Expert Guidance: Demystifying stock research With Sam Stovall, Chief Investment Strategist, Standard & Poor’s Demystifying stock research Evaluating stocks is complicated because the companies that issue the stocks are complicated. A company’s fortunes, and so the fortunes of its stock, depend on a vast array of factors, including market demand, competition, legislation, technology, the general economic climate, and the skill of its management, to name a few.

So if you’re interested in investing in stocks, you’ll need to find some ways to choose among the thousands that trade on U.S. markets.

That’s not as difficult as it may sound. You can get the company’s perspective about itself and its stock from the annual report to shareholders, usually available on the company’s Web site. And you can take a look at the detailed and less glossy annual 10-k report the company files with the SEC.

You also have access to the opinions of the investment analysts who evaluate stocks. Analyst reports can help you confirm your opinion of a stock’s prospects or draw your attention to concerns that you might not discover on your own. Your broker or adviser can always help you track down the reports you need or send you those he or she thinks might interest you — or those that feature stocks the firm is advocating.
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Types of research A company’s SEC filings, in particular the annual 10-k report, is a comprehensive overview of the company’s financial health. The 10-k report gives you detailed, audited numbers — the company’s balance sheet — where you can review debts and assets, revenues, expenses, and descriptions of the company’s activities, developments, and a catalog of the risks it faces. It also contains detailed footnotes that elaborate on specific situations and may provide valuable clues to the company’s prospects. While it’s dry reading, many investors and their financial advisers view the 10-k as an indispensable resource.

It’s also important to follow the financial press, to keep abreast of what’s current in the industries and stay informed about the companies you’re following. If you’re tracking a stock closely, it’s smart to set up automatic email news alerts that send you the latest stories about the stock’s industry and company as they’re published. Your adviser can also help direct relevant news and information your way and help you single out important developments.
Many SEC filings are available free of charge through the SEC’s online database, EDGAR — the Electronic Data Gathering, Analysis, and Retrieval system. EDGAR is accessible from the SEC Web site, www.sec.gov.
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Professional research
Professional stock research comes in different formats to meet different investor needs.

The most detailed, and the one that usually goes by the name research report, is a profile of a single company’s stock: an in-depth report that examines various aspects of the stock’s potential performance — such as an analysis of the company’s balance sheet, its place in its industry, the market for its products, and its stock price and trading history.

Some research firms offer a snapshot version that provides a one- or two-page condensed report that may stand alone or summarize material from a detailed report. And some firms offer regular newsletters that summarize recent research and make stock suggestions.

You may use all of these formats: Find stock ideas in a newsletter, review the snapshot pages, and then pore over in-depth reports for the most interesting stocks. Or you may find yourself just using one kind of research. In the end, it depends on what works best for you. Unequal treatment
Not all companies are equally scrutinized. Large companies tend to get the most research attention, though some analysts focus on mid-cap or small-cap companies. Dozens of analysts may follow a star company in a hot industry, while an out-of-favor company may attract just a handful. And some companies aren’t covered at all.
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Independent and in-house research
There are two categories of analyst reports you may find through your brokerage firm: in-house reports written by analysts working for the firm and those issued by independent research firms, such as Standard & Poor’s and Thomson Financial, which are unaffiliated with a brokerage business.

Brokerage firms employ analysts who provide in-house research on a range of companies to the firm’s brokers and their clients. The cost is underwritten by the firm as part of the service they provide, and is covered in part by the commissions investors pay on their transactions. In contrast, companies that offer independent research profit by selling their information either to firms or directly to individual investors.

Although you may like the idea of getting research from an independent source, be careful not to assume that independent research is always better. There are knowledgeable and experienced analysts working for brokerage firms, as well as for independent companies. And an analyst may move between the two types of firms several times during a career.
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Where the bulls are
One important statistical difference between in-house research and independent research is that, historically, research from brokerage houses has tended to be more bullish. In other words, analysts who work for these firms are more likely to take more optimistic views of the stocks they examine.

Logically, this makes sense, since the more stocks you buy, the greater the commissions and fees you pay. So it’s in the interest of brokerage firms for their analysts to generate enthusiasm for the stocks they cover. In fact, in the past, some firms have issued few if any negative reports and have rarely advised selling. Some firms have even used counterintuitive rating terms — for example, making hold rather than sell the lowest possible rating.

