A Beginner's Guide to Analyse Stocks

Investing in stocks can seem daunting for beginners, but understanding key financial metrics can help you make informed decisions. In this guide, we’ll explore essential terms like Market Capitalisation, Enterprise Value, Revenue (TTM), Net Income (TTM), EBITDA, Stock-Based Compensation (SBC), Free Cash Flow (FCF), Cash, EV to Revenue, EV to EBITDA, EV to FCF, and Gross Margin. Each of these metrics provides valuable insights into a company’s financial health and can help you assess its potential as an investment.

Key Terms in Stock Analysis

1. Market Capitalisation (Market Cap)

Market Capitalisation, often referred to as Market Cap, represents the total value of a company’s outstanding shares of stock. It’s calculated by multiplying the current share price by the total number of outstanding shares. Market Cap is a straightforward way to gauge the size of a company.

Large-Cap Stocks: These are companies with a Market Cap of £10 billion or more. They are typically more stable but offer lower growth potential.
Mid-Cap Stocks: These companies have a Market Cap between £2 billion and £10 billion. They offer a balance between growth and stability.
Small-Cap Stocks: With a Market Cap of less than £2 billion, these companies can offer high growth potential but come with higher risks.

A very high Market Cap usually indicates a well-established company, while a low Market Cap might suggest higher growth potential but with more volatility and risk.

2. Enterprise Value (EV)

Enterprise Value (EV) is a more comprehensive measure than Market Cap because it includes not just the equity value but also debt, minority interest, and preferred shares minus total cash and cash equivalents. EV provides a clearer picture of the cost of acquiring the entire company.

High EV: A high Enterprise Value could indicate that a company is expensive to acquire, often due to high levels of debt or strong future growth expectations.
Low EV: A low EV might suggest a company is undervalued or has low debt, which could make it a more attractive acquisition target.

3. Revenue (TTM)

Revenue (TTM) stands for "Trailing Twelve Months" and represents the total income generated by a company over the past 12 months. Revenue is the top line of the income statement and reflects a company's ability to sell its products or services.

High Revenue: Indicates strong sales, but this doesn’t necessarily translate to profitability.
Low Revenue: This could signal weak sales, which might be a red flag for potential investors.

4. Net Income (TTM)

Net Income (TTM) is a company's profit over the past 12 months after all expenses, taxes, and costs have been deducted from total revenue. It is often referred to as the "bottom line."

High Net Income: Indicates profitability and financial health.
Low or Negative Net Income: This may suggest financial struggles, potential for future losses, or heavy investment in growth.

5. EBITDA

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. It measures a company’s operating performance and profitability from its core operations, excluding the effects of capital structure, tax rates, and non-cash accounting items.

High EBITDA: Suggests strong operational efficiency.
Low EBITDA: This may indicate operational difficulties or inefficiencies.

6. Stock-Based Compensation (SBC)

Stock-based compensation (SBC) is a company's expense when it compensates its employees with stock options. While SBC is a non-cash expense, it can have significant implications for a company’s valuation and earnings per share.

High SBC: This may dilute existing shareholders' equity and indicate that a company is heavily reliant on stock options to attract and retain talent.
Low SBC: Indicates less dilution and possibly a more traditional compensation structure.

7. Free Cash Flow (FCF)

Free Cash Flow (FCF) is the cash a company generates after accounting for capital expenditures (CAPEX). FCF is crucial because it shows how much cash a company has to invest in growth, pay dividends, or reduce debt.

High FCF: Indicates strong financial health and flexibility.
Low or Negative FCF: This could signal that a company struggles to generate enough cash, which might lead to financial difficulties.

8. Cash

Cash refers to the total amount of liquid assets a company has on hand. It is a critical metric as it represents the company's ability to meet short-term obligations and invest in opportunities without needing external financing.

High Cash Levels: Suggest a strong liquidity position, enabling the company to weather economic downturns or capitalise on opportunities.
Low Cash Levels: This could indicate potential liquidity problems, making the company more vulnerable to financial distress.

9. EV to Revenue

The EV to Revenue ratio compares a company’s Enterprise Value to its revenue. It provides a valuation multiple that helps investors understand how much they are paying for each pound of revenue.

High EV/Revenue Ratio: This may suggest that a company is overvalued relative to its revenue.
Low EV/Revenue Ratio: This could indicate that the company is undervalued or has low revenue growth expectations.

10. EV to EBITDA

The EV to EBITDA ratio measures a company’s Enterprise Value relative to its EBITDA. A commonly used valuation metric helps investors assess whether a stock is overvalued or undervalued.

High EV/EBITDA Ratio: This may indicate that the stock is overvalued or that the company has strong growth expectations.
Low EV/EBITDA Ratio: Suggests the stock may be undervalued or that the company faces challenges in generating earnings.

11. EV to FCF

The EV to FCF ratio compares a company’s Enterprise Value to its Free Cash Flow. It is an important metric for understanding how efficiently a company generates cash relative to its valuation.

High EV/FCF Ratio: This indicates that investors are paying a premium for the company’s cash flow, which might suggest overvaluation.
Low EV/FCF Ratio: This could suggest that the company is undervalued relative to its cash-generating capabilities.

12. Gross Margin

Gross Margin is the difference between revenue and the cost of goods sold (COGS), expressed as a percentage of revenue. It measures how efficiently a company produces and sells its products.

High Gross Margin: Indicates strong pricing power and operational efficiency.
Low Gross Margin: This could signal cost pressures, competitive pricing, or operational inefficiencies.

Conclusion

Understanding these key financial metrics is crucial for anyone looking to analyse stocks and make informed investment decisions. While each metric provides valuable insights on its own, it’s essential to consider them together to get a holistic view of a company’s financial health and valuation.

I hope you enjoyed reading this blog, it is important to remember these key terms and look into these key stats for the stocks that you are looking to invest in! Thanks for reading this blog!