How Securities Are Analyzed

(2 of 9)

How Securities Are Analyzed

Before investing in a major purchase such as a car or a stereo, most people do some extensive research to make sure they are getting the best bang for their buck. Investing in securities such as stocks and bonds is no different.

Things To Know

  • Security analysis calculates a security’s real value.
  • Security analysis can also help predict future price movements.

What securities analysts do

Security analysis is the process of researching and evaluating the factors that may influence a security’s value. A person who makes a living researching securities and recommending investments based on their research is called a securities analyst. Securities analysts often have professional designations, such as the Chartered Financial Analyst (CFA) credential. Securities analysts usually work for brokerages or other financial institutions.

There are many different ways to analyze a security’s value. Most security analysis techniques look at a company’s earnings, revenues, cash flow, equity, and dividends to determine the value of a security.

How do you use security analysis?

The main goal of security analysis is to calculate a security’s real value from analytical data. Just because a company’s stock is rising or seems to be a great bargain, doesn’t make it so. Analysts go behind the scenes to see how good a company really is relative to other companies.

The techniques of security analysis can be used by all investors to determine the kinds of securities that will help them meet their investment objectives, and they can also be used to evaluate those securities’ future potential. Investors can use security analysis to determine whether a security’s market price is over or under its actual value. Investors buy undervalued securities at low prices and hold onto them in the hopes that someday the market will realize the company’s value and increase the security’s prices.

What does security analysis look for?

Securities analysts determine a company’s profitability by looking at its returns. A return is the amount an investment earns as a percentage of the price paid to own it. It is the sum of income an investment makes over time, plus its capital gains. Analysts not only look at the security’s historical market returns, they also look at a company’s return on investment (income divided by stock and debt), return on assets (income divided by total assets), and return on equity (additional earnings made from reinvesting profits).

The importance of dividends

The amount of dividends a security returns is also an important measure of its worth. The percentage of a company’s stock price paid to shareholders in dividends is known as the security’s dividend yield. Dividend yield is calculated by dividing the sum of a company’s annual dividends by its current share price.

Important ratios used

Analysts evaluate a security’s price behavior in many different ways. The most common measurement is the price-to-earnings (P/E) ratio. The P/E ratio tells you how many years it will take at the current rate of earnings for you to make all of your investment back. Other common price indicators include the price-to-sales (P/S) ratio, earnings per share (EPS), and earnings before interest and taxes (EBIT).

Identifying future price trends

Security analysis is also used to identify a security’s future price trends. Knowledge of expected returns and true company value gives analysts a sound basis upon which to make their predictions.