when the quarterly earnings are announced, there is so much media coverage and hype.

Value Investing Analysis of Stocks

Value investors seek to find stocks that are significantly undervalued compared to the stock price.  How you value a company versus the stock price is the key to this strategy.

Investing in good companies that represent great value to the buyer.  Essentially buying a share of a profitable company when its shares trade at a significant discount to its actual intrinsic value.
Investing in good companies that represent great value to the buyer.  Essentially buying a share of a profitable company when its shares trade at a significant discount to its actual intrinsic value.

Fair Value or Intrinsic Value

The Intrinsic Value of a stock is an estimate of a stock’s value without regard for the stock market’s valuation.  There are many ways to calculate an intrinsic value which you can read about in this article How to Calculate the Intrinsic Value of a Stock [Buffet Style].

Ultimately Warren Buffett calculates the Fair Value/Intrinsic Value of a company based on the amount of cash flow it is estimated to generate over the next 10 years.

Margin of SafetyUltimate Guide To Value Investing

The margin of safety is all about reducing the risk of an investment.  The bigger the discount you can get when buying a share of a company the less risk you have, because actually how far further could the stock price fall?

If a stock price is significantly below the actual fair value of a company, that percentage difference is known as the Margin of Safety. Essentially the percentage that a company is undervalued by the stock market.

In other words, the Margin of Safety is the percentage difference between a company’s Fair Value per share and its actual stock price. If a company has profits and assets that outweigh a company’s stock market valuation, this represents a Margin of Safety for the investor. The higher the margin of safety the better.

Income & Dividend Investing Analysis of Stocks

If you are looking to invest in company’s that will pay to a regular income through dividend payments, then you will be looking for a different set of criteria.

How To Analyze A Stock for a Dividend Strategy

If you want to ensure the dividends you are banking on are safe, then you should look for additional factors to help support the notion you will continue to receive dividends in the future.

Dividend Growth Stock Screener
How To Create The Best Dividend Growth Stock Screener

Look for higher capitalized companies, preferably above $2 billion.  Lowering your dividend yield expectations to greater than 1.5% will enable companies with sustainable dividends to appear in your scan.  You might also want to drop your 1-year dividend change, 3 year and 5-year dividend average criteria to >0%.  This ensures they are paying a dividend over the long term.

Also, make sure your stocks are floated on a major (well regulated) exchange like the LSE, DAX, NYSE or NASDAQ.

In addition, you may want to drop your payout ratio criteria to <50 to ensure that the company is not already paying out too much in relation to its earnings.

Finally, you will want to make sure that the company is experiencing sales growth above the dividend averages or growth.  This is additional insurance so that you know sales are growing therefore there should not be an impact on dividends in the future.

8 Criteria to Find Stocks for a Dividend & Income Strategy

  • Market Capitalization > $2000 M
  • Dividend Yield > 1.5%
  • Dividend 1 Year Change % > 0%
  • Dividend 3 Year Average % > 0%
  • Dividend 5 Year Average % > 0%
  • Stocks on major Exchange (not OTC)
  • Payout Ratio > 30 and < 50
  • Sales Growth 5 Yr Avg > 4.5%

[Related Article: 6 Simple Steps to Build The Best Dividend Stock Screener]

10 Ways to Analyze A Stock’s Financials

  1. Enterprise Value – The enterprise value is the total value of the company including market capitalization. Enterprise value is the price another company could pay for a corporation. A classic formula to calculate enterprise value is market capitalization plus assets plus cash and equivalents minus debt.
  2. Earnings Power Value – Popularized by value investor Bruce Greenwald and considers an improvement over Discounted Cash Flow (DCF) models because it avoids the speculative assumptions about future growth. The seven-step formula for EPV excludes future growth and growth cap expenses, making the assumption that future earnings will be like the historical average.
  3. PE Ratio – The Price / Earnings Ratio helps you identify Find companies with lower PE Ratios than competitors with similar growth prospects.  The PE Ratio is only useful when comparing competitors in the same industry with similar business models. Criteria: PE Ratio < 4th decile in the industry segment
  4. Shiller PE Ratio – The Shiller P/E ratio or Cyclically Adjusted PE Ratio (CAPE Ratio) uses the 10-year inflation-adjusted average earnings to compute a P/E ratio that spans the typical business cycle. Criteria: Lower is better
  5. Price / Book Value – To a classic value investor book value is an appraisal of all a company’s assets. A good definition of book value is anything that the company can sell for cash now. Examples of book value assets include real estate, equipment, inventory, accounts receivable, raw materials, investments, cash assets, intellectual property rights, patents, etc. Price to book value compares a stock’s market value to the value of total assets less total liabilities (book value). This is also known as P/B or PB. A low P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. Criteria: Lower is better
  6. Price / Tangible Book Value – Compares a stock’s market value to the value of total assets less total liabilities and intangibles. A low ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. Criteria: Lower is better
  7. Debt / Equity – Debt/Equity is sometimes called D/E, Financial Leverage, or Gearing and it is the ratio of Total Debt to Equity. Criteria: A high ratio indicates a risky business and a low ratio makes a buyout more likely.
  8. Current Ratio – A measures of the company’s ability to pay short-term obligations, calculated as current assets divided by current liabilities. Criteria: safe investments have a current ratio > 2.
  9. Quick Ratio – Quick ratio is also called acid-test or liquid ratio and it measures a company’s ability to meet its short-term obligations with its most liquid assets. It is calculated as (Current Assets – Inventory) / Current Liabilities. Criteria: safe investments have a quick ratio < 1.
  10. The Solvency Ratio – is a measure of whether a company generates enough cash to stay solvent. It is calculated by summing net income and depreciation and dividing by current liabilities and long term debt. Criteria: A value above 20% is considered good.
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The Best Software for Analysing Stocks

To my knowledge, there is only one Stock Screener and Stock Analysis Platform on the market that will enable you to flexibly implement all of the dividend investing strategies detailed in the next section.

