How to do a short stock analysis?
Have you ever thought about how to invest in the stock market? Did you try buying one share once but sold it quickly after, because it’s value decrease? Is there some advertising that is trying to convince you to trade at their platform?
In this article, I will guide you through the process of buying and picking shares. About your emotions during this process and what to avoid. Of course, even after you will read this article, you will still lose money at some point if you will trade on the stock market. But that is just inevitable. Noteworthy is that the losses should be lower than gains. Another thing you should understand is when you lose your money, and when not, it is not as simple as it seems.
Simple investing strategy
Let me explain my easy thou powerful strategy on how to invest in the stock market.
Firstly, I always invest and keep the idea that I will hold a particular share forever. If I change my mind on the way, it is not as much important. Just at the beginning, there must be this idea. What helps me to keep toward this idea? Firstly, I want a passive income from shares. Therefore, I want to buy them, forget I own them and get just the rent.
The only explanation for this is the following:
Time will heal everything.
If you look at shares and their graphs, you will see the average increasing trend, especially If you look at five years graph and more. And this is my goal.
In the short term, the shares are fluctuant. Their value changes quite a lot, and a day after I bought them, my investment can be 10% smaller.
What did I learn from those facts? As I claimed at the beginning – I invest for the long term – no day-trading or something similar. But either I learned that there is no magical time when I can buy or sell shares. Better to say, there is this moment, but it is almost impossible to catch it in real-time. It is easy to look into history and see – here was the best time to buy! But nearly impossible doing this real-time with all emotions and fear about my money.
Buy and sell shares slowly
All I mentioned above leads me to another conclusion – buy shares slowly. It is best to buy my shares in a longer time. Let say I have 4000 Euro ready for shares. Now, firstly I would diversify this money into let say 2-4 different stocks or even more. Let say 2 for this example meaning 2000 Euro each. Then I would take 500-700 Euro (depends on fees at a broker, the smaller, the better) and buy the first share and the same with the other stocks. Then after some time, let say one month, I would buy another amount of shares for the next 500-700 Euro. That will be a total of 1000-1400 Euro in stocks. And after a few more weeks, I would use everything that rests and buy another bulk of shares.
Similarly, I will do while selling them. I will expand this time into a more extend period and even probably always keep a small number of shares forever.
This way, I did the best I could do to avoid fluctuations and get closer to the average price in this period. If the shares come up, I lost a little money. But if it goes down, I will earn something or lower my loss.
When unexpected happened
When only to act fast? When something unexpected happened to the primary source of income in your company. An example is when electricity producing company will lose its power plant that was responsible for 50% of revenue, for instance, due to a terrorist attack that blows it all. At this moment, it is not a bad idea to take all out of that share if you have time.
What if the company was insured to get ten times their yearly profit, or the news about the terrorist attack was fake? I would sell the stock, and their price will jump after this event even higher? What I would do is calm myself until I reason again and not about profit and loss. And just after that, jump back into that share if I find it still attractive.
Why not stay there the whole time and wait for a little? Well, sometimes it may be better. It just depends on the situation. But keep in mind that people, in general, have ‘loss aversion.’ That means if one lose 50%, it makes one feel worst than if one gain 50%. That’s how people work. It is better to be in a theoretical loss than a real one. Therefore, the smart should always avoid loss.
When do you lose money on the stock market?
You lose money when you sell under the price you bought your shares plus dividends.
The formula for losing money on stock:
Buy price > Sell price + Dividends
When you buy your share for 100 Euro, then hold it for five years and sell for 80 Euro, you may think you lost 20 Euro. But in those five years, you got dividends 5 Euro each year! So in total, you are still in positive 5 Euro! Well, yet not the most magnificent result, and if we count inflation, you again lost your money, but not that black result as it could be seen.
Keep in mind that all the dividends you acquire will lower your initial investment.
How to pick up stocks?
Firstly, only by heart :). Skilled investors say you should forget about emotions while investing, and they are right. How is it that I recommend using heart then? By using heart, I mean choosing a company that is producing something that makes you happy. This is where your heart should focus – on the product of the company, not the market evaluation. If the company is making a fantastic product you are using and going to recommend to all your friends and it makes you happy, I think this company is one that you should focus on. And after this selection here should come to the heartless analysis of the stock.
This method also takes away all the pennies-stocks. I’m buying only companies that products I know or use myself or understand their business.
After this first tier, I add this stock to my watchlist and read news about it, trying to understand its business. (Usually, I’m doing this more when I don’t have money ready for investment, it is better to do it in a more extended period, but can be done either in few days).
