What's the Best Way to Analyze a Stock Before Investing? A 7 Step Guide

By Myles Leva


Last Updated: April 2, 2022


If you want to be successful in self-directed stock investments, you need to learn how to analyze stocks.

Stock analysis processes are necessary for long-term success. However, you will need to consider different approaches depending on what kind of investing you’re doing.

For example, growth investors will perform analysis a bit differently from value investors. Short-term traders such as day traders have entirely different concerns.

In this article, we will simply focus on the basics of analyzing a stock, which any investor should understand.



How Do You Analyze A Stock Before Investing?

To analyze a stock is to go through a standardized process. The goal is an honest account of what prices you are willing to both buy and sell at.

1. Industry Analysis

Industries can be easily broken down for stock investing purposes. There is also a rich collection of publicly-available information. Annual reports from some companies often paint a picture of the broader industry.

You also normally find good information on the competition within their industry.

So, in practical terms, this process will look something like this:

  • Choosing an industry that you are interested in 
  • Conducting research into what drives the industry (supply chains, interactions, etc.)
  • Reading the annual reports of several companies in the industry
  • Signing up for newsletters, magazines, etc. to stay on top of industry changes

Using this process, you can begin lining up the stocks which you will later decide on.


2. Financial Analysis

Regardless of the state of a wider industry, the success of your investment will in large part depend on individual company financials. This is in fact arguably the most crucial step in analyzing a single stock.

Without studying company financials, you are not an analyst at all. So, the first step is understanding how business finance works. To do so, you can start by learning how the key financial documents work:

  • Balance sheets
  • Income statements
  • Cash flow statements

These documents, which sound similar, provide different information that is critical for you to understand.

The reason these documents are important is that they tell the cold, hard truth. The numbers you see on them get into the gritty part of investing that you won’t often see reflected in the words on annual reports.

So, after looking at industries and annual reports for a few key companies, getting into the financial statements and analyzing is the next step.

What you’re looking for will be financial health, but your specific requirements can differ depending on your investment strategy. For example, if you’re a particularly risk-averse, value-based investor, you will look for:

  • High levels of reserves, little or no debt
  • Profitability
  • Conservative financial management
  • Other signs that your investment will be stable for the long-run


3. Business Analysis

There are plenty of excellent companies working in failing or declining industries. There are also bad companies in the most promising industries.

Business analysis is about figuring out where a company is going on its own merits. So, the stock analysis includes:

  • Brand identity/branding
  • Quality of products or services
  • Customer research
  • Supply chain research
  • The company’s publications

This kind of information is especially easy to delve into. But it’s important to understand how a company you’re invested in relates to its customer base, its supply chain, and so forth.


4. Management Analysis

The quality of the company management is critically important to you and other investors.

There are good and bad companies. Normally, management is one of the key factors. The top executives are responsible for maintaining the company and preparing it for the future.

You can find board members and the executive suite of almost any company online. When you’re looking into them, focus on:

  • Their competence in managing finances
  • The adaptability they demonstrate in handling new challenges
  • Their honesty and awareness regarding the most pressing challenges the company faces

Even after you invest, this step is still key. As a holder of shares in a company, you own part of the company, entitling you to sit in on meetings. So, once you’re invested, it’s important to keep up with changes in management.


5. Growth Analysis

This is a harder kind of analysis. You never know for certain exactly where a company’s earnings are headed. However, analysts can make predictions of future growth based on:

  • Past sales
  • Profit margins
  • Industry-wide profitability trends

Essentially, growth analysis is about connecting past performance and current trends with an estimation of future performance. The golden standard is accurate earnings forecasts.


6. Valuation

Valuation means the total value of an asset. If the company is worth a certain amount, what should your stock in the company be worth?

The key here is determining if the market price of the stock is in line with the company’s value. Very often, a company is significantly undervalued or overvalued. However, there is no definitive, single metric for this.

  • Value investors look for “intrinsic value”
  • Growth investors look for “earnings potential”

The main metric that is used here is the P/E ratio (price-to-earnings-ratio). It’s a simple metric that represents the relationship between the stock’s market price and the company’s earnings.


7. Target Price

Your target price is the expected future price of your stock. It is based on earnings forecasts for the most part, but also on valuations.

The calculation for target prices is the proportion of the current price per share to the company’s earnings per share:

  • Current Market Price / Average Earnings



Conclusions: How To Evaluate a Stock?

Analyzing stocks provides a much more reliable basis for investment decisions than any subjective measurement.

Getting very good at stock analysis is extremely difficult, and the top performers are highly successful people. However, grasping the basics takes some research and time.

When you analyze a stock, you can’t overlook any of the factors covered here if you hope to gain any long-term success. These factors paint a more complete picture of where companies and the industries they exist within are going.

Photo by Christian Kaindl on Unsplash



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