04 · Stock Analysis Methods
Watching the tape and guessing direction is "speculating"; only when you can articulate "why buy, why it should rise, and under what conditions to sell" are you researching stocks. This article provides a complete framework: the three layers of fundamental analysis, how to read the three statements, key financial metrics, the mainstream valuation tools (PE/PB/PS/dividend yield/DCF), the correct use of technical and news analysis, and the three traps retail investors fall into most.
1. Fundamental Analysis: The Three-Layer Framework
Macro → Industry → Company
| Layer | What to look at | Typical questions |
|---|---|---|
| Macro | GDP growth, CPI/PPI, interest rates, FX, monetary policy, industrial policy | Is the economy expanding or contracting? Are rates rising or falling? What does policy encourage? |
| Industry | Cycle stage, policy and regulation, competitive landscape, penetration rate | Is the industry growing or mature? Is the structure oligopolistic or a free-for-all? Is policy supporting or suppressing? |
| Company | Business model, moat, management, financial quality, valuation | How does it make money? How deep is the moat? Is management honest? Is the price expensive? |
The correct order is top-down: macro sets position size, industry sets direction, company sets the pick. Looking at companies without industries lands you "cheap but perpetually depreciating" assets in sunset industries; looking at industries without macro tempts you to bottom-fish heavily indebted companies in a rate-hike cycle.
🧭 The iron rule of fundamental analysis: top-down, macro → industry → company
Macro sets position size, industry sets direction, company sets the pick. Looking at companies without industries lands you "cheap but perpetually depreciating" assets in sunset industries; looking at industries without macro tempts you to bottom-fish heavily indebted companies in a rate-hike cycle.
Industry Analysis Essentials
| Dimension | Key questions |
|---|---|
| Life cycle | Introduction (burning cash) → Growth (high growth) → Maturity (stable) → Decline (shrinking) |
| Competitive landscape | CR3/CR10 concentration; how brutal the price wars are |
| Policy cycle | Centralized drug procurement, the tutoring crackdown, subsidy phase-outs — policy can rewrite an industry's fate |
| Cyclicality | Deep-cyclical industries (steel, coal, shipping) see earnings and prices swing wildly with the economy |
Company Analysis Essentials
| Dimension | Key questions |
|---|---|
| Business model | Where does revenue come from? Is it replicable and scalable? |
| Moat | Brand, patents, cost, network effects, switching costs, licenses |
| Management | Integrity record (any fraud history), ownership structure, share sales/pledges |
| Growth | Revenue growth; changes in orders/contract liabilities |
| Financial quality | See the three statements below |
2. How to Read the Three Financial Statements
The Balance Sheet ("the estate")
Assets = Liabilities + Owners' equity
| Line item | What to watch |
|---|---|
| Cash | "High deposits and high debt" (plenty of cash on the books yet heavy high-interest borrowing — a fraud flag) |
| Accounts receivable | Is growth far outpacing revenue (possibly inflated revenue)? |
| Inventory | Inventories ballooning while turnover slows (unsold goods or hidden costs) |
| Goodwill | The M&A premium; a goodwill write-down can devour profits overnight |
| Interest-bearing debt | Short-term borrowings, long-term borrowings, bonds payable; is the debt structure dangerous? |
The Income Statement ("how much is earned")
Revenue − Cost − Expenses − Tax = Net profit
| Line item | What to watch |
|---|---|
| Operating revenue | The "quality" of growth: volume and price rising together, or consolidation/subsidies? |
| Gross margin | The most direct read on competitiveness; abnormally high vs peers demands scrutiny |
| Three expenses | Are the selling/admin/finance expense ratios out of control? |
| Non-recurring items | "Profits" manufactured by asset sales or government subsidies; not sustainable |
| Net profit | Watch net profit excluding non-recurring items (strips one-offs) |
The Cash Flow Statement ("real money")
| Line item | What to watch |
|---|---|
| Operating cash flow | The best lie detector for profits: high net profit with persistently negative operating cash flow = a giant red flag |
| Investing cash flow | Is capex rational? Serial cross-border M&A? |
| Financing cash flow | Perpetually sustained by raising money? |
| Free cash flow | Operating cash flow − capex: the money genuinely available to reward shareholders |
Three-Statement Cross-Checks
- Profit ≠ cash: the income statement uses accrual accounting (booked on sale), while cash is counted when received. Pretty net profit with ugly operating cash flow usually signals inflated revenue or profit padded by advancing funds.
- Inflated assets hide in "accounts receivable, inventory, goodwill, construction in progress"; understated liabilities hide as "off-balance-sheet debt".
- Suggested reading order: cash flow first, then profit, then the balance sheet — verify truth, then quality, then risk.