Sometimes it happens that there will be a good time for investment, then I put there a little more money at once. A great example of a similar situation is when there are trustworthy leaks about a future product of that company that will strike the sales. Another may be some ‘problem’ like Wolksvagen’s problem with emission – shares drop significantly, but their business went on more or less without a problem. Another example is some crises like it was in 2000 or 2008 – it will always come, and it is good to be ready for them with free cash.
Lastly, if you have no idea what stock to pick, I would recommend looking at some of the ‘aristocrats‘ – that are the shares that pay and increase dividends for more than 25 years.
Easy technical stock analysis
As I mentioned before, if I don’t know the company from my life, I don’t invest in it – even if the reviews may look like the best deal of Millennium. That is the first filter.
Second is also really easy – if I think about investing in some company, I try to find some news website where they write about this company and at least read some last articles about the company. If it is well known that their product is a washout and probably the company is going bankrupt, it is better to know, right?
If everything still looks promising, then I finally do small stock analyses. I may not look at every indicator I will list here, but I will explain them either to cover this topic entirely.
The stock technical indicators I may look at are:
- P/E ratio = price-to-earnings ratio
- P/S = price-per-sales
- EPS = earnings per share
- PEG = price-to-earnings-growth ratio
- P/B = price-to-book ratio
- ROE = Return-on-equity
- ROA = Return-on-assets
- Beta
- D/E = debt-to-equity
- Little more useful shortcuts:
- EAT – Earning after tax
- EBT – Earnings before tax
- EBIT – Earnings before interest and taxes
- EPS – Earnings per share
P/E ratio = price-to-earnings ratio
To calculate the P/E ratio, we need to divide the price per share by its earnings per share. Compare a stock’s P/E ratio to its competitors in the same industry. The lower P/E ratios are the better buy opportunity. The only drawback to the P/E ratio is that it cannot be calculated for companies that have a net loss. Instead, we need to use P/Sales or P/B ratios.
A small example of how to calculate P/E:
If the price of a stock is 30 Euro and its EPS is 2 Euro, then the P/E ratio is 15.
P/S = price-per-sales
To calculate the P/S ratio, we need dividing the price per stock by sales per share. The P/S ratio shows how much investors are willing to pay for 1 Euro of sales/revenue for a stock.
EPS = earnings per share
We calculate EPS when we take a company’s net income divided by its total number of outstanding common stock shares. EPS shows how efficiently its revenue is flowing down to investors. We can compare EPS to the previous year’s EPS. It is a positive development when earnings exceed the performance of the prior year. Either it is considered good when a company’s profit outperform those companies in the same sector.
Example: If a company earns 20 million Euro in net income and has 10 million in common shares of stock outstanding, its EPS is 2 Euro per share. Respectively, 2 Euro of net income is allocated to each share of stock.
PEG = price-to-earnings-growth ratio
To calculate the PEG, you divide the P/E ratio by the (12-month/expected) growth rate. PEG takes P/E a step further by considering the growth of a company. It estimates the future growth rate by looking at the company’s historical growth rate. Stocks with PEG lower than one are possibly undervalued.
P/B = price-to-book ratio
To get the P/B ratio, we need to divide the market price of a stock by the book value per share. The Book value of equity is derived by subtracting the book value of liabilities from the book value of assets. A low P/B ratio is a sign that the stock is potentially undervalued.
ROE = Return-on-equity
We calculate ROE by divide net income by average shareholder’s equity. ROE shows the rentability of its capital – how much of net profit for one unit/Euro invested. A continual increase in ROE is a good sign to investors or higher ROE compared to other companies in the same sector.
ROA = Return-on-assets
We calculate ROA by dividing net income by total assets. ROA shows the percentage of profit a company earns to its overall resources. The higher the ROA, the better. Compare it to other companies in the same sector.
Beta
On average, the price per share of a company will increase by Beta of this share when the market/sector price increases by 1%. Stocks with Beta higher than 1 are more reactive to market movement. They are considered riskier.
If the Beta is smaller than 0, then the shares move in opposition to the stock market or its index. The Beta of all stock markets of the index is one. This indicator helps to evaluate the risk of our shares.
D/E = debt-to-equity
We get D/E by dividing total liabilities by total shareholders’ equity. D/E ratio says how high debt has the company. A higher D/E ratio is riskier than lower D/E. On the other hand, a small debt is healthy either.
To sum everything up
Buy everything with the idea of holding it forever. It doesn’t matter if you decide one year later to sell it, just while you are buying it, keep in mind it will be forever.
Firstly, purchase only companies their product you are using or know at least or have in-depth knowledge inside their business.
Secondly, don’t move all your money at once into or out of position. Spread your operations through weeks or months and invest slowly.
Lastly, avoid daily trading and pennies-stocks. When you lose your money, remind your idea why you bought that company, try to evaluate that emotion-less again, and consider new action. Keep in mind that doing something is worst than doing nothing in most cases.
