Equity Analysis

Equity analysis is the process of gathering information about a company and analyzing it fully with the perspective of understanding its future growth and financial health. It also includes predicting the company’s ability to gain profit and reap maximum returns in both the short and long term. The equity analysis covers both qualitative and quantitative aspects, which means that it includes market psychology, investor behavior, industry news, updates and common sentiment of the investor's community regarding the underlying stock. The analysis not only clarifies the future but also helps calculate whether the stock is undervalued, overvalued or appropriately priced based on which investors can make investment decisions or avoid it, foreseeing the risks attached to it.

A major part of equity analysis belongs to financial modeling, which is used to forecast future performance. Every day, millions of investors and traders try their best to gauge the company fundamentals and technical aspects to make the best profits and diversify their portfolios.

Without equity analysis, there would be no concrete evidence or method for anyone to understand, interpret or give reliable information on whether and how a company shall perform or whether someone should invest in them. Therefore, it gives a strong foundation of solid theory coupled with formulas, ratios, indicators and calculative approaches to draft a proper and accurate company financial and stock performance.

There are two primary approaches to perform equity analysis, they are -

#1 - Fundamental analysis

The fundamental analysis refers to a detailed study of a company's financial statements, management growth, business model, size, economic factors, competitors, advantages and disadvantages, cash flow, and profitability to determine its intrinsic value.

The fundamental equity analysis comprises many critical ratios such as dividend yield, price-to-book ratio, earnings per share, dividend payout ratio, earnings-to-growth ratio, return to equity ratio, EBITDA, return on assets, price/sales ratio, current ratio, quick ratio, operation margin, ROI, debt to equity ratio, asset turnover ratio, debt to asset ratio and so on.

Although each of these values and ratios has its importance, an analyst doesn't need to deduce all of these every single time. In contrast, most analysts try to find a couple of these ratios and use their combination to arrive at a better outcome or company forecast.

#2 - Technical analysis

A very different approach than the fundamental analysis is the technical analysis. It is majorly focused on a company's stock market performance. Analysts interested in the technical analysis of a company focus on their historical stock price patterns, identifying market trends, industry analysis, trading volume data and understanding the market psychology towards the company's stock.

The whole concept of technical analysis is to predict the future stock price movement. Hence, it comes with various technical indicators that are created using charts, trend lines, candlestick patterns, moving averages and more to identify suitable entry and exit points for trades.

Some of the key tools and techniques in technical analysis are relative strength index (RSI), Bollinger bands, moving averages, moving average convergence divergence (MACD), volume analysis, candlestick patterns and Fibonacci retracement. Again, market analysts and traders tend to combine these techniques to predict future stock movements.

#3 - Sentiment analysis

The sentiment analysis is based on data gathered through multiple sources and operates on machine learning and natural language processing. The typical sources are news articles, blogs, social media, financial reports and feedback.

This enabled market analysts to use forecasting models and perceive how the market behaves, thinks and operates based on sentiments. It assists in determining investors’ and traders’ attitudes along with all the mood shifts, which depend and vary based on several factors such as natural calamities, major world events, management actions, etc. Each of these factors impacts stock prices in both directions. The gathered data are often filled with inconsistencies and go through step-by-step processing to get cleaned and remove errors.

Below are two distinct examples of equity analysis, both hypothetical and real-world examples -

Example #1

Suppose Howard is a new investor and a conservative one. He is very particular about his investments and has managed to create a small portfolio of nine stocks. Howard is currently eyeing an oil stock. But he is a novice when it comes to evaluating company stocks. He decides to learn equity analysis and starts by taking a small online course, where he learns about both the fundamental and technical approaches of equity analysis. He equips himself with all the knowledge to deduce different ratios and employ different indicators, and which ratios and tools best work in combination.

After spending 45 days learning about all of this, Howard comes back, collects all the data of the oil company from various sources and performs a full equity analysis. He finds out that the company has huge potential for future growth, and within two years, it shall reap maximum returns. Howard finally decides to invest in it. This is a simple equity analysis example, but many other aspects are considered in the real world.

Example #2

The second example comes from NVIDIA from May 2024, which came inches close to Apple in terms of market value. With a share price closing at $1,128, NVIDIA’s market capitalization hit $2.8 trillion, trailing Apple at $2.9 trillion market value. Derren Nathan, the head of equity analysis at Hargreaves Lansdown, remarked that the market was struggling to keep up,  whereas NVIDIA’s shares have more than doubled year to date following last year’s 200% surge.

As per equity analysis, the company is a major player in the AI sector and has reported a five-fold increase in revenue in its data center segment, given to high demand for its chips. The equity analysis also tells us that there are tech giants like Amazon and Microsoft vying for NVIDIA’s premium chips to dominate the AI computing landscape.

The importance of equity analysis can be summarised as:

• The whole process of analysis helps predict any company's prospects.
• Based on a good equity analysis, a trader or analyst can understand if the company will grow or decline in the future.
• It helps traders, market analysts, economists, shareholders and other market participants to make informed investment decisions.
• Without equity analysis, there will be no techniques or methods to understand how a company will perform.
• Equity analysis provides a strong foundation to maximize returns and predict the foreseeable risks and bad investment consequences.
• The study of in-depth company financials also includes the market sentiment and investors' behavior; hence, it covers both qualitative and quantitative techniques.