3. Key Financial Metrics
| Metric | Formula (simplified) | Meaning | Reasonable reference |
|---|---|---|---|
| ROE (return on equity) | Net profit ÷ equity | What shareholders' money earns per year — the single most important metric | Sustained > 15% is excellent |
| Gross margin | (Revenue − cost) ÷ revenue | Product-level profitability | 10pct+ above peers demands an explanation |
| Net margin | Net profit ÷ revenue | Bottom-line profitability | Industry-dependent |
| Debt-to-asset ratio | Debt ÷ assets | Leverage level | < 60% for manufacturers (finance excepted) |
| Current ratio | Current assets ÷ current liabilities | Short-term solvency | > 1.5 is solid |
| Quick ratio | (Current assets − inventory) ÷ current liabilities | A stricter solvency test | > 1 is solid |
| Operating cash flow / net profit | Operating cash flow ÷ net profit | Quality of earnings | Sustained > 0.8 is good |
| Receivables turnover | Revenue ÷ average receivables | Collection speed | Deterioration means losing bargaining power |
| Inventory turnover | Cost ÷ average inventory | Production-to-sales efficiency | A marked slowdown is a warning |
| EPS (earnings per share) | Net profit ÷ total shares | Earnings per share | Read together with growth |
| EPS growth | Current EPS / prior − 1 | The core of growth | Match against valuation |
ROE DuPont Decomposition (advanced)
ROE = Net margin × Asset turnover × Equity multiplier (leverage)- High net margin (e.g. Moutai) = product-driven; the highest quality.
- High turnover (e.g. retail) = efficiency-driven; next.
- High leverage (e.g. banks) = borrowing-driven; the highest risk.
⚠️ Risk Warning: financial metrics are "past tense" and can be faked. Use them to screen and to eliminate, never as the sole reason to buy. Any stock you "can't read the statements of but everyone is buying" is not worth your principal.
4. Valuation Methods
PE (Price-to-Earnings)
PE = Price ÷ EPS (or market cap ÷ net profit)| Variant | Description |
|---|---|
| Static PE | Uses last year's profit; lagging |
| Trailing PE (TTM) | Uses the last 4 quarters' profit; the most common |
| Forward PE | Uses full-year forecast profit; contains forecast error |
- Fits: mature companies with stable, sustainable earnings (consumer, pharma, manufacturing).
- Limits: unusable for loss-makers; cyclicals bottom on PE at the profit peak (exactly the most dangerous moment); profit can be manipulated.
PB (Price-to-Book)
PB = Price ÷ book value per share- Fits: asset-heavy businesses whose book value is meaningful — banks, insurers, real estate; below book (PB < 1) is often read as "cheap".
- Limits: book value carries water (goodwill, inventory, receivables); liquidation value runs far below book; asset-light companies justifiably run a high PB.
PS (Price-to-Sales)
PS = Market cap ÷ revenue- Fits: loss-making but fast-growing companies (SaaS, innovative drugs, early-stage new energy).
- Limits: ignores profitability entirely; ignore the quality of revenue (the receivables share) and you will step in it.
Dividend Yield
Dividend yield = Dividend per share ÷ price- Fits: dividend strategies and bond-like allocation in low-rate environments (banks, utilities, central SOEs).
- Limits: a high yield can be "manufactured by a falling price" (passively inflated), and sustainability depends on profit and cash flow.
PEG (advanced reference)
PEG = PE ÷ earnings growth (%)- PEG < 1 is often read as "growth justifies the valuation". Growth forecasts are unreliable — use only as a cross-check.
DCF (Discounted Cash Flow), Conceptually
Intrinsic value = Sum of discounted future annual free cash flows (including the terminal growth stage)- The idea: a company's value = all the real money it will ever earn, discounted to today at a risk-appropriate rate.
- Limits: hyper-sensitive to three assumptions — growth rate, discount rate (WACC), and terminal growth — change one number and the valuation can double. DCF's value is the mindset (respect cash flow and long-run returns), not precise price targets.
The Right Way to Use Valuation
- Valuation asks "is it expensive"; fundamentals ask "is it good": a great company bought expensive still loses money (the 2021 crowded-trade halvings were the lesson).
- Use historical percentiles for "relatively expensive", DCF/dividend yield for "absolutely expensive".
- No universal metric: different industries need different anchors — cyclicals on PB and supply-demand, growth names on PEG/PS, dividend names on yield.
