How to Research Stocks: A step-by-step guide

Here's how to research and evaluate a company for investment, step-by-step

I'm not a car guy.

But, in 2011, one caught my attention.

At that time, climate change was still a topic of debate.

The options for hybrid vehicles were minimal. Options for fully electric ones were virtually non-existent.

But, that year, I started seeing a fully electric sports car around town.

It seemed to keep showing up in areas surrounding the offices of big tech companies.

After asking around, I learned the car was called: The Tesla Roadster.

A red Tesla Roadster sports car

Since the car seemed to be popular with wealthy tech executives, it occurred to me that maybe the company could have a promising future.

So, I went to see if this "Tesla" company was publicly traded.

Sure enough, it was.

Tesla had been around since 2003, but it was still a young company at the time.

The stock was trading at around $24.30 per share.

I looked at what the price was in prior days and it'd been trading around $24.15 to $24.20.

So, I decided I'd buy the stock when its per-share price dropped down below $24.20.

I checked the price a couple times a day for a week or so.

But, the stock never went below $24.20.

In fact, it did the opposite. Cent by cent, the price kept increased.

And, in the end I never bought shares of Tesla.

A share of Tesla (ticker: TSLA) purchased in 2011 is worth $3,870.30 today. (This accounts for its shares splitting a total of 15:1 and a per-share price of $258.02 as of writing.)

That means the stock's grown 160x from the price I refused to purchase it at. ($3,870.30 ÷ $24.20 = 159.93).

That would've turned a $1,000 investment into $160,000.

I was there at the f****** keyboard, ready to buy.

And, I didn't because I refused to pay more than yesterday's price per share.

I gave up $159,000 because I didn't want to pay $4.13.

That was the miss of a lifetime.

It still hurts.

My "research" process looked something like this:

  1. Save some money

  2. Tell myself I need to buy stocks because that's how people get wealthy

  3. Read articles on Yahoo Finance

  4. Get excited about some speculative recommendation

  5. See if the stock's price is higher or lower than yesterday

  6. Buy the stock if its price is lower

  7. Hold the stock, no matter what, until I need to sell it because I need the cash

  8. Tell people I invest in stocks

So, instead of buying Tesla, I bought Banco Santander Brasil (ticker: BSBR) for $13 per share. It's now at $5.25.

And, when everyone was buying Peloton (ticker: PTON) bikes during the pandemic in 2021, I bought the stock for $90 per share. It's now at $4.34.

Needless to say, my "research" process was a disaster.

If I'd done actual research back in 2011, I still might not've bought Tesla.

But, I definitely wouldn't have missed a 160x opportunity for something stupid like a fractional difference in the day-to-day share price.

When I committed to becoming an investor earlier this year, I started forming a more robust research process.

But, even with the improvements, I realized I didn't really know how "real" investors do it.

Successful investors like Guy Spier, Tom Gaynor, and Chuck Akre mostly talk about investment philosophy.

They don't really give us newbies a step-by-step process we can follow until we get the hang of things.

So, I gathered up a couple articles that talk about how to do investment research and just made one myself.

If you just want to skip straight to the result, just scroll down to the bottom of the article.

Before: The process I've been using the past couple months

This is what I started doing after committing to learning to invest:

  1. Search for potentially interesting companies using stock screeners

  2. Quickly look through financial metrics to filter out companies of interest

  3. For companies of interest, look at trends in metrics (revenue, profit margin, etc.)

  4. Learn about what the company does and any notable history

  5. Look at the most recent quarterly report (10-Q) and annual report (10-K)

  6. Listen to latest earnings call (or read the transcript)

  7. Find content by, and/or about, the company's executive (leadership) team

  8. Look more closely at both current and past 10-Q's and 10-K's

  9. Investigate any concerns (mostly via searching the web)

  10. Decide whether to invest

This is better than before, but still has a lot of gaps.

Let's take a look at the take-aways from the references I found.

Summaries of 5 Stock Research Guides

Here're summaries of the 5 references used to help build my new step-by-step process.

Summary 1: "On the Job With Simple As... My Research Process"

Article: On the Job With Simple As... My Research Process
Author: Unknown (posted via username "Simple As")
Publisher: Wall Street Oasis
Retrieved on: September 20, 2024

One of the investment communities I find most helpful is the Security Analysis sub on Reddit.

