Stock analysis can be formed in a number of ways, but the end goal is determining a stock’s value.

As a brief summary, these are the stock value techniques most often used in the Australian stock market:

Discounted cash flow - is the most complex of valuation techniques but also among the most commonly used in stock analysis.

Under this technique, an investor or analyst will use a range of variables to try to accurately predict profit results for future years. These future earnings are then discounted back to their present value (value in today’s dollars) to give an estimate of what the company is currently worth (as a whole, or per share).

This technique is best used for companies in which earnings are expected to fluctuate or grow, start-ups, and companies with limited life spans.

Earnings before interest, tax, depreciation and amortisation (EBITDA) – should be used when most comparable companies are based overseas. For example, analysts rating telecommunications companies will often use this technique.

This technique strips out much of the financing and taxation effects from a company’s performance and leaves you with an indication of a company’s core earnings power. This method is also handy for valuing infrastructure companies.

Price-to-earnings ratio – one of the most commonly used valuation methods for stock analysis. P/E ratios are used when companies have relatively stable earnings and there are a number of comparable companies in the local market. Banks are often valued according to P/E ratios.

Net realisable value – is used for stock analysis when things get gloomy. An analyst will value a company according the amount the company’s assets are worth if sold (rather than the earning these assets generate) when the company is making sustained losses or is close to liquidation.

These methods mentioned above are all types of fundamental analysis, the pursuit of getting to the “fundamental” heart of a stock and analyse its worth.

Fundamental analysis observes the way a company runs – analysing the financial data that is “fundamental” to a company – its earnings, its profits, its dividends.

On the other hand, many traders instead use technical analysis, which involves analysis of stock charts in order to determine an understanding of the way prices move.

There is no “right” way in terms of approaching stock analysis, though most analysts will use a combination of both fundamental and technical analysis in their approach.

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