Thursday, March 8, 2018

A Beginners Guide to Investing

Trading the equity market requires an understanding of why stocks move, and what are the catalyst that drive share prices. Most people view the stock market as a single entity, but indices like the S&P 500 index are made up of individual stocks

A share of stock is ownership of the profits or losses that a company produces. To determine how much a share is worth you need to know how much profit or loss a company is generating.

What is a Share?

While many brokers offer CFDs on share prices, the underlying instrument that a CFD targets is the stock price. A stock is the partial ownership of a company and allows you to share in the profit and losses a company produces. 

By owning shares in a company, you are sometime eligible to vote for the company’s board of directors, as well as any special elections. Additionally, you are eligible to receive dividends which are payments from the company back to its shareholders.

When do Companies Report Profits

Most companies report profits or losses to their share holders on a quarterly basis. A quarterly earnings report, provides investors with several pieces of information which include profits, revenues, earnings per share, cash flow, as well as if the company plans on distributing a dividend. 

Most companies also offer forward guidance to their investors. This information includes what the company expects to earn during the next quarter and for the entire year, as well as the revenues they plan to generate during these periods.

What Do Trader’s Pay Attention Too?

Earnings and revenues that are reported for a quarter are pieces of information that have occurred in the past. For this reason, what is important is the numbers relative to expectations. 

Ahead of some earnings releases, analysts that cover a company will update their expectations of a company’s upcoming earnings announcement. If earnings and revenue are better than expected, the stock price might move higher. If the financial results are worse than expected, the news might create a selloff in the share price.

If earnings are lower or higher due to, for example, a one-time tax gain, traders will generally minimize the effect of the one-time gain or loss on the stock price. Investors will also evaluate a company’s forward guidance relative to expectations from the analyst community. 

If guidance is worse than expected, it might generate an adverse move for the stock price. If guidance is better than expected, the stock price might experience a rally.

How Do Analysts Calculate the Target Price?

Equity analysts uses the earnings multiple of a stock to calculate the future target price of a share. The earnings multiple along with expectations of future earnings are both subjective, which makes the process somewhat of an art. 

 The earnings multiple is provided by the market. You can use similar companies to arrive at your multiple. For example, if the earnings multiple of Pepsi is 15, you could assume that Coke has some similar earnings multiple. 

The multiple is then used to calculate the stock price by multiplying the multiple by your estimate of future earnings.

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