I found this article on their list of "useful links".

I don't really know who the author is. But, to me, they have credibility by association.

The articles's main objective is to describe the process for research and investment decisions in hedge funds.

Key points:

  • The research process is personal: Everyone has their own process

  • It's important to think independently

  • Your goal's to know the company you're researching inside and out

Note: A lot of successful investors comment on the importance of independent thinking. Jeff Henriksen, an investor who teaches a class on valuation at Oxford University, gave an interesting example of this in this interview (see time 3:46). He found that when he gave students a valuation problem to work on, the average across their results was most accurate when they worked individually. When they worked in teams, their influence on one another caused the overall accuracy to decrease.

Process:

  1. Develop an understanding of how the company makes money

    1. Understand its profit margins

    2. Understand its cash flows

    3. Understand its maintenance and/or growth plan

    4. Understand how management thinks about positioning and competition

  2. Evaluate the company's positioning with respect to competitors and customers

    1. How does the market view the company?

    2. How do competitors view the company?

    3. How do customers view the company?

  3. Evaluate the management team

    1. Identify and evaluate the management team's structure and incentives

    2. Assess the management team's capital allocation decisions

  4. Talk to peers about the thesis you've developed thus far and get feedback

  5. Dig deep into the financials: Line-by-line and numerous years into the past

    1. Prepare a list of questions for the management team

    2. Ensure there isn't any bad accounting behavior

    3. Verify that financials reflect what you've found in research up to this point

  6. Speak with the management team and ask questions

  7. Value the company

    1. Develop a range of values based on various possible situations

  8. Assess the way the stock's price moves in reaction to various types of news

Summary 2: "A Guide on How to Write an Equity Research Report"

Article: A Guide on How to Write an Equity Research Report
Author: Jan Strandberg, CEO of Acquire.Fi
Publisher: Acquire.Fi
Retrieved on: September 20, 2024

This article’s focused more on how to build a research report.

So, it includes some information about report structure in addition to the research process.

Key points:

  • Research takes a lot of time ("countless hours")

  • A key goal is to provide an objective and unbiased assessment

  • Research needs to account for numerous aspects of a company: What it does, who's running it, the industry it operates in, etc.

Preparation:

  1. Gather generic info about:

    1. The company's primary business

    2. The company's history

    3. The management team and key executives

    4. Etc.

    5. Find this in the company's website, annual reports, regulatory filings, etc.

    6. Understand the company’s products/services

  2. Analyze financial statements:

    1. Using financial ratios to evaluate health

    2. Using financial modeling to forecast future results

  3. Analyze the industry and competitors:

    1. Build an understanding of the industry the company operates in

    2. Analyze the company's competitors

    3. Assess the company's strengths and weakenesses in the context of the industry and competitive landscape

Report Structure:

  1. Executive Summary

    1. Brief company overview

    2. Overview of the industry

    3. Overview of the company's financial performance

    4. Investment recommendations

      1. Buy, hold, or sell

      2. Target price

      3. Time horizon

  2. Business model and strategy

    1. Description

    2. Evaluation of competitive advantage

    3. Analysis of growth strategy

  3. Financial analysis (financial health)

    1. Financial ratios

    2. Cash flow

    3. Valuation

      1. Discounted Cash Flow (DCF)

      2. Multiples analysis (comparison of financial ratios to peers)

      3. Precedent transactions (prices paid for similar companies in the past)

  4. Investment recommendations

    1. Buy, hold, or sell

    2. Risk factors

    3. Target price and time horizon (when target price's expected to be achieved)

Process:

  1. Gather relevant information about the company

  2. Analyze the company's financial health

  3. Evaluate the company's business model and strategy

  4. Provide investment recommendations

  5. Format and present the equity research report

Summary 3: "Equity Research Overview"

Article: Equity Research Overview
Author: Scott Powell, Co-Founder & Chief Content Officer of Corporate Finance Institute (CFI)
Publisher: CFI Education
Retrieved on: September 20, 2024

This article focuses primarily on the content of a research report.

