Blog #05 - How To Analyze A Stock?

How To Analyze A Stock?

Let's talk about how to analyze a stock. So there are two main ways to analyze a stock first is fundamental analysis and second one is technical analysis. So you can think of it as this very fundamental analysis tells you what to buy and technical analysis tells you when to buy. So for now we are focusing on the fundamental aspect, don't worry we will discuss about technical analysis in the later blogs but for now let's begin with fundamental analysis. So when you talk about fundamental analysis right it can be broken down into two categories qualitative fundamentals and quantitative fundamentals?

 

So here's the thing about fundamentals right – what you're trying to do is to gather insights information right maybe from the economy, from the financial statements from the company itself. To derive an intrinsic value for the company right this is what fundamental analysis tries to do right to derive an intrinsic value of the company and then if the stock price drops below the intrinsic value you buy if the stock price is above the intrinsic value you sell right. They’re pretty much right sums up the role of someone right trying to you know, use fundamental analysis in your investment or in their trading so again as mentioned right there are two broad ways to do fundamental analysis qualitative fundamental analysis and quantitative fundamental analysis.

 

So let’s have a look at them right in more details so we need talk about qualitative fundamental analysis right. These are fundamentals or other information that can't be quantified for example – disruption right that we are experiencing right now this is qualitative analysis that can be quantified like for example let's let me give you an example let's say I have an oil company in right now I'm profit right as you know I send my guys to dig up oil from the earth let's say you know there is this new commodity that can replace oil maybe you know there is a less hazard, it's cheaper and it can replace oil right in vehicles in machinery and stuff like that so when this new commodity comes to the market you can see that my business is going to suffer because nobody needs oil anymore my stock price is going to collapse. So how do you actually you know so-called quantify this. You can write so this is why we call it qualitative analysis. This is an insight right that someone can glean from right and realize that no this would be disruptive to the oil stock so maybe they might want to sell the stock or even shot the stocks altogether, so this is an example of qualitative fundamental analysis. 

Loss in Share Market may be zero but profit may be . . . .

 

 

Another one could be economic more right like you know what Warren Buffett is a term that I think Warren Buffett came up with and economy mode so for example coca-cola they have a strong economy mode they sell sold out they sell Cola but if you want to challenge against them can be pretty damn difficult right because they have the brand they have the reputation they've been in business for a long time so they have a strong economy more alright and this is another aspect of qualitative analysis. You can't really quantify what this economic mode is you know what it is right is their branding their trust they have been business for a long time and the recipe is pretty much you know kept somewhere secret so that is an economic mode and that's another way of you know looking at qualitative analysis or even management it can be you know qualitative aspect as well may be a good management and good CEO comes into. You know improve on things improve on the operations reduce experience you know gain new market share in different industrial sectors for example all this is what we call qualitative analysis things that cannot be quantified in numbers and moving on we have something what we call quantitative analysis so this is fundamentals that can be quantified stuff. Like you know your assets you know what your assets are your machinery you can quantify all those you can put a value on those assets your liabilities right your revenue your earnings your cash flow these are all stuff that can be quantified and this is why we call it a quantitative analysis. So when you deal with quantitative analysis you will see ratios like you know your P/E ratio your price to earnings ratio your PB ratio price to book value price to cash flow and etc so this is what we mean by quantitative analysis. So as a recap right there are two types of analysis qualitative and quantitative and I just want to talk a little bit now about the pros and cons between both of this approach so for qualitative fundamental analysis right. The pros of it is that you know if you can so call digest information you can make sense of you know what's going on in the world in the company you can gain insight that you know not many traders or investors will see and you can't really make a profit right because you can actually buy a stock below its intrinsic value so that's the good thing about qualitative analysis. The downside to it is that it is difficult I'll be honest right because there is so much information out there how do you know what's relevant to the market at this current point in time so you will get analysis paralysis analysis paralysis. 

 

How To Analyze A Stock?

 

There's so much information you do not know which are stuff that you should focus on or which are stuff that is noise in the market so you know those are the pros and cons for qualitative analysis quantitative analysis again the process is that it can be quantified you can actually use quantified data and back test and see whether you know that data or actually use you a market beating written in the long run for example right it's proven their value stocks right stocks that have a low price to book value. They tend to outperform the market okay so this means is that if you ran your stocks between those with the highest book value and those of the lowest book value right if you buy the top tempers top 10 worst stocks are if the lowest price to book value they tend to outperform over the next few years compared to stocks with high price to book value they tend to underperform the market over the next few years so you can see that quantitative analysis the good thing is it can be quantified and can give you an edge in the market.

 

So I don't really need to know or have great insights into a company because using raw price data you can actually know what works and what don't the downside to quantitative analysis is again similar to qualitative is that sometimes there's just so much information and is you know very hard to filter out you know what are the stuff out there that matters and what don't matters. So again if you ask me right qualitative or quantitative I won't say this right or wrong but I do know that quantitative fundamental analysis you can do back tests on it and you can know right which are the key matrix right that are worth paying attention to so this is just my take between qualitative and quantitative analysis or right.

 

So now let's talk about you know what are some of the fundamental matrix that you should pay attention to as a trader so based on studying you know momentum stock traders and also if you've read a book how to make money in stocks by William J.O Nell you know that stock traders they like to focus on earnings and net income why is that okay so as mentioned earlier when you look at qualitative fundamental analysis right most stock traders they just don't have the skill to you know analyze the company to know you know what is the noise and what is the signal but one thing that they can do to shortcut right they are so-called screening processes by looking at earnings and net income. Why if you think about this right a company that's about to disrupt a sector let's say you know again back to the example where there is this new element on material that can replace oil if it comes into the market and nobody buys oil anymore and buys this new element because it's cheaper is better and it's more efficient and it doesn't contribute to you know global warming you can be sure that you know people will flock to whichever company that's producing let's call element X and this company will make money right your earnings will increase because they are you know selling or you know what I call it mining for a lot of this new element X earnings will increase net income will increase right. If they are able to keep the operation costs low so you can see that earnings and then incomes would reflect the fundamental of a company right there you know maybe there are a new innovator they are coming up with something new in the market that is in demand right so that's one example another example could be let's say a company has been in decline maybe it lost his competitive edge right he has dropped ninety percent right the stock prices dropped ninety percent from the highs and then new management comes in this new management tarts to you know shake things up right fire off the you know underperforming workers it it removes underperforming SS and and focus on the stuff that is bringing in revenue and focus on stuff that actually you know helps the company get back its age and to help the company grow now from a qualitative perspective it can be quite difficult to determine whether the new management the new CEO who comes in is able to turn things around but one thing that don't lie is the earnings and net income okay. We comes in and earning starts to improve income stats to improve quarter-on-quarter your new you can be sure that you know clearly the management is doing something right so when you see earnings is improving net income is improving chances are I'm not saying guarantee because there's many cases of fraud right but chances are the fundamentals of the company is you know doing okay as well it could be even a turnaround or in a new innovation in the company and whatever the case is right as a stock trader if you want to you know buy stocks right you want to focus on stocks that have improved earnings and net income because this tells you right there's a good chance that the fundamentals in the company is pretty alright it's pretty good even okay so earnings and income is what many stock traders they pay attention to they pay attention to how the earnings have increased quarter and quarter or how the earnings have increased year-on-year right both earnings and net income so this for you a stock trader this is something that you want to pay attention.