T Journal Of Stock & Forex Trading 10.4172/2168-9458.1000163

Citation: Drakopoulou V (2015) A Review of Fundamental and Technical Stock Analysis Techniques. J Stock Forex Trad 5: 163. doi:10.4172/21689458.1000163Page 2 of 8(5) Documents concerning tender offers (a tender offer is an offer tobuy a large number of shares of a corporation, usually at a premiumabove the current market price) and (6) Filings related to mergers andacquisitions.The average 10-K annual report is overfed with numerousfootnotes, disclosures and adjusted numbers offered as alternatives tothe recognized numbers contained in the body of the income statementand balance sheet requiring a really sophisticated reader to interpretthem. Harper [5] in his article emphasized on the red flags aimed toisolate the fundamental operating performance of the business whenanalyzing financial statements. He affirmed the reader to removetwo types of gains that may not be sustained. One type of gains notsustained include the non-recurring gains - these include gains due tothe sale of a business, one-time gains due to acquisitions, gains due toliquidation of older inventory (that is, liquidation of the LIFO layer),and temporary gains due to harvesting old fixed assets, where lack ofnew investment saves depreciation expense.The other type not sustained is gains due to financing - these areimportant because, while they are real gains, they are often randomvariables that depend on market conditions and they may be reversedin future years. The sources of financing gains include special onetime dividends or returns on investments, early retirement of debt,hedge or derivative investments, abnormally high pension plan returns(including an upward revision to expected return on plan assets, whichautomatically reduces pension cost) and increases to earnings or EPSsimply due to a change in the capital structure, for example, an increasein EPS due to an equity-for-debt swap.In regard to Harper’s green flags, the key principle as far asfinancial statements are concerned is that it is important to seeconservative reporting practices. In regard to the two most popularfinancial statements, the following implies conservatism: In the IncomeStatement: Conservative revenue recognition is shown by things likeno barter arrangements, no front-loaded recognition for long-termcontracts, a sufficient allowance for doubtful accounts (that is, it isgrowing with sales), the choice of LIFO rather than FIFO inventorycosting method and the expensing of rather than capitalizing of R&Dexpenditures.In the Balance Sheet conservative reporting practices includesufficient cash balances; modest use of derivative instruments that aredeployed only to hedge specific risks such as interest rate or foreigncurrency exchange; a capital structure that is clean and understandableso those analyzing the statements don’t have to sort through multiplelayers of common stock, preferred stock and several complex debtinstruments; and a debt burden that is manageable in size, not overlyexposed to interest rate changes, and not overly burdened withcovenants that jeopardize the common shareholders.The Value Approach to InvestingThere is a plethora of valuation techniques that fall into two generalapproaches reflecting the complexity and importance of valuing stocks,(1) “the discounted cash flow valuation techniques, where the value ofthe stock is estimated based upon the present value of some measure ofcash flow, including dividends, operating cash flow, and free cash flow”;and (2) “the relative valuation techniques, where the value of a stock isestimated based upon its current price relative to variables consideredto be significant valuation, such as earnings, cash flow, book value, orsales”. Both of these approaches have several common factors such as1For the definitions of mixing and martingale, see Chapter 3 of White.J Stock Forex TradISSN: 2168-9458 JSFT, an open access journalthe (a) “the investor’s required rate of return on the stock because thisrate becomes the discount rate or is a major component of the discountrate”, (b) “all valuation approaches are affected by the estimated growthrate of the variable used in the valuation technique such as dividends,earnings, cash flows, or sales and based on the efficient markethypothesis these variables must be estimated forcing analysts to deriveto different stock valuations because they have different estimates forthese critical variable inputs”.These two approaches of equity valuation should be used asappreciative, not competitive since they both depict “the present valuesof expected cash flows”. The main diversity among the referencedtechniques is how they measure the cash flow used. The easier measureof cash flow is dividends since these are evidently cash flows paiddirectly to the investor signifying that “the cost of equity should beused as the discount rate”. The dividend technique is useful whenconsidering valuation for a stable, mature business entity with anexpected constant long-term growth. On the contrary, the dividendtechnique is laborious to execute to corporations that do not remitdividends throughout times of elevated growth, or that presentlyreward very limited dividends because they have high rate of returninvestments preferences attainable.An alternative description of cash flow is the “operating free cashflow”, which are cash flows after direct costs such as cost of goods sold,general and administrative expenses, working capital disbursementsand capital expenditures needed for perspective growth. Since we arediscussing the cash flows available for all capital provisions, the discountrate employed is the firms weighted average cost of capital (WACC), aremarkably effective model when comparing firms with diverse capitalstructures because WACCs’ formula arrives at the firm’s equity valueafter subtracting the value of the firm’s debt obligations from the valueof the total firm. The third cash flow measure is free cash flow availableto equity owners, which is similar to the operating free cash flow butafter payments to debt holders. Therefore, the appropriate discountrate is the firm’s cost of equity. A possible challenge of these cash flowtechniques is that they are very reliant on the significant inputs, whichare (a) “the growth rates of cash flows” and (b) “the estimate of thediscount rate”. A trivial modification in either of these values can haveconsequential effect on the appraised value [6].The Growth Approach to InvestingGrowth stocks are not necessarily shares in growth companies.Growth stocks are stocks envisioned to transpire a higher rate ofreturn than other stocks in the market with indistinguishable riskcharacteristics. The higher rate of return of growth stocks resultsbecause at some point in time the market undervalued it in correlationto other stocks. Although, the stock market corresponds to stock pricesquickly to depict latest information, attainable information is notalways perfect or precise. Accordingly, the use of faulty or incompleteinformation by most analysts may cause a given stock to be undervaluedor overvalued at a point in time.If a stock is undervalued when the accurate information becomesattainable, its price subsequently should increase to portray its truefundamental value. During the price adjustment period, the stock willbe considered a growth stock since its realized return will surpass therequired rate of return. A future growth stock can be the stock of anytype of company, and not necessarily limited to growth companiessince the stock need solely to be undervalued by the market.If investors identify a growth company and discount its futureearnings or cash flows correctly, the current market price of the growthVolume 5 Issue 1 1000163