Key points:

  • The main work of in equity research is producing reports

  • Reports range from in-depth analyses to short updates

  • Professional analysts have an advantage over individual investors since they have more access to company management teams

Components of a research report:

  1. Industry research

    1. Industry trends

    2. Competition

    3. Framework-based analysis

      1. Porter’s Five Forces Analysis

      2. PEST Analysis (PEST: Politics, Economics, Social trends, Technological innovation)

  2. Management overview and commentary

    1. Assess the quality of the company's management team

    2. Direct access to management may be difficult, so use whatever information's available

  3. Historical financial results

    1. Analyze historical financial results

    2. Compare past guidance given by the company to actual results

  4. Forecasting

    1. Top-down forecasting: Start with the industry, forecast the company's market share, and work down to revenue

    2. Bottom-up forecasting: Start with the basic drivers of revenue and work towards a revenue forecast from there

  5. Valuation

    1. Use financial modeling to create one or more estimates of the company's intrinsic value

  6. Recommendations

    1. Make a buy/hold/sell recommendation based on the analysis

Note: Even though we, as individual investors, don't have equal access to management teams, many interactions with management are recorded. For example, earnings calls, investor days, interviews, etc.

Summary 4: "Master Equity Research Process: Complete 7 Steps Guide For Investors"

Article: Master Equity Research Process: Complete 7 Steps Guide For Investors
Author: S. K. Singh, Founder of Ace Equity Research
Publisher: Ace Equity Research
Retrieved on: September 20, 2024

Unfortunately, since I started writing this article, the Ace Equity Research website is no longer available.

It's a detailed and well-structured article describing the research process.

Key points:

  • The goal of the research process is to evaluate the value and risk associated with a given stock

  • It's critical to tailor it to then needs of the people who'll use it to make decisions

  • It's a multi-step process that requires ongoing updates after the initial research is concluded

Process:

  1. Define the research objective

    1. Identify the purpose of the research

      1. For example, to evaluate financial performance, growth potential, or industry dynamics

    2. Set clear goals for the research

    3. Clearly identify the target industry or company

    4. Align with investor needs: Understand the target audience, objectives, limitations, etc.

  2. Gather relevant data

    1. Access sources like:

      1. Company reports and financial statements

      2. Market data and economic indicators

      3. Industry research and news sources

      4. Regulatory filings and disclosures

    2. Collect and prepare data:

      1. Review data for accuracy, reliability, consistency, completeness, and integrity

        1. Use cross-referencing to identify and correct issues

      2. Organize and structure the data

  3. Analyze financial statements

    1. Assess financial performance

      1. Look at: Profitability, liquidity, solvency, cash flow, etc.

      2. Use techniques like: Ratio analysis, trend analysis, comparative analysis

    2. Assess risk and return

    3. Assess strengths and weaknesses

  4. Conduct industry and competitor analysis

    1. Understand industry dynamics by assessing:

      1. Market size and growth trends

      2. Regulatory environment

      3. Competitive landscape

    2. Evaluate competitors by assessing:

      1. Financial performance (compare metrics with the target company)

      2. Competitive advantages

      3. Product and service offerings (identify overlap, differentiation, market gaps)

    3. Consider using frameworks like: SWOT analysis, Porter's Five Forces analysis, etc.

  5. Valuation

    1. Calculate intrinsic value using techniques like:

      1. Discounted Cashflow Analysis (DCF)

      2. Comparable company analysis (compare company's financial ratios)

      3. Precedent transaction analysis

    2. Recognize limitations like:

      1. Uncertainty

      2. Subjectivity

      3. Market inefficiency risk

  6. Formulate an investment recommendation

    1. Analyze research findings

      1. Financial performance and health

      2. Industry and market trends

      3. Competitive positioning

      4. Risk assessment

      5. Valuation analysis

    2. Develop a balanced view and buy/hold/sell recommendation

  7. Monitor and update research

    1. Revisit financials when new information's available

    2. Monitor for news and events that could impact the company

    3. Monitor for industry research

    4. Monitor macroeconomic indicators and trends

    5. Re-evaluate and update the analysis, as appropriate

Summary 5: "How To Research Stocks"

Article: How To Research Stocks
Author: E. Napoletano, Freelance Financial Journalist
Publisher: Forbes Advisor
Retrieved on: September 20, 2024

This article's a little lighter than the others. But, it gives a nice overview and provides some encouragement to those of us without a background in finance.

