Choosing the right stock is similar to choosing a date
There are many factors to consider when choosing the perfect person to date. Some individuals focus on physical appearance, while others dig deeper into a person’s principles, beliefs, and goals. Similarly, there are many ways for investors to decide which stocks may be attractive investments. Some investors focus on “technical” elements, while others focus on the “fundamentals” of a company. What does this mean and why is it important for all investors to understand?
Technical analysis focuses on stock price
There are many factors that investors must consider when evaluating stock prices. Some factors are referred to as “technical,” which means they’re based on the stock price alone. For instance, technical traders might study patterns in the movements of stock prices to decide which ones to buy and sell. These decisions do not put any ephasis on the company itself, its product, or whether a company is profitable. In other words, the only thing technical analysts look at is the stock chart versus movement in the stock’s price and trading volume.
Some investors dig deeper
In contrast, other investors focus on company fundamentals when conducting research on a stock or company (i.e., a company’s cash flows, income statements, amount of debt, etc.) in order to decide whether or not to invest in a stock. By thoroughly understanding a company and its financial standing inside and out, investors hope to determine if a stock is cheap or expensive relative to the fundamental value of the company. Unlike technical analysts, these investors focus less on a company’s stock chart and price movements. Instead, fundamental investors look to gain a deeper understanding of a company’s financial performance, so they’re able to generate positive returns and potentially outperform the overall market over time.
Profits helps determine a stock’s fair price
There are many ways in which fundamental investors are able to dig deeper. For instance, they might study a company’s strategy including its product lines, industry competitors, pricing power, and more. From this, an equity research analyst can make projections about what the company’s profits might look like over the next several years, and thus calculate a fair price for its shares today. By comparing this calculated price to the stock’s publicly traded share price, an investor can decide whether an investment may be profitable.
Corporate earnings season matters
Investors receive much of the information required to make a decision from a company’s publicly filed financial reports. This is one reason that corporate earnings seasons are essential for investors. Every quarter, investors receive new information about public company performance. They also have the opportunity to ask the company’s management team questions. Investors can use this information to update their research and make decisions about whether they should invest in a stock.
It's best to look at all the info
Just like it is best to look at multiple factors when choosing the right person to date, many investors use fundamental data alongside other information, such as technical analysis and valuations, to pick the perfect stock. By combining sources of information on a stock, investors can better understand whether or not they think the potential rewards are greater than the potential risks.