How to Analyze Stocks: Fundamental and Technical Analysis

Why Stock Analysis Matters

Before buying any stock, you should understand what you're buying. Stock analysis helps you:

• Determine if a stock is overvalued or undervalued
• Understand the company's financial health
• Make informed decisions instead of guessing
• Avoid costly mistakes

There are two main approaches: fundamental analysis (studying the business) and technical analysis (studying price patterns).

Fundamental Analysis

Fundamental analysis examines a company's financial health, competitive position, and growth prospects to determine its intrinsic value.

Financial Statements to Review

1. Income Statement (Profit & Loss)

Shows revenue, expenses, and profit over a period.

Key items:

• Revenue: Total sales
• Gross Profit: Revenue minus cost of goods sold
• Net Income: Bottom-line profit after all expenses
• Earnings Per Share (EPS): Net income ÷ shares outstanding

2. Balance Sheet

Snapshot of assets, liabilities, and equity at a point in time.

Key items:

• Assets: What the company owns
• Liabilities: What the company owes
• Shareholders' Equity: Assets minus liabilities
• Cash position: Available cash

3. Cash Flow Statement

Shows actual cash moving in and out.

Key items:

• Operating cash flow: Cash from main business
• Free cash flow: Operating cash minus capital expenditures
• Cash flow vs. earnings: Should be similar

Essential Valuation Metrics

Price-to-Earnings Ratio (P/E)

Formula: Stock Price ÷ Earnings Per Share

What it tells you: How much you pay for $1 of earnings

How to use it:

• Lower P/E = potentially cheaper
• Compare to industry average
• Consider growth rate

Example:

• Stock at $100, EPS of $5 = P/E of 20
• You're paying $20 for every $1 of earnings

Benchmarks:

• S&P 500 average: ~20-25
• Growth stocks: 30-50+
• Value stocks: 10-15

Price-to-Earnings Growth (PEG)

Formula: P/E Ratio ÷ Annual EPS Growth Rate

What it tells you: P/E adjusted for growth

How to use it:

• PEG under 1: Potentially undervalued
• PEG of 1: Fairly valued
• PEG over 2: Potentially overvalued

Price-to-Sales Ratio (P/S)

Formula: Market Cap ÷ Annual Revenue

What it tells you: What you pay per dollar of sales

When to use: Useful for unprofitable companies or comparing within industries

Benchmarks:

• Below 1: Potentially undervalued
• 1-2: Average
• Above 3: Expensive (unless high growth)

Price-to-Book Ratio (P/B)

Formula: Stock Price ÷ Book Value Per Share

What it tells you: Price relative to net asset value

When to use: Useful for asset-heavy companies (banks, manufacturers)

Benchmarks:

• Below 1: Trading below net assets
• 1-3: Average range
• Above 3: Premium valuation

Profitability Metrics

Return on Equity (ROE)

Formula: Net Income ÷ Shareholders' Equity

What it tells you: How efficiently company uses investor money

Benchmarks:

• Below 10%: Poor
• 10-20%: Good
• Above 20%: Excellent

Profit Margin

Formula: Net Income ÷ Revenue × 100

What it tells you: Percentage of revenue kept as profit

Varies by industry:

• Software: 20-30%+
• Retail: 2-5%
• Banks: 15-25%

Growth Metrics

Revenue Growth

Year-over-year increase in sales

What to look for:

• Consistent growth over multiple years
• Acceleration is positive
• Compare to industry average

Earnings Growth

Year-over-year increase in EPS

What to look for:

• Growing faster than revenue (margin expansion)
• Sustainable growth
• Not driven by one-time events

Financial Health Metrics

Debt-to-Equity Ratio

Formula: Total Debt ÷ Shareholders' Equity

What it tells you: How much debt vs. equity finances the company

Benchmarks:

• Below 0.5: Conservative
• 0.5-1.5: Moderate
• Above 2: High leverage (risky)

Current Ratio

Formula: Current Assets ÷ Current Liabilities

What it tells you: Ability to pay short-term obligations

Benchmarks:

• Below 1: Liquidity concerns
• 1-2: Healthy
• Above 3: Maybe not using cash efficiently

Technical Analysis Basics

Technical analysis studies price charts and trading volume to identify patterns and trends. While more useful for traders, investors can use it to time entries.

Key Concepts

Support and Resistance

• Support: Price level where buying increases (floor)
• Resistance: Price level where selling increases (ceiling)

When price breaks through resistance, it often becomes new support.

Moving Averages

Smooth out price data to identify trends.

Common moving averages:

• 50-day MA: Short-term trend
• 200-day MA: Long-term trend

Signals:

• Price above 200-day MA: Bullish
• Price below 200-day MA: Bearish
• "Golden cross" (50 crosses above 200): Bullish signal
• "Death cross" (50 crosses below 200): Bearish signal

Volume

Number of shares traded in a period.

What to look for:

• High volume on price increases: Strong buying
• High volume on price drops: Strong selling
• Low volume moves: Less significant

Chart Patterns (Basic)

Uptrend

Higher highs and higher lows. Generally bullish.

Downtrend

Lower highs and lower lows. Generally bearish.

Sideways/Consolidation

Price trading in a range. Waiting for breakout direction.

How to Research a Stock

Step-by-Step Process

1. Understand the Business

• What does the company sell?
• Who are its customers?
• What's its competitive advantage?
• Can you explain it simply?

2. Check the Financials

• Is revenue growing?
• Is the company profitable?
• Is debt manageable?
• Is cash flow positive?

3. Evaluate Valuation

• Is P/E reasonable for the industry?
• How does PEG compare to peers?
• Is current price below intrinsic value?

4. Assess Management

• Track record of execution?
• Aligned with shareholders (own stock)?
• Clear communication?

5. Consider the Moat

• What protects from competition?
• Brand, patents, network effects?
• Switching costs for customers?

Where to Find Information

Free Resources:

• Yahoo Finance: Quotes, financials, news
• SEC.gov/EDGAR: Official filings (10-K, 10-Q)
• Company investor relations: Annual reports, presentations
• Earnings call transcripts

Brokerage Research:

• Most brokers provide free research
• Analyst reports and ratings
• Screening tools

Red Flags to Watch For

Financial Red Flags

• Declining revenue for multiple quarters
• Negative cash flow while reporting profits
• Rapidly increasing debt
• Frequent "one-time" charges
• Accounting changes

Business Red Flags

• High management turnover
• Insiders selling heavily
• Losing market share
• Dependent on single customer/product
• Regulatory troubles

Valuation Red Flags

• P/E much higher than industry without justification
• Stock up 100%+ with no fundamental change
• "This time is different" narratives
• Everyone talking about it (late to the party)

Building Your Analysis Checklist

Quick Analysis (15 minutes)

• [ ] Revenue growing?
• [ ] Profitable (positive net income)?
• [ ] P/E reasonable?
• [ ] Debt-to-equity under 1?
• [ ] Positive free cash flow?

Deep Dive (1-2 hours)

• [ ] Read recent 10-K annual report
• [ ] Listen to latest earnings call
• [ ] Compare metrics to competitors
• [ ] Research industry trends
• [ ] Check insider buying/selling
• [ ] Read analyst reports

Key Takeaways

1. Always do your homework before buying any stock
2. Fundamental analysis helps find quality companies
3. Key metrics: P/E, PEG, ROE, debt-to-equity
4. Technical analysis can help with entry timing
5. Compare to peers in the same industry
6. Watch for red flags in financials and business
7. Use multiple sources for research
8. If you can't explain it, don't buy it