Key points:

  • Anyone can do, and eventually master, equity research

  • There's no magic number; research takes work

  • Every investor has unique goals and interests, so research is a personal process

Process:

  1. Gather data

    1. Equity analyst reports: Check for access via your brokerage firm

    2. Data on fundamentals: Annual and quarterly financial reports (10-K's and 10-Q's) filed with the Securities and Exchange Commission (SEC)

    3. Online research sites: Yahoo Finance, Seeking Alpha, Motley Fool

  2. Understand the numbers

    1. Use the info gathered to evaluate the company's financial health

    2. Look at key metrics like:

      1. Price-to-Earnings (P/E) ratio

      2. Price-to-Earnings-Growth (PEG) ratio

      3. Price-to-Book (P/B) ratio

      4. Return on Assets (ROA)

      5. Return on Equity (ROE)

  3. Learn about the company

    1. Leadership

    2. Culture

    3. Environmental, Sustainability, and Governance (ESG) initiatives

    4. Trends

  4. Assess the company based on your investing strategy and goals

My shiny, new research process

The key things I want to know are:

  1. What am I looking for?

  2. Does this business have the potential to fulfill it?

  3. What's the probability of success and what're the risks?

The steps listed are roughly sequential.

But, my expectation is to continually revisit previous steps as I gather new information.

As I make progress through the list, I intend to continually form new questions that drive additional investigation.

For example: Why did revenue drop 50% in quarter X only to recover in the next? How’s management preparing for increasing costs of debt with rising interest rates?

My time’s limited, so I want to make sure most of it’s spent investigating the companies most likely to match what I'm looking for.

That means minimizing time spent on companies that don't.

So, I'll terminate the research process at any point where I have enough evidence to feel confident the company's not a match. (Unless I'm going through the process just to practice researching.)

Okay, so at long last, here's the process:

  1. Choose a company

    1. Identify a company I want to research

    2. Specify why the company's of interest

    3. Assess how it might fit into my investment strategy (Dividend? Growth? Value? Hedge? Something else?)

    4. Create a repository (folder) for my research

      1. Use this to store all data, analysis, and notes generated by this process

  2. Sniff test

    1. Based on how the business makes money, decide if I’m comfortable owning and funding it

    2. Scan over the company’s financial metrics for any red flags

      1. These can come from general sites like Yahoo Finance or info provided by my brokerage firm

        1. IMPORTANT: Take data from general sites with a grain of salt. I've found that sometimes the data's incorrect or not calculated in the way I was expecting.

      2. Flags might include general concerns, like a business that's loaded with debt and losing money

      3. Or, they might include personal concerns like a mismatch with my investing objectives

    3. Evaluate if it's worth spending more time

  3. Review financial trends

    1. Choose a couple key metrics

    2. Look at trends for the past 10 years (e.g. on FinanceCharts.com)

    3. Evaluate if it's worth spending more time

  4. Learn about what the company does and its history

    1. Find the company website and learn what I can from it

    2. Search for additional info about the company, its business, its history, and important events

      1. Good staring points are: Yahoo Finance, Google search, Google News, YouTube, and Wikipedia

  5. Scan over the company's most recent annual report (10-K) and quarterly report (10-Q)

    1. Evaluate financial metrics

      1. For example: Gross Margin, Operating Margin, Price-to-Earnings (PE) Ratio, Price-to-Book (PB) Ratio, Capital Structure, etc.