However, today’s regulations require firms to use plain English definitions for their ratings. A hold rating must mean to hold, not to sell. And the Financial Industry Regulatory Authority (FINRA) requires that firms provide information about their ratings distribution — in other words, what percentage of the stocks they analyze receive each rating. That way, if a firm’s analysis tends to be heavy on the bulls, you’ll be able to see it.
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Conflicting loyalties
Regulatory investigations have focused on the potential conflicts of interest at the handful of large firms that offer both brokerage and investment banking services. At these firms, the desire to please corporate investment banking clients had come into conflict with the firms’ responsibility to provide fair stock analysis to individual brokerage clients.

In 2002, to address this concern, ten major firms with investment banking businesses reached an agreement with regulators to improve the quality of their research services in several ways. Among other things, they agreed to provide brokerage clients with research from at least three independent sources, and to set up barriers between the two sides of their business, to prevent investment banking concerns from influencing research and analysis.

What’s disclosed

If you’re wary of potential conflicts, you can always look for full disclosures on any of these firms’ research reports. They list any dealings the firm has with the companies whose stock they analyze. And you can examine the ratings distribution data, which include separate information on the stocks of the firm’s investment banking clients, so you can compare the data with the general ratings distribution and look for bias.
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Subscription stock research
Some independent stock research — such as the Value Line Investment Survey and Morningstar’s Buy/Sell Reports — is available only to paid subscribers. Some services take a broad view, such as the Value Line Investment Survey, which has tracked 1,700 stocks over more than 70 years, and some have a more narrow focus or a shorter history. In fact, there are scores of subscription investor research services, from the well-known to the obscure.

Depending on the service you use, subscription research may be available in print only, online, or in either format. You may use the information these companies provide to supplement or confirm research you find from other sources. Or you may follow the investment advice that the firms provide or the systems they have developed for choosing which stocks to buy, when to buy and sell them, and how to assemble a diversified portfolio.
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Newsletters
There are also scores of newsletters that offer stock recommendations and advice based on a single analyst’s opinion or methodology. Sometimes these newsletters also offer general investment advice and broader assessments of economic trends. Many of them track their performance by reporting on the ups and downs of a model portfolio invested in the stocks they recommend.

Many newsletter subscriptions market themselves by offering a sample edition or inviting you to sign up for a free trial, so you can review their format and the general scope of their advice. It’s a good idea to sample before you buy because newsletters vary widely in their quality and approach. For example, you may find that some newsletters focus on stocks that are too risky for your portfolio, while others may be too conservative for your taste. And you might find some stock-selection methods suit you better than others. It’s also a good idea to seek details about the newsletter’s track record.

What’s it worth?

Subscription newsletters can be expensive, with annual fees ranging from about $100 to $600. But if a subscription newsletter gives you solid analysis, excellent stock advice, and practical ideas you wouldn’t have found otherwise, you may find that the cost is worth it.
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How analysts work
Typically, an analyst follows a number of companies, often in the same industry. The analyst’s job is to know these companies inside and out, and to deliver objective, accurate recommendations about their stocks. Analysts must examine whether a company is financially sound, whether it has potential for increased future earnings, how it measures up to others in its industry, and whether its current price is worth paying.

Whose side are they on?

There are two kinds of analysts: buy-side and sell-side. As an individual investor, you use sell-side analysis, which comes from the side of the financial services industry that concentrates on selling stock. This includes investment banks that help a company create and distribute its stock, brokerage firms, and analysts who advise the public.

Buy-side analysts research investments for big institutional investors, such as mutual funds and pension funds. There are more buy-side analysts working on Wall Street than sell-side analysts, but the buy-side never makes its research public.
Getting to know them
Analysts are like journalists — some get most of their information from company-authored press releases, and others are thorough investigators who dig deep for more facts. When companies misrepresent the facts, analysts who rely heavily on official company reports can be misled. Furthermore, investigative analysts may have their work cut out for them, since many companies have been known to be uncooperative with analysts viewed as overly critical.
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Fundamental analysis
Fundamental analysis is the more traditional branch of stock analysis: the evaluation of the company’s business and financials. To gauge how well a company will perform in the future, analysts look at the company’s balance sheet, organization, management, and business strategies to see how well the company is positioned and whether it manages its day-to-day operations well.

