Most investors are often clueless when it comes to investing in stocks as they have no idea about how to analyze stocks. In fact, the question “How to analyze stocks before investing?” ranks as one of the top rated searches on most leading search engines including Google.
One of the best ways to screen and identify quality stocks for investment to build a robust portfolio is fundamental analysis. Fundamental analysis can help an investor to collate the right information to make intelligent investment decisions by separating fundamentally strong companies from fundamentally weak companies.
How to analyze stocks using fundamental analysis?
In fundamental analysis an investor uses a company’s income statements, cash flow, balance sheets and other publicly available data to analyze its financial health. In addition to these information an investor should also consider taking a look at the economic factors affecting the market as well as the overall industry in which the company is operating. The main objective of fundamental analysis is to identify businesses that are trading below their intrinsic value.
Here are a few key ratios which can help you in fundamental analysis of stock market investments:
- Price-to-Earnings Ratio
This is a key ratio to evaluate the market value of a stock in comparison with the company’s earnings. It reveals how much price the market is willing to pay currently for a stock based on its past or expected earnings in future.
- Price-to-Book Ratio
The P/B ratio denotes whether a stock is overpriced or underrated by comparing the net assets which a company has with the price its outstanding shares.
- Free cash flow
Free cash flow is the cash produced by a company through its operations, minus the expenditures. It reveals the efficiency of a company in generating cash and helps an investor to determining whether the business has enough cash for dividends and share buybacks.
- Check for the debt
Company’s debt levels matter a lot as a company cannot perform well if it has a huge debt ratio. In is strictly recommended to avoid companies with huge debt.
- Analyze the future prospects of the company
This is a very important factor to consider. It is strongly advisable only to invest in a company with a long future prospects. An investor should always look at those companies to invest whose product or services will have an ever growing demand.
“How to analyze stocks before investing?” is one the most common question which rages across minds of investors in the stock market. The above pointers should effectively resolve all your queries regarding how to analyze stocks before investing in the stock market. Careful evaluation of a company’s fundamentals can tell you a lot about a stock and how you can expect it to perform in the future. Accurate fundamental analysis can help in not only multiplying your returns from the stock market but also reducing the risk associated with equity investment substantially.