Understanding Market Analysis and Market Valuation Metrics For Stocks, Commodities, Futures & Forex

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Two Analytical Models

When the objective of the analysis is to determine what stock or commodity to buy and at what price, there are two basic methodologies:

• Fundamental Analysis maintains that markets may misprice a security in the short run but that the correct price will eventually be reached. Profits can be made by purchasing the mispriced security and then waiting for the market to recognize its mistake and re-price the security.
• Technical Analysis maintains that all information is reflected already in the stock price. Trends are your friend and sentiment changes predict trend changes.Investors emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does care what the real value of a stock is but in correlation to the public perception value of the stock or commodity. Their price predictions are only extrapolations from historical price patterns and emotional responses.

Investors can use any or all of these different but somewhat complementary methods for stock picking. For example many fundamental investors use technical analysis for deciding entry and exit points. Many technical investors use fundamentals to limit their universe of possible stock to good companies.

Technical analysis stands in contrast to the fundamental analysis approach to security and stock analysis. Technical analysis analyzes price, volume and other market information, whereas fundamental analysis looks at the facts of the company, market, currency or commodity.

Most large brokerage, trading group, or financial institutions will typically have both a technical analysis and fundamental analysis team.

The choice of stock analysis is determined by the investors belief in the different paradigms for how the stock market works.

First let’s Cover Fundamental Analysis

Fundamental analysis of a business involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets. When applied to futures and forex, it focuses on the overall state of the economy, and considers factors including interest rates, production, earnings, employment, GDP, housing, manufacturing and management.

When analyzing a stock, futures contract, or currency using fundamental analysis there are two basic approaches one can use; bottom up analysis and top down analysis. The term is used to distinguish such analysis from other types of investment analysis, such as quantitative analysis and technical analysis.

Fundamental analysis includes:

1. Economic analysis
2. Industry analysis
3. Company analysis

On the basis of these three analyses the intrinsic value of the instruments are determined. This is considered as the true value of the stock, or futures contract. If the intrinsic value is higher than the market price it is recommended to buy. If it is equal to market price hold and if it is less than the market price sell.

Fundamental analysis is performed on historical and present data, but with the goal of making financial forecasts. There are several possible objectives:

• to conduct a company stock valuation and predict its probable price evolution,
• to make a projection on its business performance,
• to evaluate its management and make internal business decisions,
• to calculate its credit risk.

Fundamental Analysis & Stock Valuation Metrics

If youre a value investor, theres no right way to analyze a stock. Even so, any successful fundamental investor will tell you that focusing on certain fundamental metrics is the path to cashing in gains. Thats why you need to keep your eye on the metrics that matter.

Fundamentals Are King!

Fundamentals, which include a companys financial and operational data, are preferred by some of the most successful investors in history, including the likes of Warren Buffett. Thats no surprise, as knowing the ins and outs of a companys financial numbers like earnings per share and sales growth can help an in-the-know investor weed out the stocks that are trading for less than theyre worth.

But that doesnt mean that all metrics are created equal – some deserve more of your attention than others.

The fundamental valuation is the valuation that people use to justify stock prices.

The other way stocks are valued is based on supply and demand. The more people that want to buy the stock, the higher its price will be. And conversely, the more people that want to sell the stock, the lower the price will be. This form of valuation is very hard to understand or predict, and it often drives the short-term stock market trends.

There are many different ways to value stocks. The key is to take each approach into account while formulating an overall opinion of the stock. If the valuation of a company is lower or higher than other similar stocks, then the next step would be to determine the reasons.

Heres A Look At The Must-Have Fundamentals For Your Value Portfolio.

1. Price-to-Earnings Ratio (Lower is better)

While the price-to-earnings ratio (also known as the P/E ratio or earnings multiple) is likely one of the best-known fundamental ratios, its also one of the most valuable. The P/E ratio divides a stocks share price by its earnings per share to come up with a value that represents how much investors are willing to shell out for each dollar of a companys earnings.The P/E ratio is important because it provides a measuring stick to compare valuations across companies. A stock with a lower P/E ratio costs less per share for the same level of financial performance than one with a higher P/E.What that essentially means is that low P/E is the way to go .In general, a low P/E is considered a sign that a stock may be undervalued, or that investors expect poor future earnings. By contrast, a high P/E is thought to indicate an over-valued stock, or one that is expected to post significant earnings increases.It should be noted that there is no mathematical basis for what a companys P/E should be. Rather, a high or low P/E is defined only in relative terms.Historically, P/E ratios for US listed companies have averaged between 14 and 16, though functionally, stocks with P/E below 12 are considered low while P/Es above 40 or 50 are considered high, in absolute terms.But one place where the P/E ratio isnt as valuable is when youre comparing companies across different industries. While its completely reasonable to see a telecom stock with a P/E in the low teens, a P/E closer to 40 isnt out of the line for a high-tech stock. As long as youre comparing apples to apples, though, the P/E ratio can give you an excellent glimpse at a stocks valuation.