They review annual and quarterly reports, attend shareholder meetings, and talk to employees, management, and industry experts. They ask about assets and debts, how much money the company brings in, how much it spends, and whether earnings are expected to rise or fall. Analysts pay extra attention to developments that could affect the company’s expenses and earnings: for example, mergers and acquisitions, new products, expansion, or the launch of advertising campaigns.

Looking outside

Some factors that affect a company and its stock are outside its control. The actions of competitors, legislators, and customers play a big part in a company’s fortunes. General economic trends may push a company’s stock price up or down. And changes in related industries may affect the company as well. For example, if the price of gasoline rises, an analyst may ask how that added expense could affect delivery companies that rely on ground transportation.
From the Expert
Sector analysis is critical. Academic studies have shown that from 60% to 80% of a stock’s price change is the result of the direction of the overall market, and whether the sector of the stock is in or out of favor. Hence the phrase "A rising tide lifts all boats." Only the remaining 20% of a stock’s move appears to be company specific. So even though many "smart" investors claim that the "herd" is frequently wrong, it can be very risky to buck the trend.
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Technical analysis
Most of what’s considered stock analysis is known as fundamental analysis: the study of the company itself. But if you’ve determined that a company is financially sound and shows signs of the growth you’re looking for, your next question is whether the stock is worth its market price. Technical analysts try to answer that question.

Technical analysis is based on data that track trading and price movements for a stock. Analysts can use this data to see how certain events have affected the demand — and therefore the price and trading volume — for a stock in the past, which may give them some insight into how the stock may behave in the future.

The price is right

Technical analysts review a stock’s average rate of growth and look for aberrations, such as jumps or dips in the stock price or trading volume, to see how the market has reacted to past events. Based on previous prices, they make judgments about whether a stock’s price is on its way up or down.

Aside from revealing historical patterns, technical data can also provide early evidence of current developments. For example, if today’s technical data show a leap in a stock’s trading volume because a big institutional investor is selling off that stock, it may be a sign that other big investors are about to follow suit.
Technical analysis alone rarely gives you enough information to determine how a stock’s price will move. Most analysts use technical analysis in tandem with fundamental analysis. So price charts often raise questions — for example, what might have happened the year the price jumped or fell — and fundamental analysis fills in the details.
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Analyzing the analysts
Even though stock research is based on numbers and facts, the quality of the analysis depends upon the skill and the experience of the analyst. So you shouldn’t be surprised if you find that recommendations and reasoning vary from one analyst to the next.

Consensus

You may also want to look at reports that include analyst consensus, which compiles ratings and estimates from all the analysts following a particular stock and compares the entire universe of analysts following a stock with the views of independent analysts alone. By comparing a single analyst’s opinion to the field of opinion, you can determine how mainstream it is.

You may also use the consensus numbers as a recommendation in themselves: Which rating gets the most votes? Or you could examine the spread and determine whether there is a generally uniform opinion or if they vary widely. If there’s a wide spread of opinion, the company may be going through controversial changes, and you may want to read two drastically different opinions before you make up your own mind.
Contrariwise
The majority opinion has been wrong before. Analysts are only human, and they too can fall for positive or negative hype surrounding a stock. They may also take the opinions of other analysts into consideration as they prepare their reports. And they may feel pressure to bring their opinions into line with the majority, to avoid close scrutiny or criticism. Since analysts too can be misled by consensus, it’s a good idea to review at least one report that offers a point of view contrary to the consensus opinion.
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Analysts’ reports
It would be convenient if all analyst reports followed a simple, fill-in-the-blank template, edited and organized for maximum clarity and easy skimming. That way, curious investors could rapidly skim through their pages and find, in seconds, precisely what they needed. For better or worse, this is not the case.

Instead, each firm’s proprietary report highlights different types of information presented in different formats, often using different terminology. The benefit of variety is that the wide range of presentations allows you to glean different insights from different reports. The challenge, of course, is learning how to read the information you get.

No single universal guide can define every term and statistic you’ll find in every research report. But many reports share some elements, so you can get a feel for the basics. And if you’re ever stumped, you can do what many savvy investors do: Ask an expert. That’s what financial advisers are for.
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Anatomy of a report
Some reports seem crammed with facts, some with opinion. Some spell out detailed reasons for their recommendations, and others leave it to you to connect the dots.

