Valuing stocks is an important analytical process investors go through to ensure they do not lose money when buying stocks. Learning this process can take some time, especially when new investors are not very familiar with the financial information released by companies. Two types of analysis are common on how to value stocks: technical and fundamental. Each offers its own advantages and disadvantages. Investors can use one or both, depending on their investment preference and current knowledge of businesses and industries.
Technical stock analysis is a review process that involves looking at a company’s historical record. Essential information includes past prices and volume of stock sales. The investor will learn how to value stocks by taking the historical information and look for repeating patterns in current or future time periods. The company’s intrinsic value or other specific features are not really a concern in technical analysis. Investors will key in on market activities and factors that drive the patterns leading to price increases or decreases that can result in potential gains if seen in future months or quarters.
Another approach on how to value stocks is the fundamental analysis, which is pretty much the opposite of technical analysis. Investors use fundamental analysis to measure the intrinsic value of a company rather than looking only at stock price history, information, or performance. For example, macroeconomic factors such as government regulation, industry conditions, and foreign competition are a few overarching factors that can affect a company. Factors specific to the company can include capital reserves, operational conditions, management, and the amount of debt or equity financing on a company’s books. Fundamental analysis ultimately looks at the company behind the stock listed on the exchange.
Learning how to value stocks also requires obtaining an understanding of basic accounting information. Publicly held companies must release an income statement, balance sheet, and statement of cash flows each quarter. From this information, an investor can calculate basic financial ratios to determine how well the company is operating. For example, liquidity ratios provide information on how well the company can pay short-term financial obligations. If the number is significantly lower than previous periods, the company is having a hard time generating capital. Other formulas indicate long-term capital needs, gross profit on sales, return on assets, and the amount of debt used by the company. Each ratio helps investors understand how to value stocks and companies based on the accounting information that is the result of economic transactions.