      2. Consider both vertical analysis and horizontal analysis

    2. Start forming a picture by relating the the financials to what I've learned about the business thus far

    3. Make note of any key items to follow up on

      1. This can include positive surprises, negative surprises, or anything where I want stronger confirmation

    4. Evaluate if it's worth spending more time

  6. Learn about the industry and and the company's competitors

    1. Identify the industry/space the company operates in

    2. Look for reports on the industry and trends within it

    3. Identify competitors

    4. Understand the company's positioning

      1. Build deeper clarity of who the company's customers are

      2. SWOT analysis

      3. Porter Five Forces analysis

      4. Helmer Seven Powers analysis

    5. Compare the company's financials with those of competitors

    6. Evaluate if it's worth spending more time

  7. Evaluate performance

    1. Gather several years of financial reports

    2. Evaluate how the financial metrics have changed over time

    3. Evaluate how cash flows have changed over time and how management's allocated capital

    4. Evaluate how the balance sheet and Capital Structure has changed over time

    5. Review as many earnings calls as possible

    6. Review investor presentations, press releases, and other records

    7. Evaluate the company's progress and performance against management's goals

  8. Estimate the business's intrinsic value

    1. Discounted Cash Flow (DCF) analysis, including best, worst, and most-likely cases

    2. Liquidation Value

    3. Other valuation methods, as-appropriate (e.g. comparison of financial ratios to peers, precedent transactions, etc.)

  9. Get familiar with the management team and the board

    1. Identify key members of the management team

    2. Identify members of the board

    3. Look into each of their backgrounds

      1. Build profiles using info from LinkedIn, Google search, etc.

      2. Look for interviews and presentations on YouTube and Spotify

    4. Assess the board's control/influence (e.g. can they actually remove the CEO, if needed?)

    5. Review SEC filings for insider holdings and transactions (SEC Form 4)

  10. Any additional flags

    1. Check any SEC filings I haven't looked at yet

    2. Check the potential impact of macro trends

      1. For example, regulatory, economic, technological, social, etc.

    3. Check for expiring lock-up periods or other upcoming one-time events

    4. Check for current and past legal action by and/or against the company

    5. Check customer sentiment

      1. Check product reviews, complaints, feature requests, comparisons with competitors

      2. Check conversations on Reddit, Twitter/X, etc.

    6. Check company culture and employee sentiment

      1. Company careers page, GlassDoor, LinkedIn, etc.

    7. Check stock holder sentiment

      1. Seeking Alpha, Yahoo Finance, Reddit, etc.

  11. Evaluate the current market situation based on the story I’ve constructed and estimation of intrinsic value

    1. Look at the current stock price and historic behavior

    2. Evaluate the current price against value

    3. Evaluate any challenges in building or exiting a position

      1. For example, potential challenges related to liquidity (how much demand there is to buy and sell the stock at any given moment)

  12. Look for external input

    1. Do this after everything else to form an independent opinion first

    2. Look for analyst reports

    3. Look for hedge fund ownership via filings of SEC Form 13F’s

      1. It's easiest to start via the site Insider Monkey

    4. Socialize research with others

  13. Make a plan of action (invest, don't invest, monitor)

Conclusion

That's it for now.

Hopefully, someday, I'll find another 160x investment and not f*** it up again.

Meanwhile, I'll be applying my new process and refining it as I learn.

In the coming weeks, I'll try to put together an article where I apply the process.

Until then, happy hunting!

And now for something completely different

Last week, I completed Aswath Damodaran's (free) self-study course on Accounting for Finance and Investing.

It includes tests and solutions.

I got a fair number of the questions incorrect.

As in, I'd probably fail his class if it were in-person.

It made me feel kind of bad.

But, then I realized that each time I get a question wrong, it means I'm fixing my misunderstandings. 💪

So, then, in a weird turn of events, I started getting excited when I got answers wrong.

This makes me think about how backwards school feels. Getting things wrong should be exciting because it's a learning opportunity.

Anyways, I thought the class was great! I'd recommend it as a low-commitment way to boost your financial knowledge.

I plan on doing his Foundations of Finance class as well. And, ultimately, his full class on Valuation.

References

Articles summarized:

  1. On the Job With Simple As... My Research Process. Wall Street Oasis. Retrieved 2024-09-20.

  2. Jan Strandberg. A Guide on How to Write an Equity Research Report. Acquire.Fi. Retrieved 2024-09-20.

  3. Scott Powell. Equity Research Overview. CFI Education. Retrieved 2024-09-September 20.

  4. S. K. Singh. Master Equity Research Process: Complete 7 Steps Guide For Investors. Ace Equity Research. Retrieved 2024-09-20.

  5. E. Napoletano. [How To Research Stocks](https://www.forbes.com/advisor/investing/how-to-research-stocks/]. Forbes Advisor. Retrieved 2024-09-20.

Additional resources:

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