How To Analyse A Stock Before Investing

Analysing a stock chart

In this article, we will detail everything you should look into when choosing a stock to invest in. You can then take this knowledge and start investing!

13.5% of all UK stocks are owned by members of the general population

Finder UK, Investment Survey 2021  

Before we jump straight into things, it makes sense to understand what a stock is.

What is a stock?

A stock is a type of investment that allows you to purchase a portion of a company. When you buy a portion of the company, you buy a “share.” Investors usually buy stocks and expect them to grow over time and generate a high return on investment (ROIs).

What to analyse before investing in a stock

  1. The fundamentals
  2. Assess the viability
  3. The company’s debt to equity ratio
  4. The company’s price to earnings ratio (P/E ratio)
  5. The company’s historical stability

Focus on the Fundamentals

Evaluate the fundamentals to ensure you choose the right stock for your investment. Experts recommend focusing on different stocks, such as UK stocks, global companies, or a combination of these two stocks. London Stock Exchange is the central stock exchange in the UK market, representing hundreds of companies from different industries.

The most prominent players in the UK and global market are Royal Mail, HSBC, Tesco, and British American Tobacco. Another crucial fundamental to consider is the dividends. Assess whether the company you want to invest in pays dividends. The purpose is to entitle yourself to a share of the profit the organization makes.

The average annual dividend payment in the UK is 3% to 4%. However, you can look for companies that pay more than this percentage in dividends. According to Fool, BP paid about 10.2% of dividends to investors in 2019. So, look for companies that pay higher dividend payment amounts.

Assess the Viability

Evaluate the company’s current stock price and compare it with the organization’s all-time high price. Although a stock always goes up and down, depending on the market conditions and its overall performance, the company should focus on increasing its valuation indefinitely.

Bear in mind that companies do business to stay competitive in the market, reach their target customers, and make money. So, analyse the stock price for the last 12 months and see whether it had gone up or down.

Moreover, if the company has more buyers, its stock price will increase. On the other hand, if there are more sellers and fewer buyers, the stock price will decrease. In that case, the company’s stock may not return to the good condition as it was in previously.

Calculate the Debt-to-Equity

Debt-to-equity is another critical factor to consider when choosing a stock. The purpose is to evaluate a company’s debt and compare it to its shareholder equity. Bear in mind that all companies have some sort of debt. Even big giants in the market like Apple has debts.

However, it is crucial to understand the difference between debt and too much debt. So, take a look at the company’s balance sheet to compare to analyse the debt to equity. We recommend looking at the company’s liabilities, including creditors, bond obligations, and short-term and long-term loans.

Add these things to get the total and divide that number into the shareholder’s total amount of equity to get the debt to equity ratio. The purpose is to avoid risks and streamline the process of stock selection.

Analyse Price-to-Earnings Ratio

The price-to-earnings or P/E ratio refers to the company’s current share price with respect to its earnings. You must analyse the company’s P/E ratio to know whether the company is overvalued or undervalued.

Obtaining the P/E ratio requires you to perform simple calculations. Take the company’s current stock price and divide it into its earnings per share. Let us give you an example so that you understand the concept better.

Suppose that the company has a current price of £100. Likewise, the company’s stock carries £9.5 in earnings per share. In that case, the P/E ratio is 10.52. Research shows that the suitable P/E ratio for a company ranges between 13 and 15. In this example, the company’s P/E ratio is 10.52, which is not viable, meaning you should avoid choosing the firm’s stocks.

Determine the Company’s Stability

There are numerous methods to determine and evaluate a company’s stability. You can do this in both fundamental and technical ways. If you want to streamline the process, make sure you see how the firm or company has responded to a stock market downfall previously. Consider the following factors when determining the company’s stability.

  • The company’s recovery and the time it took for recovery
  • Comparison of the current stock price with pre-recession levels

What should I invest in? – Funds, Bonds, or Stocks

Investing in funds

Funds or mutual funds are a popular investment option for people in the UK. Investing in funds allows for portfolio development and management, fair pricing, dividends, and using them as reinvestments, convenience, and risk deduction.

When you purchase a fund or mutual fund, you pay the expense ratio, a management fee to hire an experienced portfolio manager who buys and sells bonds, stocks, etc. The downsides of investing in funds include tax inefficiency, high fees, inadequate trade execution, etc.

Investing in bonds

Moreover, bonds are another popular investment option that offers a wide range of benefits. For instance, bonds are more durable than other securities. Unlike stocks, bonds have lower volatility, which is valid for both short and medium-dated bonds.

However, when you invest in bonds, you will receive a fixed return. You need a lot of money to invest in bonds, meaning if you have a limited budget, it is better to avoid bonds investments. Bonds are likewise less liquid than stocks and have direct exposure to increased interest rates.

Investing in stocks and shares

Furthermore, many people in the UK invest in stocks to receive higher returns on investments. The primary advantage of stock investment is that they are easier to purchase than other assets. You can use the stock market to buy companies’ shares.

Stocks also enable you to stay ahead of inflation. They have an average return of 10% annually. Besides, you can take advantage of the growing economy. For example, when the UK economy grows, corporations, companies, and firms generate higher profits. In that case, you will have a higher return on investment. We think stocks are better than funds.

Final Words

Choosing a stock or fund is not an easy task. It requires careful planning and preparation, including analysing the current status of the stock market, the company’s financial position, and other crucial factors given above.

The choice of investing in stocks, funds, or bonds is ultimately yours, but we think stocks are a better investment opportunity than bonds. The reason is that stocks have higher liquidity and ROI potential. That being said, a growing trend in today’s climate is ESG investing.

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