You’ll find some or all of the following elements in a research report:

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Understanding ratings
The part of an analyst report that tends to get the most attention is the rating — which also serves as a recommendation. The analyst assigns a rating to a stock as a way to sum up his or her opinion.

If an analyst believes a company will increase future earnings at a rate higher than its peers, the analyst gives the stock a high rating, or recommends that investors buy. If the analyst believes the stock isn’t worth buying at its current price, he or she may counsel investors to hold it — saying that it’s neither hot nor cold. And if the stock looks set for a fall, the analyst may give it a low rating, or urge investors to sell.

Different scales

Some companies use rating scales with finer gradations between high and low to distinguish a stock that may be poised for disaster from one that may be only temporarily downtrodden, and to differentiate the stellar performers from those that are slightly better than average. Unfortunately, although these scales are meant to give the investor more information, they often end up causing more confusion, since the difference between a buy and a strong buy, for example, may seem arbitrary.

Furthermore, the language of ratings may not be as intuitive as buy and sell. For example, one firm refers to overweight, equal-weight, and underweight stocks in its research, while another prefers to rate stocks using the terms outperform, in-line, and underperform. And two analysts may use the same terms to mean different things. You may have to read the firm’s explanation carefully to understand what its ratings really mean.
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Stock ratings in context
Ratings sometimes make the news. When an analyst changes a stock’s rating for the better, it’s called upgrading the stock, and lowering a rating is called downgrading. When a respected analyst downgrades or upgrades a stock’s rating, many investors take that advice seriously — both because they respect the analyst’s opinion and because they know that the market will react to the rating change.

On the other hand, if you’re an investor who’s looking for value you might take the opportunity to buy a downgraded stock after prices dip, if you believe that the stock could turn around. This may also be true if you have a contrarian style of investing — buying when others sell, and vice versa. And long-term investors may not worry so much about changes to ratings, unless the situation is particularly dire.

What’s the latest?

Because the analyst reports you review may be a few months old, you may need to examine them in light of the latest news and price movements to determine if the analysis still holds firm. For example, if an analyst has downgraded a stock because the price-to-earnings ratio (P/E) is too high — in other words, the stock seems overpriced — selling in the stock may have brought the P/E down to a more reasonable level.

In fact, you might entirely disagree with the analyst’s recommendation. You may decide a stock is right for your portfolio now, even if an analyst recommends that you wait for a better price. That’s why some investors prefer to look beyond a report’s rating and use more of the supporting research to make their decisions.
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Target price
If you’re considering buying a stock in hopes of selling it later at a profit, one of your top priorities is to evaluate whether you believe the price will go up or down, and by how much. Therefore, the analyst’s target price is considered by many investors to be as important or even more important than the rating.

The target price tells you what the analyst believes the stock price will be a year from now. It may be a single price or a range of prices, with an estimated high and low for the period.

Current Price (as of July 15, 2003) $25
Target Price $35
52-Week Range $36-$20

In general, analysts calculate target prices by estimating earnings for the following year. By multiplying next year’s estimated earnings per share (EPS) by the likely price-to-earnings ratio (P/E), the analyst calculates what the stock price will be next year if both estimates are accurate.

Pros and cons

You may find target prices a more useful measure of a stock’s potential than ratings, since ratings, by nature, are generic, across-the-board recommendations that don’t take your particular portfolio needs into account. A target price can help you calculate whether a stock is worth its current market price given its estimated future performance. However, target prices are based on estimates that may not turn out to be accurate. Furthermore, if your financial needs are more long term, an attractive target price for next year may not be the best indicator of a stock’s potential for long-term growth.
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Evaluating target price
Some experts caution investors to assess target prices carefully, since the underlying assumptions may not hold true. To judge whether a target price is reasonable, you can read the report for the analyst’s evidence, looking in particular at the reasoning behind P/E and earnings estimates. To see how well a particular analyst has predicted performance in the past, you can also review the analyst’s track record, which compares the analyst’s recommendations and price targets to the stock’s actual performance.

