How to Analyse a Stock Like a Pro

If you’re only new to investing in stocks, it might seem a bit overwhelming. With so many different options available across multiple industries from tech, fashion, clean energy and even the metaverse, Aussies are really spoiled for choice.

But, how do you know what stocks are worth piling your hard earned cash into? This is where stock analysis comes in, a process where you deep dive into a stock and the company behind it to determine if they are deserving of being part of your investment portfolio.

If you’re keen to invest like the experts do, here’s an explainer on how to analyse a stock like a pro.

Differences between ‘expert’ vs everyday investors

Compared to everyday investors, expert  or institutional investors – also known as professional investors or investment managers – predominately invest for other people, companies or organisations. They are pension funds, mutual banks, money managers, insurance companies, investment banks, commercial trusts, endowment funds, hedge funds, and other private equity investors.

These investors move large blocks of shares and have a significant influence on the stock market’s movements. Due to their significant size, institutional investors can often negotiate better fees on their investments and have the ability to gain access to investments that everyday investors don’t. This can include investment opportunities with large minimum buy-ins like private and commercial real estate, gold and even artwork.

Adapting professional strategies to build personal wealth

Good news! Many of the strategies that institutional investors use can be leveraged by everyday investors. Most of the information professionals source can be commonly found on a company’s website, on market analysis publications, or in the 10-K and 10-Q filings for all publicly traded companies.

When it comes to stock picking, most institutional investors and retail investors frequently follow the same ethos when constructing and managing portfolios; Warren Buffet’s advice of investing in what you know.

When analysing a stock most institutional investors look at:

• Whether a company is a small-cap or large-cap stock. (A small-cap is generally a company with a market capitalisation of between USD$300 million and USD$2 billion. A large-cap stock has a value of over USD$10 billion or more.)
• Current valuation
• Future growth potential
• Market trends
• Candle-stick charts and key indicators such as MACD, RSI and moving averages.  (A candle-stick chart is a chart composed of individual candles, which investors use to understand price action. Key indicators are a quantitative tool that is used by investors to interpret financial data in order to forecast stock market movements.)

Related articles: Are small cap stocks a good investment?

Best ways to analyse a stock

In order for investors to arrive at their own decision about whether a stock is a winner, they need to understand the different ways to analyse a stock.

Some investors follow a top-down strategy, starting with an industry and then seek to identify a victorious company. Others follow a bottom-up approach, starting with a particularly interesting company and then learning about the broader industry.

Industry analysis

There are publicly available sources of information for almost any industry. Often, the annual report of a company itself gives a good overview of the industry, along with its future growth outlook. Annual reports also tell investors about the major and minor competitors in a given industry. Simultaneously reading the annual reports of two or three companies should give investors a clear picture of sector growth.

Business and financial analysis

Investors should focus on a company’s strengths and weaknesses in their revenue models and earnings reports. In some cases there can be a strong company in a weak industry, or a weak company in a strong industry. The strengths of a company can often be reflected in things such as its unique brand identity, products, customers and suppliers, which should translate into profitability and revenue growth. Understanding the financial strength of a company is perhaps one of the most crucial steps when analysing a stock. Investors should be able to understand a company’s balance sheet, income statement, and cash flow statement. Often, the numbers in the financial statements speak louder than the words of an annual report.

Volatility

The movement in a stock’s price can also be linked to market volatility, and the frequency and volume with which the stock is being bought and sold. During times of high volatility, the stability of a stock is unpredictable and carries greater risk. Investors should be wary of these periods and invest with caution. To understand the volatility of a stock, an investor may also note a number of key indicators, such as the 5, 10 or 20 day moving averages (price average), RSI (Relative Strength Index, indicating how much a stock is being bought) or the MACD (Moving Average Convergence Divergence, indicating bull or bear trends).

Growth analysis

Stock prices are often impacted by earnings reports, so in order to gauge whether a stock’s price may be moving up or down in the future, investors should know where future earnings are heading. Generally, analysts make their own estimates by assessing past sales growth figures and profit margins, along with profitability trends in the industry. These analyst predictions are often covered by certain media outlets, and investors can analyse the growth of a company by connecting historical data to what’s expected to happen in the future.

Overall, analysing a stock isn’t rocket science, but it does take a bit of time and effort to do. Who knows, after a bit of experience and hard work you might become the next Warren Buffett.

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