Become Your Own Stock Analyst

• Manoj Singh
• On 4:33 pm EDT, Thursday October 29, 2009

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. So, 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 in 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 company's suppliers, customers and competitors. Some analysts also visit the company and interact with the management of the company to have a first hand understanding of its workings. Step by step, professional analysts connect all the dots to get the full picture.

You too can think of doing your own research before making any investment. It is always better to research several stocks in the same industry so that you have a comparative analysis. But 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 of starting your own analysis. In 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, its strengths and weaknesses, its main competitors, industry outlook, future prospects and many other things. 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.

Further, 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 various steps involved in a stock analysis. Any process of analyzing a stock would involve the following steps. Some analysts follow 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 finding about the outlook of industry. You can make your own order but the entire process must flow smoothly.

1. Industry Analysis
   There are many sources of information about a particular industry. Often, the annual report of a company itself gives a fairly good 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 keeping tabs on latest industry happenings.

2. Business Model Analysis
   You should focus on 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 its unique brand identity, its products, its customers, suppliers etc. You can learn about a company's business model from its annual report, trade magazines and web sites.

3. Financial Strength
   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 can't 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.

4. Management Quality
   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.

5. Growth Analysis
   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 headed. Unfortunately, there is no quick formula that can tell you about future earnings. Analysts make their own estimate by analyzing past figures of sales growth and profit margins, along with profitability trends in that particular industry. It's like connecting what has happened in the past with what will happen in the future. Making earnings forecasts is the ultimate test of your stock analysis capabilities. It tells how well you understand the industry and the company.

6. Valuations
   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.

7. Target Price
   Finally, it's all about setting a target price. Once you know about future earnings, you can calculate high and low target price by multiplying estimated earnings per share (EPS) with estimated high and low P/E Ratio. The high and low target price is the price band within which the future stock price is likely to move in response to the expected future earnings. Once you know the target price, you can very well use it to reach your destination.

Conclusion
The ultimate goal of every investor is to make a profit. But all roads do not lead to Rome. You should not blindly accept what stock analysts have to say. Although everybody can't become a grandmaster of stock analysis, developing your own analytical skills will always help you in becoming a better judge.

Buzz up!