Estimates like target price do tend to be more reliable when they relate to companies with established track records and relatively stable P/E ratios. Younger, smaller, less well-known companies tend to be quite volatile in pricing, which makes it difficult for analysts to predict their future value.
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The fundamental numbers
Beyond a report’s rating and target price is the detailed research, much of which focuses on comparing the price of the stock to some measure of its value. You may also see more subjective analysis of the company’s management team, its business strategies, and its products in an overall discussion of how well the company is positioned for the future.

The reports you use might also provide information about a company’s performance relative to its industry peers. For example, if the company is lagging behind, you might hold off buying until it resurges. If it’s leading the pack, you may ask whether it can maintain its position, especially if a rising competitor is nipping at its heels.

Most reports also include information about the company’s assets and liabilities, since too much debt, for example, can affect a company’s profitability.

Some investors pore over every chart and sentence of the analysis they read. But you can also delve into a report and hunt out just those elements that interest you.

Where numbers come from

The reported numbers come from the company’s public statements, including its audited annual SEC filing and unaudited quarterly filing. You can get many of these numbers yourself, from the filings. But an analyst report may put the numbers in context, to give you a better sense of why sales are up or down, for example. And analysts also provide estimates, which, while never perfect, can give you a sense of the company’s likely direction.
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Stock valuation
Many investors find the qualitative part of analysis — examination of the competence of management and the strength of the company’s strategies — makes more intuitive sense than valuation. But you may have a real interest in understanding how an analyst examines fundamental numbers to calculate what a stock is worth.

When it comes to physical assets like houses or jewelry, valuation is a straightforward appraisal of current worth. But when it comes to stock valuation, analysts are attempting to evaluate stocks you might buy today in terms of their future worth. Because this is a more complicated question, and because the value of a stock depends on so many factors, there are several ways to evaluate a company, and an analyst report may use one or many.

Valuation is also where all those numbers and acronyms come in — the part of the report that many investors would rather skip. However, once you understand what the numbers have the potential to tell you, you may be much more interested in what you’ll see.
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Measuring stock value
One way to think of stock valuation is that it’s a way to measure bang-for-the-buck: For each dollar you spend on a stock, what are you likely to get back? Since companies have different share prices and different numbers of shares, analysts break down the value of a company’s stock into a number of per-dollar values so that you can compare one stock to another more accurately.

The type of number that analysts use to express valuation is called a multiple — a measure of a stock’s price against some measure of its value, expressed as a ratio. The most commonly used multiple is the price-to-earnings ratio (P/E), but it’s just one of many you may find in a report. Following are explanations of some of the most common valuation numbers you’re likely to encounter.
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P/E: Price-to-earnings valuation
Fiscal year ends (Dec 31) 2002 actual 2003 (estimated) 2004 (estimated)
EPS ($) 2.00 1.56 1.70
P/E 13.9 17.8 16.3

Because part of a stock’s intrinsic value is the percentage of a company’s earnings it represents, one of the most popular valuation methods is looking at earnings-per-share (EPS) — the company’s total earnings divided by the number of shares — and at the price-to-earnings ratio (P/E). The P/E, which is the stock’s share price divided by its EPS, tells you how much investors are currently willing to pay for each dollar of the company’s current earnings.

If a stock’s P/E is higher than the average — historically about 15 for the market as a whole and more recently closer to 22 — then investors are willing to pay more, perhaps because they believe that earnings will rise dramatically. But if analysts believe that the P/E is too high and investors are paying more than the stock is likely to be able to deliver, they say the stock is overvalued.

Bargain hunting

If a stock’s P/E is lower than average, it may attract investors looking for a bargain, but it may also be a sign that the market is staying away with good reason. If an analyst believes a P/E is too low in light of a company’s future earnings, the analyst says the stock is undervalued.

Value investors — those looking for stocks trading at bargain prices — have traditionally been on the lookout for solid companies trading at low P/Es.
From the Expert
Price-to-earnings targets can be helpful if the stock you own is in a cyclical industry that has a long enough history to have established a P/E range. But many "new economy" stocks, while still cyclical in nature, have not been around long enough to have a P/E range. In addition, a stock’s P/E is only one of many variables that analysts look at. Besides, recent high-profile lawsuits have brought to light the many methods companies use to manage reported earnings. Many investors use other valuation methods (or "metrics"), such as EBITDA, free-cash flow, and debt-to-equity ratios to help determine a stock’s risk and reward potential.
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PEG and EBITDA
Many analysts still recommend stocks that trade at higher than average P/Es if they expect earnings to grow at a rate that makes up for the higher price. To illustrate this idea, analysts sometimes use a multiple called price-to-earnings-growth (PEG), which is the P/E ratio divided by the likely rate of earnings growth.