5. Technical Analysis in Stocks: Uses and Limits
What It Can Do
| Use | Description |
|---|---|
| Timing aid | Moving averages, MACD, and volume-price relationships help time entries and exits |
| Sentiment gauge | Volume spikes, limit-up boards, and the Dragon-Tiger list reflect money's mood |
| Stop-loss execution | Breaking support or a moving-average death cross as disciplined exit signals |
The Limits (must be understood)
- Lag: indicators are computed from price — price moves first, indicators follow; they are a "rear-view mirror".
- Survivorship bias: the "chart patterns" you see were tallied by winners; the losers' samples are forgotten.
- Self-fulfilling, then self-defeating: once too many people trade the same pattern, it distorts or even reverses.
- Stocks are anchored by fundamentals: technicals suit "finding entries on good companies" and cannot save a stock whose fundamentals are deteriorating — in a downtrend, every "oversold bounce" can be a falling knife.
Recommended usage: fundamentals pick the stock (what to buy), technicals pick the timing (when to buy), risk control decides survival (how to exit when wrong). The order is not negotiable.
📐 The three orders of investing: fundamentals pick the stock → technicals pick the timing → risk control decides survival
Fundamentals pick the stock (what to buy), technicals pick the timing (when to buy), risk control decides survival (how to exit when wrong). The order is not negotiable — without passing fundamentals, the prettiest technicals are a castle in the air.
6. News Flow and Theme Speculation
| Concept | Description |
|---|---|
| News flow | Moves driven by policy, earnings, announcements, and industry news |
| Theme speculation | Short-term money games around a concept (AI, the low-altitude economy, robotics) |
| Dragon-Tiger list | The exchange's disclosure of the top five buying/selling seats in unusual movers — a window on hot money |
| Board chasing / streaks | Chasing limit-up boards for next-day premium — speculation taken to its extreme |
News-Flow Traps
- Good news landing is bad news ("die on exposure"): expectations have already been priced; the announcement's arrival smashes the price instead.
- Bad news exhausted is good news: priced down thoroughly before the event, it stops falling once the event lands.
- Retail is always the last link: by the time news reaches your ears, it is usually already in the price.
- Earnings seasons (dense disclosure at the ends of January/April/July/October) are wildly volatile — "position before the news, exit when it lands" is discipline, not cowardice.
7. Common Analysis Traps
1. Financial Fraud Signals (priority screening)
| Red flag | Description |
|---|---|
| Receivables growing far faster than revenue | The revenue may be IOUs |
| High net profit, persistently negative operating cash flow | The profit may exist only on paper |
| Gross margin abnormally above peers, unexplained | Premium assets out of nowhere? |
| High deposits and high debt | Big deposits plus big high-interest borrowings — signs of tied-up funds |
| Frequent auditor/audit-firm changes | Usually irreconcilable disagreements |
| Goodwill / construction-in-progress perpetually inflating | The hiding places of inflated assets |
| Major shareholder heavily pledged, frequently selling | Insiders run before you do |
| Results "precisely on target" | Profits meeting promises/financing conditions to the decimal every year — suspiciously coincidental |
2. Buying at the Top
- Heavy volume, no progress: enormous turnover with no price advance = distribution.
- All good news spent: when every positive has landed and the story is everywhere, it is usually the last link.
- The board opens after a limit-up streak: gigantic volume on the break = the big players handing off.
- Price far above the moving average: after a runaway short-term rally, mean-reversion pressure is heavy.
- The retail classic trilogy: don't chase the small rise → can't resist after the big rise → buy the "dip" that is actually the top.
3. Speculating in Small and Junk Stocks
| Phenomenon | Risk |
|---|---|
| Speculating in ST/*ST shell value | Under registration reform, shell value collapses; delisting and zero at any time |
| Speculating in loss-making theme stocks | No earnings support; musical chairs |
| Chasing "high bonus ratios" | Bonus shares create no value; post-ex-rights "number illusions" follow |
| Chasing micro-cap limit-up streaks | Thin liquidity; one big red candle traps you for good |
| Trading on tips / stock-pick groups | The standard pig-butchering script — the bag holder is always you |
Under the new delisting rules, financial delisting criteria have tightened and transaction-based delisting (par-value delisting) is now routine — the room for "small and junk" speculation in A-shares is being institutionally squeezed; delistings have visibly multiplied since 2024, and the risk/return of betting on shells or ST names is now severely asymmetric.
⚠️ Risk Warning
⚠️ Risk Warning
No method of stock analysis guarantees profit — fundamentals can be faked, valuations can stay un-reverted for years, technicals can slap you repeatedly, and news may be planted for you by operators. No single metric is a reason to buy; combining methods, scaling in, strict stop-losses, and diversified holdings are the way to survive long term. This article is methodology education, not investment advice. Do not buy a company's stock before you understand how it makes money.