How to evaluate equity

Apart from bonds, equities are also an important component of any investment portfolio. It is therefore important to understand the characteristics of equities.

Since World War II, with the industrialization of global economies, there are more and more companies, through the stock exchanges, raise capital to expand their business. Investors, both large pension funds and small investors can also participate in the economic growth of certain countries by investing through the equity market. Buying shares of a listed company generally means the ownership of a business. It also entitles you to vote in the shareholders meeting. For example, if you are a shareholder of HSBC shares, you actually own a percentage of the Bank. When a company makes profit during the year, they will declare dividend (usually quarterly or semi-annual) to shareholders. If you own the shares of a company, you will be entitled to receive dividend. The value of the share will also increase when the company grows. Equity prices are much more volatile than bonds as prices are affected by a lot of factors, such as economic environment, interest rate trend, corporate earning potential, etc. There are different ways in analysising the value of a company:@

1.Fundamental Analysis

We can evaluate the real value of a company by analysising the following information through annual reports, brokers' reports, trade journals, government publications, company management interviews:
  1. income statement
    • sales growth
    • margins
    • tax rates
    • earning per share growth
    • net income
    • research & development spending

     

  2. balance sheet
    • price to book value
    • return on equity
    • return on assets
    • working capital
    • inventory

     

  3. cash flow
    • Debt and repayment schedule
    • capital raising
    • dividend payout ratio

     

2.Technical Analysis

Technical analysis is based on the concept that all market information, which affects the price of the stock, has already been reflected in the price movement. Therefore, by analysising the price movement, we can forecast the price trend and sentiment. Through technical analysis, we can study the general market as well as individual price trend. Some of the indicators include price moving average, relative strength, advance/ decline ratio, supply/demand analysis, etc. Technical analysis tends to be more effective on efficient markets, such as UK and US where regulations governing the market are more stringent. For less efficient markets, such as HK and other Asian markets, fundamental analysis is more effective.

Evaluating equity investment is time consuming and is a full time profession. It is advisable to seek assistance from professionals for advice.

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