Add it up

Earnings are also known as net income, and they’re the company’s revenues from sales minus expenses. Although this sounds straightforward, companies can calculate expenses and revenues in significantly different ways.

For instance, some calculations, such as the popular EBITDA (earnings before interest, taxes, depreciation, and amortization) — also known as operating earnings — leave out many accounting expenses that can seriously affect a company’s profits. There’s also no set definition or standard for what items should be included in a company’s reported operating earnings.
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Core earnings
Some analysts have started using another measurement of earnings known as core earnings that has been pioneered by the research firm Standard & Poor’s. This measure requires companies to count employee stock options as an expense and to leave out any revenues or expenses that come from something other than the company’s core business. For example, gains and losses in a company’s pension plan investments can be included in a calculation of its operating earnings but not of its core earnings.

Further, some companies differ on when they record revenue: on a cash basis, when the income is received, or on an accrual basis, when the income is earned, or when the sale is recorded. When you compare the earnings of different companies, it’s legitimate to ask how earnings are calculated, to avoid comparing apples to oranges.
From the Expert
EBITDA stands for earnings BEFORE interest, taxes, depreciation, and amortization. While it is a useful valuation measurement, it is not synonymous with earnings, since a company still has to pay interest to bond holders, taxes to Uncle Sam, and still account for depreciation and amortization.
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Sales valuation
Some years, a company might not record any earnings but could still be a good investment. There might be industry-wide problems. Or the company might be going through a period of rapid expansion or new product development, causing expenses to eat up earnings. In cases like these, analysts often use sales numbers as a better indicator of a company’s future success. The logic is that if sales are strong and growing and the company is otherwise healthy, earnings may be just around the corner.

To calculate the price-to-sales ratio (P/S or PSR) analysts divide the company’s market capitalization —the current share price multiplied by the number of existing shares —by its past year’s total sales, also listed as revenues. Some analysts also subtract debt from the market capitalization, to examine how much debt a company takes on in its efforts to increase sales.

Room to grow

Often you won’t find the P/S multiple in a report at all. Instead, you’ll find sales results for the year and estimates for the future. Analysts concentrate on sales trends by comparing the current quarter’s sales to the same time period from a year ago.

  2Q 2002 2Q 2003 % Change
Sales 5,000 5,150 3%

Analysts also compare sales to expectations, such as in the example below, which links the analyst’s forecast for the quarter with the actual results. Here, the company’s actual sales missed the analyst’s mark by 5%.

  2Q 2003 Forecast 2Q 2003 Actual Variance
Sales 5,400 5,150 -5%

What kind of sales growth is significant? Many analysts look for companies posting double-digit or higher increases —in other words, more than 10% growth — but may expect more or less depending on the company’s age, size, and industry.
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Free cash flow valuation
Cash flow, in investing terms, usually just means EBITDA — a measurement of earnings that focuses just on the profitability of the company’s business operations before interest, taxes, and other accounting expenses. But free cash flow is quite different. While EBITDA leaves out a large number of expenses, free cash flow addresses every expense that results in a payment out of the company’s coffers.

In essence, free cash flow subtracts all cash expenses from all the cash that comes in from revenues, investments, and other items to see what, if anything, is left over. Many investors and analysts see free cash flow as a better measure of a company’s health and future worth than EBITDA, because free cash flow calculates the money that can be used to pay dividends or that the company can reinvest in the business. Some analysts also believe that free cash flow is a more dependable measure than EBITDA, because free cash flow also accounts for the risks that may come with a company’s debt.
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Price-to-book ratio
Many analyst reports cite the price-to-book ratio, which compares the price of a share to its book value, which is the company’s net assets minus its outstanding debt. You’ll often see this multiple cited on the first page of a report, along with other major measures of stock valuation. Book value is supposed to represent the value per share if, today, the company shut down operations, paid off its debts, and its assets were sold off. As such, the usefulness of book value depends significantly on the industry.