The best tool for the job is Stock Rover the Winner of our Top 10 Best Stock Screeners Comparison. Also, Stock Rover won our Best Value Investing Stock Screener Comparison.

Stock Rover Review

Option 1 – Get Stock Rover – For U.S.A. & Canadian Investors

Sign Up For A Free 14 Day Trial of Stock Rover (no card required), this will give you the Premium Plus Service for free for 14 days.  You need the Premium Plus Service to access the awesome 10-year dividend history, Fair Value and Margin of Safety criteria, exclusive to Stock Rover.

Option 2 – Get TradingView – For International Investors

If you are planning to build a portfolio of dividend stocks outside of the USA & Canada, then the best option is TradingView as it provides detailed value and dividend stock screening for nearly every stock on the planet.  Easy to use yet powerful, TradingView is an excellent choice for international investors.

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The Results of Analysing Stocks for Value Investing

Using the above methodologies and a great stock screener you can generate a list of great stocks to invest in and most of the analysis is done for you.

The Warren Buffett Stock Screener - Completely Configured
The Warren Buffett Stock Screener Strategy Results Using Stock Rover

Video – Analyzing & Finding Great Stocks with Stock Rover

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How to Analyze a Stock Using Technical Analysis

What is the Technical Analysis of Stocks?

For the short-term stock trader, technical analysis is the key to success.  Technical analysts evaluate the supply and demand dynamics in the trading of stock on the exchange to predict future price moves.  The 3 main factors are the stock price, the number of buyers and sellers and the volume of stocks being traded.  These 3 factors are visualized in the form of stock charts, indicators, patterns and trends.

How to Understand a Stock Chart

Here we have an OHLC (Open High Low Close) stock chart.  As you can see the stock price moves up and down.

How to use a stock chart
Using a Stock Chart to Analyze Stock Price Trends.

Stock Price & Trend Analysis

Often on charts, you may see support an resistance lines drawn by someone else or automatically by a stock chart indicator.  This is a chart of Apple Inc (Ticker: AAPL), it shows various trend lines in a downward price move and an upward price move.

How to Draw Trendlines and See Price Patterns for Stock Analysis
How to Draw Trendlines and See Price Patterns for Stock Analysis

 

Using the Price Volume Relationship to Analyze a Stock

The use of stock chart patterns to analyze a stock is primarily to represent volume and price.  here is an excellent example of one of the most popular stock chart patterns, the “Head & Shoulders”.  Here you can see and understand the relationship with supply and demand of the stock.

Stock Chart Patterns for Stock Analysis
Stock Chart Patterns for Stock Analysis

There are some important characteristics of volume and price in the market place.

Price Up–Volume Up (PUVU) Price moving up on increased volume. This is bullish as it shows us that more participants are interested in selling the stock at higher prices and that most importantly more people are interested in buying the stock at those higher prices.  In an uptrend this signals the trend will continue, in a downtrend, this signals a possible correction or change in the trend’s short term direction to upwards.

Price Up-Volume Down (PUVD) in an uptrend this is very bearish as it suggests that although prices are rising there are fewer participants suggesting people are backing away from the higher prices.  This also infers that the trend is weakening.  In a downtrend, it suggests a continuance of the downtrend.

Price Down–Volume Up (PDVU) in a downtrend this may signal that a change in trend is likely, as we saw with the “Blow off bottom” there might be a huge selling climax, then the trend adjusts from down to sideways or down to up.  In an uptrend, this may indicate a crisis, panic selling or simply when a stock is going out of favor.  The pressure is on the sell-side and to sell they have to accept lower prices. A strong negative signal!

Price Down–Volume Down (PDVD) in a downtrend this can suggest that the retreat is slowing or beginning to end as there are fewer people interested in buying or selling the stock at these prices.  In an uptrend, this may indicate the stock is stopping for breath or due a pullback before continuing on its upward trajectory.   Volume tends to trend in the same direction as the price trend, so PDVD also suggests a continuation of the main downtrend, or a pullback and possible continuation of an uptrend.

Using RSI to Analyze a Future Stock Price Move

Here we have a very popular indicator called Relative Strength Index, or Wilders RSI. Developed by J Welles Wilder, this indicator measures the strength of any stock by using its average net up closing day prices by its average net down the closing prices for the period set.

RSI fluctuates between O and 100, 0 is oversold and 100 being overbought. It is a leading indicator and can be used to predict future trend changes using positive or negative divergences compared to price.

Divergences are one of the most powerful ways to use most indicators. The fact that it is a leading indicator, as opposed to moving averages which are lagging, and can thus indicate future directional changes.

Analyzing a Stock Using The RSI Stock Chart Indicator
Analyzing a Stock Using The RSI Stock Chart Indicator

Summary

As you can see there are many ways to analyze a stock.  How you analyze a stock very much depends on whether you are a short-term trader or a long-term investor.  As a trader, you will use the technical analysis of stock charts to analyze future stock price movements.  As a long-term investor, you will use fundamental analysis to analyze a company’s value or income potential.

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