Investors may be attracted to shares in a particular company because:

• they work in that firm or sector
• they are attracted to the products of the company or sector
• they believe the sector's prospects are good
• they have read a newspaper write-up
• they have seen some positive research and analysis about the company or sector

These are all good sources. Once you have defined a selection of shares or sectors, there are a number of indicators which you can use to analyse the relative attractiveness of the companies as investment propositions. Below are some of the most important, which where possible should be examined together, rather than relying on just one measure.

Price

The share price is the first thing with which you are usually confronted. You will want to know if you are buying at the top of the market and compare the figure with historic prices. The spread is also important - that is the difference between bid and offer - as a wide spread might not be advantageous. The price cannot be used as a measure of expensiveness. A stock trading at 500p is not necessarily cheaper than one trading at 800p. This is simply because the price does not take into account the number of shares in issue. Should there be a share split, doubling the number of shares in issue, investors should expect the price to halve.

Price / Earnings Ratio (P/E)

The P/E ratio is used to determine a share's relative expensiveness. The P/E can be calculated as:

price

earnings per share

Earnings per share (EPS) is calculated as:

earnings

number of shares in issue

The P/E figure shows how many years of earnings it would take to equal the current share price: a high figure and the share is expensive, low and it is cheap. That being said, you should not buy a company simply because the P/E is low any more than you should avoid it if the P/E is high. A high 'rating' indicates that the market expects continued strong profit growth. A low P/E indicates low expectations. The P/E ratio is, therefore, a judgement given other factors. If you are seeking value, might look for low P/Es whereas a growth investor may be content to see a healthy rating.

Sectors will also differ. Some sectors, such as telecoms in recent years, are highly rated while others, such as engineering, carry low ratings. It may not be possible to make meaningful direct comparisons between two companies in very different sectors. It is a useful measure, however, of competing firms within the same sector. Where prospects, management, market and other factors are equal, a lower P/E figure will be a positive in any decision to buy. Conversely, a very high P/E figure might indicate it is time to sell the stock.

Dividend Yield

Companies distribute profits to shareholders by the dividend. Expressed as a percentage of the current share price, the yield can be established.

The yield is useful for a number of reasons. On a basic level, income-seeking investors will require stocks which offer a given level of income, and the yield will demonstrate the income to be derived from an investment.

The yield might also be used to analyse the prospects of a company. A very high yield may indicate investors expect the dividend to be cut (the yield rises as the price falls). You should also look at the P/E ratio here as you may be able to identify recovery stocks amongst the high yielders. The dividend cover will also be useful as it shows how secure the payment is by demonstrating the number of times the dividend can be paid from earnings.

You would expect a dividend cover of at least 1 and preferably closer to 2. Dividend cover is calculated as:

earnings

dividend payment

Net Asset Value (NAV)

Unit Trusts , OEICs and ETFs trade at NAV: the price reflects precisely the sum of their worth. Investment Trusts usually trade at a discount to NAV and this discount is a useful measure of the vehicle's value and attractiveness. See the section on discounts .

Likewise, some other companies can be assessed by their NAV, a figure which is included in the balance sheet. Clearly some sectors like those in the service industries have low NAVs in comparison to their share price. This is because assets are limited to maybe office equipment. Most companies will trade at a premium to NAV, either because assets are few or simply because the market expects earnings to continue. Indeed, most companies trading at a discount to NAV will have been hit by poor sentiment in the market (investors do not rate the companies' prospects). Other than Investment Trusts, property companies, which will usually possess substantial assets - may trade at a discount. Here the measure is useful because, given that the business is not at risk of failure, a measure of value is introduced.

Capitalisation

The market capitalisation of a share is its worth as valued by the market. To calculate the figure, multiply the price by the number of shares in issue. The one hundred largest UK quoted companies by market cap form the FTSE 100. The measure is useful as a guide to a company's size and, therefore, potential liquidity.

The measure may also be useful where a company owns a proportion of another quoted company. Consider company A trading at 500p with a market cap of 100m. Company A owns 50% of company B itself currently trading at 100p with a market cap of £20m. 50% of £20m is £10m, which represents 10% of company A's market cap. 10% of 500p, however, equals 50p, half the level at which company B is trading. Although it may not be realised, this makes company A relatively better value in comparison with a connected business.

This happens now and again in the market and is a calculation worth making. Very occasionally the subsidiary is worth more than the parent company. This happened with Arm, which was 25% owned by Acorn in 1998, yet that 25% was worth many times Acorn's value. A form of reverse take-over eventually occurred to release the value for shareholder.

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For trend analysers, the tracked movement in a share price can mean more than merely a positive-looking direction. A technical analyst will examine long term price movements to establish market behaviour. There are many indicators to look out for. Below are some of the important ones.

Trends

On a very basic level, examining the performance of a share price is possible by simply looking at the chart for a positive or negative trend. It is useful to compare charts with events that occurred - for instance, results or economic news. It is not unusual for a share price to rise on (say) an unimpressive result, if the market anticipated the news and it was already factored into the price so the announcement merely confirms the extent of the problem.

