Analyzing and trading stocks and ETFs can be very rewarding. But it takes a lot of time to identify potential opportunities, entries, and exits, not to mention good risk management. A successful trade starts way before opening a position.
We’re going to group analysis into two areas — fundamental and technical (using charts). You’ll find traders who prefer one over the other religiously. Some traders think you can’t mix these two types of analysis together. However, there isn’t any rule or particular reason the two can’t complement each other.
In this article, we'll focus on explaining how to perform fundamental analysis when analyzing and trading stocks and ETFs. Below, we cover four key steps to making more informed trade decisions.
4 Key Steps To Analyzing And Trading Stocks And ETFs
Analyzing a company’s financials, place within its industry, management, and competitive advantage all fall under fundamental analysis. Fundamental analysis plays an important role in both the value investing and growth investing strategies.
It involves both quantitative and qualitative analysis. Just like technical analysis, it’s a very large area. You can spend days analyzing just a single company.
So, where do you start? This really depends on what you are trying to accomplish. Are you looking for a stock that will go up very fast? Are you interested in startups or biotech? Or do you just want a stable stock with good dividends?
Let’s look at the latter — a stable stock that pays a dividend and has some potential for appreciation.
1. Screen Out Securities That Don’t Meet Your Criteria
Above, we said we wanted to find a "stable" stock or ETF. To meet this criterion, you'll want a security that has a good track record. Otherwise, how do you know if it's stable? That rules out startups. Stable also means non-volatile. That rules out biotechs, pharmaceuticals, and certain tech stocks.
We're likely looking for a larger company with a fairly large market cap. Market cap is the number of shares outstanding multiplied by the stock’s price. Over $50 billion in market cap and at least a $100 stock price are good minimums.
You can find these companies using the screener tool at Yahoo Finance. Click the "Create New Screener" button. Next, click “Large Cap” and at least a $100 stock price.
Currently, some of the stocks that appear after applying these filters include Lockheed Martin Corporation, Target, and FedEx. These are companies that have been around for a long time and have good management.
2. Examine An Asset’s Volatility Using Its Beta
If you click Target (TGT), it will bring you to the stock’s page. You can see the stock pays a dividend. It has a Beta (5Y Monthly) of 0.99.
Beta is a measure of a stock’s price movement compared to the S&P 500. Less than 1.0 means the stock moves less than the S&P 500. Greater than 1.0 means the stock is more volatile than the S&P 500.
We're looking for stability. A beta of 1.0 is about the max we’d want. Although less than 1.0 is more desirable.
3. Use P/E Ratios To Discover Value
As of writing, TGT has a P/E Ratio of 20.72. That means a trailing 12-month price to earnings of 20.72. A high PE ratio can mean the stock is overvalued or expensive. A low PE means the stock might be a good bargain. Is 20.72 a good PE for TGT?
To find the answer, we need to know TGT's historical PE and compare it to the retail industry's PE. To view TGT's historical P/E, we can use Macrotrends.
You’ll notice at the top of the table on that page, TGT is part of the Consumer Defensive sector. You can see that sector’s average PE here at Finviz on row 3, which is 26.45.
That means TGT is undervalued compared to its industry. Looking at the chart below, TGT is just below its 2014 historical high PE of 21.34. Shortly after that high, TGT's P/E fell into the low teens and began to rise slowly.
The stock price remained fairly stable during this period. Since the end of 2019, both the PE and stock price have been rising. Should we be concerned that TGT is overvalued?
Well, we know both the stock price and P/E are at or near all-time highs. All-time-highs don’t represent a good value. By definition, you’re paying the highest price the company has ever been. It may not be the best time to invest in TGT. And, if we have a lot of shares of TGT, it might be a good time to sell some and capture profits.
4. Inspect Company Financials
This is an area that we could spend days on. However, as an individual investor, being able to quickly look at a company’s financials and assess its financial health is a valuable skill.
We’re going to provide you with a few tools for some quick analysis. Below are some key values (pulled from Finviz) to consider for TGT:
For each of the factors above, it's important to compare Target to its industry peers. For example, a Quick Ratio of 0.40 (meaning Target's liquid assets equal only 0.40 of its liabilities) might seem concerning on the surface. But it could help set your mind at ease to learn that Walmart has an even lower Quick Ratio of 0.20.
Fundamental analysis is important in determining a company’s financial and competitive strength. It can be used in the same way for ETFs. If you're ready to get started analyzing and trading ETFs, check out our favorite stock brokers here.
We’ve only scratched the surface of fundamental analysis in this article. Even after completing the steps above, you'll still need to analyze the company’s management, industry trends, financial trends for the company, and major competitors.
That might seem like a lot of work and it is. But the more you become involved in fundamental analysis, the more proficient you'll become. However, if you prefer to be more hands-off with your investing, you may want consider an index fund or robo-advisor approach. Compare robo-advisors here >>>
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.
Editor: Clint Proctor