"The market is there only as a reference point to see if anybody is offering to do anything foolish. When we invest in stocks we invest in businesses." Warren Buffett

Picking an investment well involves researching good businesses. It is important that you look at the business first and there are standard ways of doing this – either top down or bottom up analysis. Top down involves looking for industries that are likely to grow and have greater economic significance in the future. Then you must determine those businesses within those industries that will drive this growth. Bottom up looks at the business performance itself, and its relative strengths and qualities that make it a good investment.

Some definitions

Qualitative analysis: This type of analysis includes understanding the quality of management and governance of a business, the direction of the market for its products, brand, ethics, reputation and its market share. This helps you determine the inherent or intrinsic value of the business.

Quantitative analysis: This includes balance sheet analysis to determine the financial performance of the company. When you read company research, annual reports or summaries of company performance you will encounter some frequently used terms. So in order for this information to be useful to you, we have provided an explanation of the four most commonly used terms. Knowing and calculating these will help you determine a shortlist of securities for the strategies we outline further on.

Frequently Used Terms

When you read company research, annual reports or summaries of company performance you will encounter some frequently used terms. So in order for this information to be useful to you, we have provided an explanation of some of the most commonly used terms. Knowing and calculating these will help you determine a shortlist of securities for the strategies we outline further on.

1. EPS (Earnings per share)

This is the after tax profit generated for each share on issue.
It is calculated by dividing the earnings by the average number of shares on issue in the earnings period.
Many analysts use forecasted, rather than historical, profit in this equation as a measure of future prospects.

2. P/E Ratio (Price to Earnings Ratio)

This look as at the relationship between the stock price and the company earnings.
It is calculated by dividing the company's stock price by the EPS.
A high relative P/E Ratio compared to similar companies will indicate a general market expectation of higher profit growth.

3. NTA/share (Net Tangible Assets per Share)

This is used to determine, in theory, the money each shareholder would receive if all assets were sold at that point in time.
It is calculated by dividing net assets by the number of shares issued.
If the NTA/share is higher than the current share price, it may indicate the company is undervalued.

4. Dividend Yield

This is the rate of return received by an investor for dividends paid by the company.
It is calculated by dividing the dividend per share by the current share price i.e. if a company with a share price of $2 returns a dividend of 20 cents per share each year; the dividend yield is 10%.

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