Welcome to lesson two of our Investing Basics course.  This second lesson will cover how to research and select shares to invest in. We will look at stock screeners, watch lists and earnings reports plus how to make your own judgement on how much a share is worth using fundamental analysis. Here’s what we will cover:

• What is a stock screener?
• What is a watch list?
• What is fundamental and technical analysis?
• What is quantitative and qualitative analysis?
• What are earnings reports?

Stock Screeners

Now you know the basics of how shares work you are likely asking: How do I find shares to invest in? The answer is by using a screening tool.

A stock screener is a tool that allows you to search through a large number of companies to find shares that meet your criteria. They allow you to filter for a wide variety of metrics to find shares that fit your investment goals and strategy. Your broker may have its own screening too, as well as filters for different types of investments.

Common metrics – such as market capitalization, price-to-earnings (P/E) ratio and dividend yield – are covered by most stock screeners. Other screeners will include more advanced metrics that allow you to pinpoint the exact shares that will fit your strategy.

There are many free stock screening tools available, including FinViz and TradingView.

Watch Lists

Once you have identified a number of shares that fit your chosen criteria, it’s a good idea to add them to a watch list. A watch list is simply a shortlist of stocks you might want to invest in. Your broker will most likely offer a watch list tool, but they are also available for free on Google and Yahoo’s finance pages.

Watch lists are incredibly simple to use – just add your chosen stocks to the list. The hard work comes in selecting the shares. You can add any number of shares to a watchlist, but experts recommend no more than about 25 shares.

It’s also a good idea to create different watchlists for different purposes. For example you may have a watchlist for large cap Australian shares, another for international shares, another for value shares and so on.

Fundamental and Technical Analysis

As previously mentioned, the hard work comes in selecting the shares and knowing what to search for. The primary goal of investing is to buy shares when they are cheap and sell them for a profit. So how do you determine what a share is worth? The answer lies in fundamental and technical analysis.

Fundamental analysis seeks to determine the natural or inherent value of a company or asset. To do so, analysts look at financial statements and the industry and environment they operate in. For example, investors will focus on the company’s earnings, net income, free cash flows, listed assets, revenue, sales, growth potential and liabilities.

Technical analysis is based on the idea that these factors are already reflected in the price of a share. Instead of analysing a company’s balance sheet, technical analysis focuses on analysing price charts.

Both approaches have their benefits and drawbacks. Most investors will use a combination of the two, using fundamental analysis to decide which shares to invest in, and technical analysis to find the right time to buy. We will focus on fundamental analysis for now and look at technical analysis later.

Quantitative and Qualitative Analysis

Fundamental analysis can be split into two parts – Quantitative Analysis and Qualitative Analysis. Quantitative Analysis uses statistical and mathematical analysis of “hard” data to assess potential stock investments, whereas qualitative analysis looks at “soft” factors – such as business model and personnel – that are not always reflected in the numbers.

Quantitative analysis is the first step in the fundamental analysis of a company. Financial analysts comb through a company’s balance sheets and earnings reports, looking for relationships between reported metrics. The result is a series of ratios that can determine how much a company is worth.

Investors can then sort through these ratios to find shares that are best suited to their strategy. For example, the price to earnings ratio (P/E) is arguably the ratio most relied on by investors. Those looking for “value” stocks at bargain prices will gravitate towards stocks with low P/Es – indicating that the stock may be undervalued. Those looking for “growth” stocks will gravitate towards stocks with high P/Es, indicating market participants are willing to pay more for a stock’s expected future growth.

The next step is qualitative analysis, looking beyond the ‘hard’ data to ‘soft’ factors that are not always reflected in the numbers, but can be just as important. There are a whole host of intangible factors that affect the value of a company but the three most important are the business model (how the company makes money), the competition (the industry they operate in and who their rivals are) and the people (who runs the company). It is just as important that you have a good understanding of these ‘soft’ factors, as well as the ‘hard’ numbers.

Earnings Reports

Earnings reports are the financial statements that are issued by publicly traded companies. It is a report that details the gains or losses made by the company in a specific quarter, half year, or full financial year. These reports also include data such as profit margins, sales volume and revenues.

You might find it overwhelming to read these reports in full, but a basic understanding of the key metrics will make them easier to comprehend. It can help to compare the results with previous quarters as well as with the company’s and analyst’s projections to understand whether the company has met, missed or beaten the estimates.

These reports can have a huge impact on the price of a company’s shares, as they form the basis of fundamental analysis. Failing to meet estimates for key metrics can cause a company’s share price to fall, whereas beating estimates can cause prices to rise. Many investors will wait for earnings reports to be released before deciding whether or not to invest.

Earnings per Share (EPS) is the headline number that investors and analysts will be paying attention to. Other important metrics to watch include revenue, sales and profit. A lot of companies issue guidance that provides the expected results for the upcoming quarter. It is important to compare this to the actual results to see if a company is ahead of or behind expectations.

Key Points

• Stock screeners are tools that allow investors to sort through shares based on various metrics
• Watch lists are simply lists of shares. They help investors narrow down the shares they might wish to buy
• Fundamental analysis is a way of analysing company information to determine the inherent value of their shares
• Quantitative analysis looks at ‘hard’ financial data to determine the value of a company’s shares
• Qualitative analysis looks at ‘soft’ intangible factors, such as a company’s business model, to determine their value
• Earnings reports are financial statements that publicly traded companies are required to regularly issue. They detail how the company is performing.