Being wealthy and being rich are two different things. Creating wealth demands a serious effort and gives your well-deserved earnings a greater longevity. With the world becoming flatter and technology growing at an exponential rate every day, the common man can aspire to, and build himself wealth that can last his future generations. One can build fortunes by investing in the stock markets, trading in bonds, commodities or even currency! Stock market holds attraction for the common man because of its fairly easy access, not so complex valuations and low entry and exit barriers to trade. The following article attempts to concisely explain what to look for in a company while investing.
There are two basic forms of analysis that can be done by an average investor. These are very simple to follow and can be done sitting right at home, accessing the required information over the Internet!
The Technical Analysis
The first analysis is termed "The Technical Analysis". As one of the things to consider before investing in a company, the investor should spot and exploit the recurring and predictable patterns in the stock movements of a company to obtain superior returns. The theory does not argue with the principle that the company's stock price is a reflection of its intrinsic value, but believes that the prices gradually close in on the intrinsic value. As the companies are in a constant state of evolution, their equilibrium shifts to a different high or low. An aware investor can make use of the lack of efficiencies in the information dissemination and get better returns. This is usually done by studying charts recording historic data of price movements.
There are various time series charts available online. The investor should study three types of trends:
- The primary trend: long term movement of prices lasting from several months to several years.
- The secondary or intermediate trends: caused due to short term deviations of prices from the underlying trend line or intrinsic value.
- The tertiary or minor trends: these are the daily fluctuations caused in the prices.
An investor with a long term view can analyze the primary trends and identify the supports (lowest prices) and ceilings (highest prices) historically recorded and plan the investments accordingly. An investor needs to be patient and needs to be able to afford a lock down period while using these trends to plan the investment strategy. One can also follow the secondary trends, but it is required that the investor is more in touch with the market happenings.
The secondary are not as long-lived as the primary trends. So good returns can be obtained in a fairly short period of time, provided the investor's entry and exit timings are right. The tertiary or minor trends require highest level of involvement and a very "hands on" approach. They are difficult to predict and should be followed only by trained and experienced investors who can catch the pulse of the market. The basic problem with technical analysis is that the investors can see the trend only after the event has occurred in the past and is an established fact. Recognizing trends as they emerge can be a bit difficult.
It is very important to study the macroeconomic and industry analysis with respect to these companies to see how external factors have affected them. If the investor is risk-averse then companies are being fairly less impacted by the policy changes. If the investor plans to be more involved in following the market trends and be proactive in investments then he should go for companies with high intraday trading patterns and high volatility. This will enable him to make quick profits. Companies with dubious records and imperfect information should be avoided at any costs though.
The next analysis is a "Fundamental Analysis" of the companies. An investor having a long term view of his investments should go for companies that are undervalued on the stock exchanges. The purpose of the Fundamental Analysis is to identify companies and stocks that are wrongly priced relative to their 'true value'. The true value of the stocks can be easily obtained from published and available financial data of the companies.
The financial data of all public companies which are listed in the U.S. can be easily found online. There are various valuation techniques that can be used like the Dividend Discount Models, Price Earnings Ratio Technique and the likes to find out the true value. The detailed techniques are beyond the scope of this article and can be found on tutorials online. A little study will help you know the best ways to invest money in a profitable manner with assured returns.
Financial Statement Analysis
Apart from valuation models and techniques, the investor can also look into undertaking a basic financial statement analysis. This is a fairly straight forward and simple exercise for the investor. On obtaining the financial statement of the company, the investor should make a list financial ratios. These ratios need not be published in the financial statement of the company and investor needs to derive them. These values are published online by the government sources and/or by U.S. Department of Commerce. Companies which have outperformed the industry average values on profitability parameters. The asset utilization parameters are said to be managed well and can be looked into for investments.
There cannot be any quick fire, bite size solution to select companies to invest in. No analysis mentioned here should be done on a standalone basis by the investor as all of them are intricately linked and share a cause-effect relationship. A generalization should not be made by any investor regarding some key benchmarks or ratios saying that high ratio is good and low ratio is bad. Selection of companies to invest in should be done in relation with the economy and current happenings also.
Investors should also look into the past operations of the company, the management, locations through which the company operates, etc. as even these parameters play a major role in deciding the returns made on investment. These analysis techniques and some experience will greatly help an investor hone the skills required for spotting the trends and understanding how the future trends will be affected. All the parameters described in the techniques given above are, in short, what an investor needs to look into with great detail.