Citation: Drakopoulou V (2015) A Review of Fundamental and Technical Stock Analysis Techniques. J Stock Forex Trad 5: 163. doi:10.4172/21689458.1000163Page 3 of 8company’s stock will reflect its future earnings or cash flows. Investorswho purchase a growth company’s stock at this correct market pricewill gain a rate of return coherent with the risk of the stock, even whenthe superior earnings growth is achieved. In several occasions, investorsovervalue the estimated growth rate of earnings or mislead the growthperiod for the growth company and as a result over appraising theintrinsic value of a growth company’s stock. Investors who pay theinflated stock price for a growth company will earn a rate of returnsubordinate to the risk-adjusted required rate of return, despite thefact that the growth company experiences above-average growth ofsales and earnings. An analyst can adapt the Greenspan model for usewith individual equity securities. The Greenspan stock value computesthe ratio of a company’s estimated earnings per share for the next 12months to the current yield on a 1-uear Treasury security. If this ratio isless than the current stock price, the security is overvalued. If it is more,the stock is undervalued.Growth at a reasonable price (GARP) investingGrowth at Reasonable Price (GARP) is precisely a compoundstock investment strategy that emphasizes the assortment ofundervalued investments with anticipated continuous income growthin the forthcoming years. GARP investors integrate value metrics andindividual judgment to decide on stock choices. GARP Investors chasestocks of companies with estimated profits or income in the 10-20%range. Furthermore, Growth and GARP investors analyze the financialof corporations with predictable imminent-term growth and accordconcentration to growth forecasts of corporations inside the same lineof business.GARP investors given that they are concerned about growth, applythe “P/E ratio valuation metric” as it allocates how income correlatesto stock share prices. The P/E ratio can be assessed by “dividing thecurrent share price by the earnings per share (EPS) price (P/E Ratio Current Share Price / Earnings per Share)”. A “P/E ratio in the 10-20%range provides more unbiased information for a GARP investor as it isless pricey and, less riskier than a stock with a P/E ratio of 25 or abovewhich indicates an overvalued stock”. Chasing stocks with lesser P/Eratios is also a stratagem of value investors. On the contrary, Growthinvestors choose stocks with higher P/E ratios because there are highanticipations the company will feature momentous growth.GARP and growth investors also are concerned for corporationswith a lower price to book (P/B) ratio. “The P/B ratio is used to gaugehow much value the market actually places on the book value of thebusiness in question and it is computed by dividing the current shareprice by the book value per share (P/B Ratio Current Share Price/ Book Value per Share), where Book Value per Share Book Value(Assets - Liabilities) / Outstanding Shares”. GARP investors look for alower P/B ratio as it is inclined to reveal larger values. GARP investorsspecifically purse corporations with a P/B ratio that is lesser than thestandard for the industry since it designates a greater prospective forprofit when the market rectifies itself and values the stock correctly.While the P/B ratio is used to gauge the respective value of acorporation and assist conclude if its stock is under or overvalued thePEG ratio is another favorite valuation metric used by GARP investorsto assess growth potential in relation to the value of the company. “It iscalculated by dividing the P/E ratio by the projected growth in earningsof the company (PEG Ratio P/E ratio / Projected Growth in Earnings).For the GARP investor, a PEG ratio of 1 or less is a good indicatorthat the company warrants additional examination. For example, acompany with a P/E ratio of 15 and a projected growth in earningsof 25%, or 15/25 equals a PEG ratio of 0.6 and, would be considered aJ Stock Forex TradISSN: 2168-9458 JSFT, an open access journalgood investment by most GARP investors. While a 1 or less is desired,companies with a PEG ratio of around 0.5 are considered better as theyhave good growth potential but, are also slightly undervalued - Growthat a Reasonable Price” [7].Income InvestingIncome investing is likely one of the simplest stock-picking accessesas it primarily centers on companies that give a fixed income. Wheninvestors think of fixed income they prevalently think of fixed-incomesecurities such as bonds and, stocks of substantiated firms, whichhave attained an assured magnitude and are no longer competent toextend higher levels of expansion. These companies usually no longerare in rapidly ontogeny industries and so as a recourse of reinvestingretained earnings, mature firms cultivate to pay out retained earningsas dividends as a way to supply an income to their shareholders.According to Doan [8] preferred stocks are appointed as fixedincome securities. Fixed income preferred stocks pay out fixed yearlyquotas as dividends in quarterly, monthly or semi-annual outflows andthese fixed settlements generally do not deviate over the life-span ofthe securities. Preferred stocks reward an exact fixed amount that isclarified in the Prospectus consented to the inaugural buyers in thesecurity’s original public offering (IPO) when the security was firstoffered to investors. The

of fundamental analysis is that the price on the stock market does not . analysis come primarily from two groups the proponents of technical analysis and believers of the “efficient market hypothesis” [1]. . Journal of Stock & Forex Trading. Citation: Drakopoulou V (2015) A Review of Fundamental and Technical Stock Analysis Techniques .