Insights into Stock Valuation

To gain insights in stock valuation, you are best served by considering a wide variety of perspectives. While this is initially challenging, it allows you to discover the valuation methodology most suited to your views and observations. While there are an infinite number of approaches, stock valuation is often broken into two types of analysis: fundamental analysis and technical analysis. Each uses a different set of metrics to gauge a stock’s relative position. Considering each will allow you to make an informed decision.

Fundamental Analysis

The basis of fundamental analysis is to consider the major economic factors that drive a company’s business. From this information, you are then able to make a determination as to the real value of the company and where its stock should be trading. If the stock is trading below the value that you have determined to be accurate, the stock is considered a good value and should be bought. If the stock is trading above this value, the stock may be shorted. This type of analysis tends to lead to longer-term positions, as it often requires months of trading activity for the fundamental factor to become reflected in the stock’s price.

Some of the most common factors that you should consider include the earnings history, the dividend history, the gross and operating margins, and the stock’s relative position within its own industry. If, for example, the stock is in a high-margin business, you should factor this in when considering the quality of the stock. Considering the industry gives you a context into which this data can be considered. Metrics for a utility company will appropriately differ from those for a tech stock.

Technical Analysis

Technical analysis operates under the assumption that you can discern all the relevant information you need about a stock by considering its price action and volume. Rather than considering various economic factors, under this approach you make the assumption that the market will price-in the data and reveal the impact of that information in how the stock trades. A technical analyst considers various indicators which are driven by the price action and volume of a stock.

The relative strength index (RSI), for example, measures the relationship between buyers and sellers in a given security. When a stock has been pushed higher by a disequilibrium between buyers and sellers, you can say that the stock is overbought. As equilibrium returns and sellers balance out, the stock is expected to trade lower. There are hundreds of indicators that can be considered, many of which are provided as part of most basic trading packages. Considering a collection of these indicators allows you to make a determination of the relative attractiveness of a stock and to act on this information.

Putting It Together

Many successful traders use a blend of these two approaches. In either case, if you have exposure to each, you will be able to determine which is more in line with your style and beliefs. Using a combination of the two will provide unique insights and allow you to develop a successful approach.

blog comments powered by Disqus