An important aspect of the fundamental analysis of stocks is comparing stocks of the same sector. The most basic way to analyse and compare stocks from the same sector is to conduct an analysis of different ratios like Earnings per share (EPS), Price-to-Earnings (P/E Ratio), Return on Equity (ROE), Return on Capital Employed (ROCE), and Debt-to-Equity ratios. (D/E Ratio).
Analysts and investors all over the world perform quantitative and qualitative analysis to ascertain which stock is undervalued and which stock is overvalued. This is considered as one of the most preferred and important methods to find the quality stocks an investor caninvest in. A thorough study of the ratios and financial statements helps investors in making an informed decision.
To start the analysis and comparison, make a list of companies from the same sector, e.g.- banking, information technology, chemicals, etc. Firstly, take stock and include the names of all competitor and peer group companies. Next, pick a ratio that you will analyse for all the companies (many tools and websites online can provide you with this data—pls use our website to do indepth research).
Now that you have your sector representation ready, you can go ahead with an analysis of the stock ratios.
For e.g.- A high P/E Ratio means that the stock is priced highly (due to the market reaction, business performance, or any other reason) whereas a low P/E Ratio calls for an investment opportunity (depending on other factors) as the price of the stock is low. But this ratio should never be used in isolation, peer group comparative analysis for the same is important.
Similarly, an increasing trend of ROE would mean that the company’s management is effectively using the shareholders’ money and a decreasing trend signifies vice-versa. Let’s say a stock that you wish to invest in shows an ROE of 75% whereas the sector, in general, shows an average ROE of 50%. It signifies that the company has a good capacity to convert its earnings into profits.
A high D/E ratio means that the company relies highly on debt to finance its business whereas a low D/E ratio means that the company is self-sufficient or has other modes (excluding debt) to finance its operations.
You can also include more ratios to conduct a thorough analysis based on your requirements. Additionally, you can also consider more details like market capitalization, turnover, corporate actions, 52-week high and low of the company which will give you a fair idea of the scenario of the company and its rate of return vis a vis it’s peer group.
Another important method that is used in the comparison of stocks from the same sector is the Porter five forces model. This model helps in analyzing the competition of a business based on five factors- the threat of new entrants, the threat of substitution, bargaining power of suppliers, bargaining power of buyers, and competitive landscape. This study will help an investor in determining the competitive intensity of the company and the market at large. This is a lesser financial way of utilising the data available about the stocks, but if used properly can provide some important insights about the business being studied.
It is still possible that you may not obtain a clear image even after doing a complete ratios analysis of companies and a detailed examination of financial statements from companiesin the same sector. In such circumstances, an investor must examine the company's management quality to try and come to a decision.
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