A software company, for example, may have few tangible assets, so its book value may be low, making the price-to-book ratio seem very high. Meanwhile, a bank may have all its assets in investments that are easy to liquidate at current worth, so its book value will be very near the company’s actual value to investors. Today, many companies might seem vastly overpriced if evaluated only on their book value, since they lack tangible assets, even if they produce valuable services or products. Furthermore, a company’s profitability depends on the usefulness of its assets: $1 million of outdated inventory is a significantly different asset than $1 million of the latest model.

So even though the price-to-book ratio may get front-page attention on an analyst report, its significance in the report depends on the company and industry.

Debt-to-equity

Book value addresses an important factor in company valuation: debt. Analysts also examine the role of debt in book value through a ratio called debt-to-equity, which is the book value divided by the debt. If the analyst feels the company is carrying too much debt, it could affect the recommendation.
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Beyond the balance sheet
Even though you can learn a lot about a company by studying its balance sheet and income statement, you may also be interested in an analyst’s breakdown of the stock’s story. What else is happening that could affect the stock’s price? Most reports include a summary of the analyst’s opinion, and some reports include detailed analysis of each factor in the analyst’s reasoning, with sections devoted to an analysis of the industry, the company’s strategy, or other factors. Fundamental analysis beyond the financials includes: Although some investors and analysts rely more heavily on the financial numbers and other quantitative measures, you may find that the qualitative analysis — such as the talent of the company’s management, its marketing plans, or its product development — is also important to your stock selection process.
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Technical analysis
Most analyst reports first examine whether a company is fundamentally sound before deciding whether the price is right. However, an analysis of a stock’s trading history and expectations is an extremely important part of most analyst reports. Where you see trading data, including price charts and statistics on trading volume, you’re looking at the technical side of a report.

Technical analysis looks at how a stock trades on the market to find meaningful patterns. The technical data that an analyst examines include the price history, trading volume, insider trading, and volatility. Standard & Poor’s reports, for example, offer technical data like this:

The analyst calls the stock bullish because the price has been going up. The Relative Strength Rank measures the stock’s past year’s price performance compared to the overall market. And insider activity shows that insiders — executives who work for the company itself — have been trading the stock unfavorably. In other words, they’re selling more than they’re buying.

Insider trades

The way that company insiders trade their employer’s stock may reveal their positive or negative appraisal of the company’s performance. Insiders are required to report their plans to trade company stock to the SEC in advance, which allows analysts to gauge how the insiders are trading.

An analyst report may also include a measurement of insider trading volume — the quantity of trades being made. If there’s a flurry of activity, it may be a harbinger of changes to come. Of course, dramatic changes in general trading volume, which may also appear in a report, may also point to important news and developments.
From the Expert
There is an old saying that "the trend is your friend," so spot the overall trend first to see if the share price is likely to continue rising or falling. Next, try to determine how far the trend will go, by looking for areas of "support" or "resistance." Support is a term that describes a price around which investors appear willing to buy the shares. On a chart, it will look like an invisible floor off of which a falling stock price bounces. Resistance is merely the opposite. It’s an invisible price ceiling, at which investors appear very eager to sell the stock. Trading the trend within support and resistance has proven to be a very profitable technique for many investors.
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Volatility
You may also find information on a stock’s volatility in an analyst report, sometimes expressed as a number called the beta — a measure of a stock’s relative volatility. To measure beta, the volatility of the stock’s benchmark index is set equal to one. Therefore, a stock with a beta lower than one can be expected to fluctuate less than its benchmark index, and a stock with a beta higher than one will fluctuate more.

Volatility risk may play a big part in your investment decisions. For example, you may not want to invest in a highly volatile stock even if the analyst recommends it strongly — or on the other hand, you may be actively seeking out highly volatile stocks in a rising market.
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Disclosures
As part of the effort required by recent changes in the law to make in-house analysis more transparent, or open, these stock research reports include disclosures about conflicts of interest and other information:
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Using stock analysis
Using stock analysis wisely means more than just making sense of the language and format of analyst reports. It also means knowing how that information relates to your financial goals.

As you educate yourself about the different stock selection strategies available, never lose sight of the most important factor in any stock investor’s arsenal: your financial plan. For example, if all the winning stocks one year seem to be in a single hot industry — say, technology stocks — it’s best to examine your investment strategy before you sink all your money into a sector that might not seem so hot a couple of years from now.
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