Different Types of Analysis
The following investment analysis techniques are helpful in analyzing and predicting a stock's current and future performance:
- Fundamental Analysis: One widely used approach to stock investing is to focus on fundamentals. Fundamentals include factors such as the earnings, cash flow, and balance sheet statistics of a given company, plus general economic conditions and the industry in which the company operates. Such an analysis looks at whether the current valuation of a company, as seen in its stock price, adequately reflects the level of business success perceived for it in the future.
- Technical Analysis: A second approach to investing emphasizes technical factors related to trading activity. A technical analyst, or chartist, attempts to forecast the direction of stock prices by examining their trends. For example, if a stock price breaks above a prior resistance level, it may be headed up further. Obviously, there is a relationship between the fundamental and the technical factors. If a stock price has what appears to be upward momentum, this probably reflects favorable fundamental factors, such as a good earnings report from the company or the announcement of a new product. Although an awareness of trading patterns can be helpful in timing investments, technical analysis can be quite specialized, and we suggest that most investors utilize a fundamental approach to investing.
- Past Performance: Although past performance is not necessarily indicative of future results, it is advisable to examine a company's historical performance. Look at 10-year trends in the company's income statement data, as published, for example, in Standard & Poor's Enhanced Analytics. Have revenues and profits been generally growing? If not, why? Also, has revenue growth primarily been coming from higher volume, new products, acquisitions, or increased prices? What has the trend in profitability been? Have earnings as a percentage of revenues been on the rise?
Diversification—Don't Put All Your Eggs (Money) into One Basket (Stock)
Diversification is a risk management technique that mixes a wide variety of investments within a portfolio. Designed to minimize the impact of any one security on overall portfolio performance, it is achieved by spreading out your investments among different securities. This way if a security or sector suffers a downturn, your losses would be limited.
The SEC defines stocks that are traded under $5 per share as penny stocks. Also called micro-cap stocks, these are the stocks traded on the Pink Sheets or OTCBB. Most penny stocks do not have much information available to public, which is essential to many stock investors. Stocks on the OTCBB and Pink Sheets do not have to fulfill minimum standard requirements to remain listed and Pink Sheet companies are not required to file with the SEC. As a result, if anything happens to the firm, there is no safety cushion for investors using the penny stock strategy. Therefore, penny stocks, which have higher than expected returns, are considered to be much more risky than exchange listed stocks.
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