Five ways to research a stock before you buy

CommSec CommSec

20 December 2018

Choosing investments is a complicated process. And once you’ve chosen an investment, that doesn’t mean it’s time to put your feet up. You’ll need to keep an eye on your portfolio and make decisions about how to react to any changes in its performance. This is why research is such an important tool for investors. If you’re new to the research process, or you need a refresher, here are five practical ways you can get started.

 

1.     Find out what the company does and how it makes money

A good place to start researching a company is to find out how it makes money. Sometimes it’s easier to start with companies you’re already familiar with, or to focus on business models that are simple to understand. This is because if you don’t understand how a company makes money, it might be harder for you to keep track of how your investment is performing.

With CommSec, you can access information about a company’s business activity on the website:

Step 1: Log into your CommSec account and select Quotes & Research

Step 4: Select Financials to view the company’s historical sales, cash flow, and earnings

Step 2: Search for a company
 

Step 3: Select About to find basic details about the company

If you want to dig deeper, most companies publish information for investors on their website. You can often find financial results, announcements, annual reports, and notes from past Annual General Meetings.

As well as researching a company, look at the landscape surrounding it. The type of questions you can think about here are:

  • Does the company have a competitive advantage within its industry?
  • Does it operate in an industry where it’s relatively easy for competitors to enter the same market?
  • Are there any particular events or economic conditions that could have an impact on the company?
  • Does it provide a product or service that could be easily substituted for another?
  • Do the company’s customers or suppliers have a lot of power over its prices?

Need inspiration on what companies to research? Find out where to get stock ideas.

 

2.     Read the research from the experts


If you were a professional money manager, you’d probably use independent equity research to challenge your thought processes and investment decisions. You’d look at research pieces from in-house analysts, large investment banks, and independent research firms. These research pieces are written by analysts who regularly speak with industry experts, competitors, and company management. They analyse everything about a stock and the sector it belongs to.

If you’re not a professional money manager, it’s not practical to do the same in-depth analysis. However, you can read the same research to educate yourself around your current and future investments.

At CommSec, we offer our customers access to research from Goldman Sachs and Morningstar, covering hundreds of stocks.

To view research:

Step 1: Log into your CommSec account and select Quotes & Research

Step 2: Search for a stock
 

Step 3: Select News, Research & Recommendations from the horizontal menu

Once you have bought a stock, keep an eye on the financial press. This will help you stay on top of your investments and learn about other views from industry experts.
 

What to look out for in analyst reports:

  • Price Target or Fair Value – this is the value that the analyst has projected the stock should be worth. If an analyst’s price target is higher than the current share price, it means the analyst believes the stock is currently undervalued, and the price should rise toward the price target over time.
  • Methodology – this is the approach used to arrive at both the price target and the recommendation. It’s important to look at this to understand how the analyst reached their forecast. For example, Morningstar provides a description of their research methodology on their website so investors can get a better understanding of their ratings system.
  • Any change for a re-rating/price target - what has caused the analyst to change their forecast? Has there been a regulatory change, a shift in sentiment towards a specific sector, a change in economic forecast, or an announcement by the company? Find out the context so that you can build an understanding of what influences share prices.
  • It’s important to read the whole report and not just skim across the recommendations of buy, hold or sell. That way you can start to understand how the analyst reached their conclusions.
     

3.     Charting

Look at the company’s price chart and try to gauge whether the stock might be trending up or down. If the price has fallen over time, take a closer look at the company to find out why. Charts can also tell you how much demand there is for a stock (known as the trading volume). If there’s a sudden increase or decrease in trading volume, try to find out what prompted it. With a CommSec account, you can access various charts on our website.

To access charting:

 

Step 1: Log into your CommSec account and select Quotes & Research

Step 2: Search for a company
 

Step 3: Select Charting from the horizontal menu
 

Find out more about how to use charts and other tools to help you decide when to invest.

4.     Look at the company’s financials


If you’re keen to do your own analysis, CommSec provides a range of company fundamental data points on our website, including balance sheet numbers, projections, and ratios like in the table below. These can help you analyse investments and compare different companies.

To access a company’s financials:

Step 1: Log into your CommSec account and select Quotes & Research

Step 2: Search for a stock
 

Step 3: Select Financials
 

Ratio

Formula

Description

Current ratio

Current assets / current liabilities

The current ratio is a liquidity ratio that shows whether a company would be able to repay its short-term debts quickly if it got into trouble. In most cases, an investor would probably be looking for a current ratio of at least 1. This shows that in a worst-case scenario, a company would at least be able to pay its most pressing debts.

Return on equity (ROE)

Net profit / Shareholders’ equity

Return on equity measures how well a company is generating profit using the money shareholders have invested. In general, a falling ROE can be a bad sign.  However, some industries are naturally inclined to have a higher ROE than others so ROE is best used to compare companies that operate in the same industry.

Earnings per share (EPS)

Net profit available for ordinary shareholders / Number of ordinary shares in the company

EPS is the portion of a company’s profit that can be attributed to each ordinary share in the company. EPS can show whether a company is growing its earnings from one reporting period to the next. However, it’s difficult to use EPS to directly compare companies with one another because the composition of a company’s share capital may differ. 

Price to earnings ratio (P/E)

Current share price / Earnings per share

A P/E ratio shows how the market price of a company’s shares relates to its earnings per share. In other words, it represents the amount of money investors are willing to pay for a share in the company's earnings. A higher P/E number generally suggests investors see high growth potential, while a lower ratio suggests the opposite. The PE ratio of the broad Australian share market has fluctuated between 10 and 20.  

Price to book ratio (P/B)

Current share price / Book value

P/B ratio is an indicator of how fairly priced a share is. A lower ratio could indicate that a stock is undervalued, however it could also indicate that there’s something wrong with the company. For this reason, a P/B ratio is not a particularly useful measure on its own.

5.     Ask CommSec Community

If you’re looking to canvas opinions on a particular stock or chat about a trading idea, you can start a discussion in CommSec Community. To visit the Community, log in and select Community in the main menu.

 

The bottom line

When you’re researching a stock, every bit of information is just one piece of the puzzle. Investors should look at a range of sources including (but not limited to) company reports, expert analysis, market news and announcements.

And remember to trust your instincts. Question any research that doesn’t make sense, and read widely to stay on top of your investment portfolio. The more research you do, the more empowered you’ll be to make informed investment decisions.

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Important Information

This information is directed and available to and for the benefit of Australian residents only and is not a recommendation or forecast.

This article is intended to provide general information of an educational nature only. It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice. Investors should consult a range of resources, and if necessary, seek professional advice, before making investment decisions in regard to their objectives, financial and taxation situations and needs because these have not been taken into account. Any securities or prices used in the examples given are for illustrative purposes only and should not be considered as a recommendation to buy, sell or hold. Past performance is not indicative of future performance. Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 (CommSec) is a wholly owned, but non-guaranteed subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945 ("the Bank") and both entities are incorporated in Australia with limited liability.

 

Disclaimer

This site is directed and available to and for the benefit of Australian residents only. © Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 ("CommSec") is a wholly owned, but non guaranteed, subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945 and both entities are incorporated in Australia with limited liability.

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