Comparing the price to that of a relevant benchmark will also help in forming a judgement about the quality of the trend. It is important to remember that bull markets are characterised by indiscriminate buying and bear markets by indiscriminate selling meaning that price rises will often result in more buying and falls in more selling, until the point that investors feel the market is too rich or too cheap. We are all sheep really. It is possible to be more professional in examining trends by identifying one or more technical indicators. The more that can be identified, the more certain you can be in the trend.

Trading Range Breakout

Charts can reveal a share's trading range: that is the upper and lower levels within which the price usually fluctuates. In a drifting market, these trading ranges might be prolonged whereas in a bull market they will be shorter lived. By establishing the trading range, it is possible to discover breakout. This is where demand for the stock exceeds usual supply and the price rises above the upper level. Seasoned breakouters will not attempt to anticipate this movement but will wait until it is firmly established.

Triangles, Rectangles and Channels

As a trading range becomes established, investors can identify both the upper 'resistance' level, at which point profit taking occurs, and the lower 'support' level, where investors' demand is crystalised. These patterns are known as Rectangles. Confidence is often diminished where a stock (or market) falls below its level of support. A Channel is where the parallel upper and lower limits move in an upward or downward direction.

When searching for a trend, Triangles are indications of a continuing course. The lines of a triangle indicate a convergence in the level of support and resistance until the point where the price breaks out.

Moving averages

Moving averages are calculated over a given number of days.

Let's say you establish the average price over the five day period: with each successive day, the new price is included in the calculation and the oldest price drops out, creating a moving average and providing an underlying trend that does not suffer from the vagaries of fluctuation. By identifying the longer term moving averages, investors may be warned of possible buy signals or 'golden cross'. This is where a rising short term moving average crosses a rising medium term moving average.

Similarly, sell signals or 'dead cross' occurs where a falling short term moving average crosses a falling medium term average. Analysts will repeat the exercise using longer moving averages to establish a trend.

Volume

Share prices can move in fairly thin volume, that is, few players in the market moving the price. It is important to examine this when identifying a trend, because high volume - whether buying or selling - lends credence to that trend. Traders will often seek thin volume breakouts from trading ranges, as participation is relatively easy.

Flags and Double Tops

Two formations to look out for are flags and double tops (or bottoms). Flags are characterised by rapid upward shifts in the share price as positive volumes increase. This often occurs where a company which the market has largely ignored, perhaps in favour of a more exciting sector, announces exceptionally good news. Double tops and double bottoms are formations which indicate a share price that has broken out of its trading range, has peaked (because profit taking has occurred twice) or that has established a new level of support.

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The great investor Warren Buffett has spent most of his life examining company reports. They are important and form part of any comprehensive examination of a direct stock exchange investment. All quoted companies are required to publish the document annually and in a format that is predetermined. You can order company reports by clicking here. The sections that matter to investors are described briefly below.

The Directors' Report

The Directors' Report outlines the activities of the company, providing a review of the business and future developments. This report is good at highlighting the effective control of the company both in terms of the board and their interests. By assessing control it may possible to judge direction inherent within the firm.

The Profit and Loss Account

By examining a company's profits and losses it is possible to form a judgement about the past success of the business. As with most aspects of accounts, the figures become more meaningful when compared to previous years. It is only then that trends can be analysed. Impressive looking sales figures might be undermined if the trend is downward. Increasing sales trends may not appear so attractive where the profit margin is gradually being squeezed.

The Balance Sheet

The Balance Sheet should be read alongside the Profit and Loss account and provides a snapshot in time of the company's position. A basic examination of this document will allow you to judge how healthy the business is. The accounts show what a company is worth in terms of capital, what it owes and what it is owed. A company's balance sheet can be used to derive ratios such as gearing (the amount of borrowing expressed as a percentage of shareholder funds). Investors will want to judge the quality of the accounts in terms of its assets and availability of cash companies with bad debts can suffer even where there are healthy sales.

The Cash Flow

Reading alongside the Profit and Loss and the Balance Sheet, the Cash Flow Statement allows a comparison between what the company reports as profits and real cash generated. The trends developed in the previous sections should be mirrored in the cash flow. In a basic sense, if profits are increasing, cash inflow should be positive. If it is not, there should be a suitable explanation such as heavy investment in the period.

The Auditors' Report

Even where the rest of the company report appears daunting, the Auditor's report is a simple check and can be enlightening. It is important that the Auditors state that in their opinion the Report and Accounts issued by the company give a 'true and fair view'. Special attention should be paid where Auditors have qualified their opinions.

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Under stock exchange rules, directors of Britain's quoted companies are required to notify the exchange when they (or their spouse) buy or sell shares in their firm. Some investors follow directors' dealings as an indicator of confidence, believing that these are the people who know the business best of all. It is not an exact science and you should not rely on directors' dealings alone as a buy or sell indicator. However, tracking these movements can form part of an investment decision.

Search for the latest director's dealings (Selftrade members/account holders only)

Things You Should Consider

There are a number of considerations to factor in.

Directors are precluded from dealing where they may be in possession of price-sensitive information and may not deal two months before results are published. To do so could put them in breach of the insider dealing regulations. It may be that they are unable to deal at the optimum moment.

