The rally in stocks came to a screeching halt following poor jobs data and inflation numbers. Many of the stocks that couldn’t lose in 2020 have been the biggest laggards in 2021, with the biggest losses concentrated in the tech sector. The economy is beginning to shift into reopening mode, but the transition has been anything but seamless. Many analysts refer to these types of shifts as “sector rotation.” Investors who piled into tech names are now moving to the energy and financial sectors.
When economic conditions begin to change, especially after an unprecedented event like the COVID-19 pandemic, markets tend to be unpredictable. If you’re looking to profit off of these trend shifts, you’ll need to select companies with strong foundations in well-positioned industries. Researching stocks is more important than ever, and if reading 10-Ks isn’t your forte, you’ll need a plan. Use this beginner’s guide on how to research stocks to get started.
If you need assistance with your portfolio, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.
Invest in What You Know
Peter Lynch once claimed he made an investment in TJX because his wife couldn’t resist shopping there. While this isn’t exactly the type of research you should be performing yourself, it can be helpful for creating guideposts. The market is far too large to research every company and stock, so a narrow focus is necessary.
To narrow your focus, consider the following questions:
- What types of industries do you think will profit most in the current economic environment?
- Could regulatory trends create headwinds or tailwinds for any specific niche of stocks?
- Do you have any unique insight into a particular industry based on personal experience? (ie. working in procurement for a manufacturer that requires semiconductors)
Investment research starts with broad trends that can eventually be narrowed down into individual company research. Think about the market and economy as a whole before picking random companies to investigate.
Types of Investment Research
Two schools of thought are at odds when it comes to individual equity research. But don’t think of this as a rivalry like Yankees vs Red Sox—even the guys on the same team don’t agree on what matters in stock research.
The most accurate research often comes from a combination of these two schools:
- Fundamental analysis. This type of analysis has a strong focus on the underlying metrics of the company. While plenty of argument exists over which factors matter more, fundamental analysts care about the same thing on the bottom line—how much money will this company make? Some important data points here include sales growth, margins, debt levels, and dividend yields.
- Technical analysis. Technical analysts care little for the day-to-day operations of the underlying company. This type of analysis is all about charting by looking at moving averages, finding signals, and acting on trades before the herd piles in. Larger economic trends still play a role, but they aren’t as important to those utilizing technical analysis. Many quantitative hedge funds like Renaissance Technologies and AQR use math and charts to plot their trades with little regard for the product or service the company provides.
Important Research Metrics
Stock research is usually a combination of technical and fundamental analysis, so it’s worthwhile to learn terminology from both schools. Most of these data points and charting signals can be found from a common source like Yahoo Finance or Macrotrends, so you don’t need to break the bank for sophisticated research reports. Just remember your trading goals and focus on the metrics most valuable to you.
Fundamental Analysis Terms
Below are some common fundamental analysis terms you should make yourself familiar with:
- Price/Earnings Ratio. Often shortened to P/E ratio, this metric measures how expensive (or inexpensive) a stock is compared to its quarterly earnings. A P/E ratio under 15 has historically been good, but valuations are higher now, so this might be outdated.
- Gross Margins. Not all revenue is retained by the company. How much does it cost a company to sell its product or service? That’s what gross margins measure—sales revenue minus the cost of selling the goods or service. The higher the margins, the more money a company earns as profit.
- Debt/Equity. Even the most promising companies can be sunk by uncontrolled debt. Debt/equity ratio measures a company’s long-term debt load compared to the total equity owned by shareholders.
Technical Analysis Terms
Below are some common technical analysis terms you should make yourself familiar with:
- Moving Averages. Stock price data is often choppy, so moving averages are used to smooth it out. A timeline is chosen (usually 20, 50, or 200 days) and price data is averaged over that timeframe. Simple moving averages (SMA) use all data equally, while exponential moving averages (EMA) give more weight to recent price points. Many technical indicators like Bollinger Bands or MACD are derived from moving averages.
- Support and Resistance. Stocks often consolidate around similar price points, whether to the upside or downside. When a volatile stock consistently finds buyers at a certain price level, that level is known as support. On the other hand, price points often create ceilings that stocks struggle to break through. These are known as resistance levels. Sellers unload shares or short at these points in anticipation of a decline.
- Volume. Volume levels are very important to technical analysts and numerous indicators have been created around their measurement. Volume begets volatility and traders using technical analysis often have short timeframes, so sharper price movements are required to profit.
Putting it All Together
Not all stock research needs to fall into technical or fundamental categories. Both can be used to create actionable trading plans based on both price data and underlying business metrics. For example, a company with a strong balance sheet and high gross margins could still see its stock price fall. Technical analysis might help identify when a sleeping giant begins its turnaround.
Likewise, a certain stock chart might look like a screaming buy at first, but digging deeper into the company might unveil high debt levels or declining sales growth. Fundamentals don’t always work and technical signals are chock full of head fakes. Use both to enhance your stock-picking success rate.
Work With an Experienced Financial Advisor
If you have any questions about how to research stocks, reach out to a team member from Good Life Financial Advisors of Mount Pleasant today! We’re happy to assist you.
The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.