How Serious DIY Investors Analyze Stocks — Step by Step
A systematic 5-step process for evaluating any stock. No guesswork, no gut feelings—just clear criteria and consistent methodology.
How to Analyze a Stock in 5 Steps
Stock analysis is the process of evaluating a company's financial health, valuation, and growth potential to determine if it's a good investment. A systematic approach removes emotion and ensures consistent decision-making.
- 1. Check Fundamentals — Profitability, debt levels, cash flow quality
- 2. Assess Valuation — P/E ratio, fair value estimate, comparison to peers
- 3. Review Technicals — Price trends, support/resistance, momentum
- 4. Eliminate Red Flags — Declining revenue, insider selling, accounting issues
- 5. Make the Decision — Buy, wait, or pass based on complete analysis
Most investors know they should "do their research" before buying a stock. But what does that actually mean? Without a systematic process, research becomes reading random articles and hoping for the best.
This guide walks you through the exact 5-step process used by serious DIY investors. By the end, you'll have a repeatable framework for analyzing any stock.
Step 1: Check the Fundamentals
Fundamentals tell you about the quality of the business. A stock might be "cheap," but if the underlying business is weak, that cheapness is justified.
Key Metrics to Check:
Profitability
- Net profit margin > 5% (higher for tech)
- Return on Equity (ROE) > 15%
- Consistent positive earnings
Financial Health
- Debt-to-Equity < 1.0 (varies by industry)
- Current ratio > 1.5
- Interest coverage > 3x
Cash Flow
- Positive free cash flow
- FCF growing over time
- FCF > Net Income (quality signal)
Growth
- Revenue growth > 5% annually
- EPS growth positive
- Growth exceeds industry average
Example: Analyzing a Software Company
Let's say you're analyzing a mid-cap software company. Here's what you might find:
What You See:
- • Net margin: 18% (strong for software)
- • ROE: 22% (exceeds 15% threshold)
- • Debt-to-Equity: 0.3 (low leverage)
- • Revenue growth: 15% YoY (healthy)
- • Free cash flow: $180M vs $150M net income (quality earnings)
The Verdict:
This company passes Step 1. Strong profitability, low debt, growing revenue, and FCF exceeds net income (a quality signal). It warrants moving to valuation analysis.
A Trovest score: Profitability 8/10, Financial Health 9/10, Growth 7/10
Step 2: Assess the Valuation
A great company at an overpriced valuation is a bad investment. Valuation tells you if you're paying a fair price for the business.
Valuation Methods:
Relative Valuation
Compare to peers and history:
- P/E ratio vs. industry average
- P/S ratio for growth stocks
- EV/EBITDA for capital-intensive businesses
Intrinsic Valuation (DCF)
Calculate what the business is worth:
- Project future cash flows
- Discount back to present value
- Compare to current stock price
Example: Valuing That Software Company
Continuing our example from Step 1. The stock trades at $85 per share.
Relative Valuation:
- • Current P/E: 28x
- • Industry average P/E: 32x
- • 5-year average P/E: 25x
- • PEG ratio: 1.9 (P/E ÷ growth rate)
DCF Fair Value:
- • Estimated fair value: $78/share
- • Current price: $85/share
- • Premium to fair value: +9%
Verdict: Slightly overvalued. Not a screaming buy, but not overpriced either.
Rule of thumb: If a stock is trading more than 20% above your fair value estimate, wait for a better entry. If it's 20%+ below, it might be undervalued.
Step 3: Review the Technicals
Technical analysis helps with timing. You don't want to buy a fundamentally strong stock right before a major correction.
Key Technical Indicators:
Trend
- Is price above/below 200-day MA?
- Higher highs and higher lows?
- Support and resistance levels
Momentum
- RSI: Overbought (>70) or oversold (<30)?
- MACD direction and crossovers
- Volume confirmation
Technicals are secondary to fundamentals and valuation. Use them to refine entry timing, not to replace fundamental analysis.
Step 4: Eliminate Red Flags
Before buying, actively look for reasons NOT to buy. This prevents confirmation bias. Learn more about why investors miss red flags.
Common Red Flags:
- ⚠Declining revenue — Growth companies should grow
- ⚠Rapidly increasing debt — Why are they borrowing?
- ⚠Insider selling — Management knows something
- ⚠Shrinking margins — Competition eating profits
- ⚠Cash flow < earnings — Earnings quality issue
- ⚠High short interest — Others see problems
Step 5: Make the Decision
After completing Steps 1-4, you have all the information you need. Now it's decision time.
BUY
Strong fundamentals, fair valuation, no red flags, reasonable technicals
WAIT
Good company, but overvalued or poor technicals. Add to watchlist.
PASS
Red flags present, weak fundamentals, or better opportunities elsewhere
Your Stock Analysis Checklist
- Profitability metrics checked (ROE, margins)
- Financial health assessed (debt, liquidity)
- Cash flow quality verified
- Growth trajectory evaluated
- Valuation compared to peers and history
- Fair value estimated
- Technical trend and momentum reviewed
- Red flags actively searched for
- Management quality considered
- Industry dynamics understood
Want this process automated?
Trovest runs this entire analysis process for every stock, instantly. Get scores, research reports, and red-flag alerts without the manual work. You can also connect your portfolio to monitor all your holdings.
Try Trovest FreeSources & Further Reading
Frequently Asked Questions
What is the best way to analyze a stock before buying?
Start with fundamentals (profitability, financial health, cash flow), then assess valuation (P/E, fair value), review technicals for timing, actively search for red flags, and make a decision based on the complete picture. A systematic process prevents emotional decisions.
How long does it take to analyze a stock?
Manual fundamental analysis typically takes 2-4 hours per stock if done thoroughly. AI-powered tools like Trovest can complete the same analysis in seconds by automatically scoring across 10 metrics and generating research reports.
What are the most important metrics for stock analysis?
The most critical metrics are profitability (net margin, ROE), financial health (debt-to-equity, interest coverage), cash flow quality (free cash flow vs net income), and growth trajectory (revenue and earnings growth). No single metric tells the full story—you need to evaluate balance across all dimensions.
Should I use fundamental or technical analysis?
Both serve different purposes. Fundamental analysis tells you what to buy (business quality and value), while technical analysis helps with when to buy (entry timing). Fundamentals should always come first—technicals are secondary for long-term investors.