A new director will usually be obliged to purchase shares just as one who is due to exit is likely to sell. It is important that you take a view on the individual director's position.

A director may not be dealing purely on investment grounds. He or she may need to raise funds to buy a new Mediterranean villa or to consolidate a tax position. The significance of the transaction should also be examined as it may relate to an exercise of options, corporate action or a Bed and ISA, each of which may not be significant for the private investor's purposes. You need to make judgement about the personal motivation of a director.

The larger the transaction the more significance can be attached to it, particularly if the deal compares favourably to the size of an existing holding. The significance is further increased where a number of directors deal at around the same time, particularly if the Finance Director is involved (as this person is likely to be closest to the company's prospects). However, it is not unknown for directors to buy stock in an attempt to improve market confidence. Similarly, they may be loath to sell even when they know fortunes are in decline.

Using Directors' Dealings Information

Directors' dealing might be of most use to investors when used in conjunction with the charting facilities. If dealing coincides with trend indicators, investment decisions can be strengthened.

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Economic factors have a paramount role in determining the value of investments. Economic news, both actual and expected, can drive the value of stocks, and therefore indices, up and down. Thus, the worsening US trade deficit is widely identified as the cause of the market crash in 1987. Similarly, the market often adjusts in expectation of a change in interest rates so that, when the change is announced, there is only a minor reaction in terms of share price. The market in such cases is said to have 'priced in' the change. Unexpected changes in interest rates, like surprises in life, tend to have a more dramatic impact on asset prices. Some key indicators are discussed below.

Interest Rates

Since 1997, control of UK interest rates has passed from the Treasury to the Monetary Policy Committee (MPC) of the Bank of England. The MPC meets monthly to determine changes to the rate. Chaired by the Bank's Governor (who also holds the casting vote) the committee is constituted of experts and academics for most of whom the MPC is not their main job.

The City and markets are interested not only in the decision itself (which can have repercussions for the economy and stock market) but also in the minutes of the meeting, published a fortnight later. MPC watchers examine the trend of voting: the 'hawks' and the 'doves'.

The level of interest rates determines the overall level spending, saving and investment by individuals and firms within the economy. Interest rates thus exert an influence over the level of aggregate demand.

Higher rates are a preferred instrument to combat inflation, but the effects of a strengthened currency (because the country becomes more attractive for international investors) and higher borrowing costs hit company earnings. Apart from export-oriented firms, those firms most affected by higher interest rates are those which depend on debt for financing. Such firms typically are found in the engineering, manufacturing and other old economy sectors.

Conversely, a lowering of rates will work to the benefit of companies for which exports are an important element of their sales. Equally, companies that rely on debt financing will find that their bottom line figures improve with a fall in the interest charge.

Inflation

The Retail Prices Index (RPI) is the standard measure of inflation in the UK. It is a survey of consumer goods and services prices across the country measuring the overall change relative to both the previous month and the previous 12 months. Sometimes the 'underlying' rate is quoted as rather than the 'headline' rate. Indeed, the underlying rate (RPIX), which excludes mortgage interest payments, is the inflation target monitored by the MPC.

Why? As a nation of home owners, mortgage payments are a key component of monthly expenditure. Mortgage payments tend to track changes in interest rates. Therefore, an increase in interest rates designed to reduce inflation can have the perverse effect of initially increasing the level of inflation as measured by RPI. Targeting RPIX removes the distortion of mortgage payments.

Inflation erodes the value of investments. Cash left under the mattress is eroded in value each year by inflation. That is, its purchasing power today is less than a year ago because prices have risen. Similarly where inflation stands at 5% a share price growing at 12% can be said to have grown in 'real' terms at 7%.

If inflation is higher than in competitor countries, the economy is more inefficient and less competitive. Price stability is, therefore, sought by governments and is important to investments. During the 1970s stock market returns were whittled down by surging inflation.

Demand

Demand, which is influenced by factors such as price, income and fashion, is an essential feature in driving economic activity in any economy. A variety of indicators are used by policymakers to gauge demand in the economy and therefore its overall health, for instance retail sales, household expenditure and consumer confidence.

From the figures policymakers can determine whether the economy is overheating, growing at sustainable levels, in neutral, slipping into recession or stuck in recession. At every stage of the economic cycle, governments will look to stimulate, sustain or dampen demand through direct or indirect policies.

In the UK, successive Chancellors since the Thatcher era have largely acted as 'one club golfers' and relied principally on interest rates to influence demand. Fiscal policy is a further instrument at their disposal, but one that is used very much as an adjunct and support to monetary policy.

Growth

Economic growth is the swelling of productive potential in a country's economy. Usually measured as Gross Domestic Product (GDP), it is a measure of wealth creation during a given period, that is the value of goods sold and services paid for. Clearly mature economies, such as those in Europe, will have limited potential for growth when compared to emerging economies.

Nevertheless, growth is considered an important measure of the health of the economy. In terms of efficiency, the GDP deflator is an important comparison particularly with other economies. This effectively measures the difference between growth and inflation. While GDP is the most commonly used measure, Gross National Product (GNP) might also be used. GNP includes income from investments abroad.

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