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Nobody asks you to become your own
doctor or your own lawyer, so why should anybody ask you to become your own
stock analyst? Some people like to take up cooking simply because they enjoy
doing it. Similarly, there are people like Warren Buffett who enjoy the process
of making investments. Therefore, if you are an investor who likes to be
self-reliant, then you should consider becoming your own stock analyst. With a
big question mark hanging over analysts' credibility, it is always better to
learn the ropes. Read on to find out how you too can think like an analyst,
even while sitting at home.
Analysis Is a Process
It doesn't matter whether you are an
investor looking for growth or value; the first step in thinking like an
analyst is to develop a probing mind. You need to find out what to buy or sell
at what price. Analysts usually focus on one particular industry or a sector.
Within that particular sector, they focus on select companies. An analyst's aim
is to deeply probe the affairs of the companies on their list. They do this by
analyzing the financial statements and all other available information about
the company. To cross-check the facts, analysts also probe the affairs of a
company's suppliers, customers and competitors. Some analysts also visit the
company and interact with its management in order to gain a firsthand
understanding of the workings of the company. Gradually, professional analysts
connect all the dots to get the full picture.
Before making any investment, you
should do your own research. It is always better to research several stocks in
the same industry so that you have a comparative analysis. However, the biggest
constraint in doing your own research is time. Retail investors who have many
other things to do may not be able to devote as much time as professional
security analysts. However, you can surely take up just one or two firms in the
beginning, to test how well you can analyze them. That would help you in
understanding the process. With more experience and time, you can think of
putting more stocks under your lens.
The Best Place to Start Is
Where You Are
Analyzing the analysts' reports is the
best way to start your own analysis. That way, you save a lot of time in
cutting short preliminary work. You can learn about your selected company
simply by reading analysts' research reports. You may not blindly follow
analysts' sell or buy recommendations, but you can read their research reports
to get a quick overview of the company, including its strengths and weaknesses,
main competitors, industry outlook and future prospects. Analysts' reports are
loaded with information, and reading reports by different analysts
simultaneously would help you in identifying the common thread. Opinions may
differ, but basic facts in all reports are common.
Furthermore, you can take a closer look
at the earnings forecasts of different analysts, which ultimately determine
their buy or sell recommendations. Different analysts may set different target
prices for the same stock. Always look for the reasons while reading analysts'
reports. What would have been your opinion about the present stock, given the
same information? No clue? Then move on to the next step.
What to Analyze
For reaching your own conclusion, you
need to understand the various steps involved in a stock analysis. Some
analysts follow a top-down strategy, starting with an industry and then
locating a winning company, while others follow a bottom-up approach, starting
with a particular company and then learning about the outlook of industry. You
can make your own order, but the entire process must flow smoothly. Any process
of analyzing a stock would involve the following steps.
There are publically available sources
of information for almost any industry. Often, the annual report of a company
itself gives a good enough overview of the industry, along with its future
growth outlook. Annual reports also tell us about the major and minor
competitors in a particular industry. Simultaneously reading the annual reports
of two or three companies should give a clearer picture. You can also subscribe
to trade magazines and websites that cater to a particular industry for
monitoring the latest industry happenings.
Business Model Analysis
You should focus on a company's
strength and weaknesses. There can be a strong company in a weak industry and a
weak company in a strong industry. The strengths of a company are often
reflected in things such as its unique brand identity, products, customers and
suppliers. You can learn about a company's business model from its annual
report, trade magazines and websites.
Whether you like it or not,
understanding the financial strength of a company is the most crucial step in
analyzing a stock. Without understanding financials, you cannot actually think
like an analyst. You should be able to understand a company's balance sheet,
income statement and cash flow statements. Often, numbers lying in the
financial statements speak louder than the glossy words of an annual report. In
case you are not comfortable with numbers, no need to hesitate, just start
learning as early as possible.
Analysts also focus on management
quality. It is often said that there are no good or bad companies, only good or
bad managers. Key executives are responsible for the future of the company. You
can assess company management and board quality by doing some research on the
Internet. Tons of information is available.
Ultimately, stock prices follow
earnings. So in order to know whether stock prices would be moving up or down
in the future, you need to know where future earnings are heading.
Unfortunately, there is no a quick formula that can tell you what to expect for
future earnings. Analysts make their own estimates by analyzing past figures of
sales growth and profit margins, along with profitability trends in that
particular industry. It's basically connecting what has happened in the past to
what's expected to happen in the future. Making accurate enough earnings
forecasts is the ultimate test of your stock analysis capabilities, because
it's a good indication of how well you understand those industries and
Once you know about future earnings,
the next step is to know about the worth of a company. What should be the worth
of your company's stocks? Analysts need to find out how much the current market
price of the stocks is justified in comparison to the company's value. There is
no "correct value," and different analysts use different parameters.
Value investors look at intrinsic worth whereas growth investors look at
earning potential. A company selling at a higher P/E ratio must grow at a
higher price to justify its current price for growth investors.
The Bottom Line
The ultimate goal of every investor is
to make a profit. However, as the saying goes, not all roads lead to Rome.
Never blindly accept what stock analysts have to say and always do your own
research. Not everybody can be an investing expert, but you can always improve
your analytical skills when it comes to stocks.