Fundamental analysis is the process of looking at a company's basic or fundamental financial level. This type of analysis examines important terms of a companies to determine its financial health and gives you an idea of the value its stock.
Many investors use fundamental analysis alone or in combination with other technical tools to evaluate stocks for investment purposes. The idea behind this is to determine the current worth and, more importantly, how the market values the stock in coming future.
The following points are based on important tools of fundamental analysis and what they tell you. Even if you don't plan to do in-depth fundamental analysis yourself, it will help you to follow stocks more closely which will give you good returns in future/long term investments.
It's all about earnings. When you come to the bottom line, that's what investors want to know. How much money are the companies making and how much is it going to make in the future.
Importance of Earnings - Earnings are profits. Quarterly or yearly companies increasing earnings generally makes its stocks price to move up and in some cases a pay out of regular dividend. This is Bullish sign and indicates that the companies in growth phase.
When the companies declare low earnings then the market may see bearishness in the stock which may affect the stock price in negative manner.
Quarter1 - (April to June and earnings will be declared in July)
Qyarter2 - (July to Sept and earnings will be declared in Oct)
Quarter3 - (Oct to Dec and earnings will be declared in Jan)
Quarter4 /final - Also called as financial year end - (Jan to Mar and earnings will be declared in April)
Now by this time you may be come to know how earnings are important for a stock price to move up or down. But depending only on earnings one should not make investment or trading decision. To make decision more risk free you should look into more tools as mentioned below so that your investment decision becomes more solid and you should get excellent returns in future.
Conclusion - Keep a close watch on quarterly earnings and trade accordingly.
Make use of following tools to find excellent growth stocks
Following are the most popular and important tools to find excellent growth stocks which focuses on earning, growth, and value of the company's.
To make you understand more easily we have explained in very simple steps.
Following are 10 simple steps.
1) Earning per share - EPS
2) Price to Earnings Ratio - PE
3) Projected Earning Growth - PEG
4) Price to Sales Ratio - PS
5) Price to Book Ratio - PB
6) Dividend Yield
7) Return on Equity
8) Debit ratio
9) Company's announcements
10) Profit after Tax - PAT
(Note - No need for you to do any calculation or to calculate any ratios, you will get all ratios easily available.-
Note - Single tool from above list should not be used to make your investment or trading decision nor will they provide you any buy or sell recommendation. All tools should be used to find growth and value stocks.
After making use of above all tools you will get excellent stocks which will give you excellent returns in mid term to long term.
Understanding Earning Per Share - EPS
EPS plays major role in investment decision.
EPS is calculated by taking the net earnings of the companies and dividing it by the outstanding shares.
(Nowadays you will get this ready made, no need for you to do calculation.)
That is EPS = Net Earnings / Outstanding Shares
For example - If Company A had earnings of RS 1000 crores and 100 shares outstanding, then its EPS becomes 10 (RS 1000 / 100 = 10). Second example - If Company B had earnings of RS 1000 crores and 500 shares outstanding, then its EPS becomes 2 (RS 1000 / 500 = 50).
So which companies stock do you want to buy?
Answer - You should go buy Company A with an EPS of 10. But it's again not advisable to make your investment decisions based on only single tool analysis.
Conclusion - You should look for high EPS stock/company. The higher the better.
Note - You should compare the EPS from one company to another, which are in the same industry/sector and not from one company from Auto sector and another company from IT sector.
But it doesn't tell you what the market thinks of it. For that information, we need to look at some more ratios as following.
Before we move on, you should note that there are three types of EPS numbers:
·Trailing EPS - Last year's EPS which is considered as actual and for ongoing current year.
·Current EPS - Which is still under projections and going to come on financial year end
·Forward EPS - Which is again under projections and going to come on next financial year end
EPS is the base for calculating PE ratio.
Understanding Price to Earnings Ratio - PE ratio
PE ratio is again one of the most important ratio on which most of the traders and investors keep watch.
Important - The PE ratio tells you whether the stock's price is high or low relative to its earnings.
The high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. but, the P/E ratio doesn't tell us the whole story of the company. It's more useful to compare the P/E ratios of one company to other companies in the same sector/industry and not in other industry.
The PE ratio is calculated by taking the share price and dividing it by the companies EPS.
That is PE = Stock Price / EPS
A company with a share price of RS 40 and an EPS of 8 would have a PE ratio of 5 (RS 40 / 8 = 5).
Importance - The PE ratio gives you an idea of what the market is willing to pay for the companies earning. The higher the P/E the more the market is willing to pay for the companies earning. Some investors say that a high P/E ratio means the stock is over priced on the other side it also indicates the market has high hopes for such companys future growth and due to which market is ready to pay high price.
On the other side, a low P/E of high growth stocks may indicate that the market has ignored these stocks which are also known as value stocks. Many investors try finding low P/E ratios stocks of high value growth companies and make investments in such stocks which may prove real diamonds in future.
Which P/E ratio to choose?
If you believe that the companies has good long term prospects and good growth then one should not hesitate to invest in high P/E ratio stocks and if you are looking for value stocks which prove real diamonds in future then you can go with low PE stocks provided that companies has good growth and expansions plans.
At all if you would like to do PE ratio comparison then it has to be done in same sectors/industry stocks and not like one stock from banking sector and other stock from pharmacy sector.
So now you would have come to know how to choose stocks based on PE ratio.
Understanding the Projected Earning Growth - PEG
Because the market is usually more concerned about the future than the present, it is always looking for companies projected plans, financial ratios, and other future announcements.
The use of PEG ratio will help you look at future earnings growth of the company.
PEG is a widely used indicator of a stock's potential value. If you are making use of PEG ratio then no need to make use of price/earnings ratio because PEG also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued.
You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings.
That is PEG = P/E / (projected growth in earnings)
For example, a stock with a P/E of 30 and projected earning growth for next year is 15% then that stock would have a PEG of 2 (30 / 15 = 2).
In above example what does the "2" mean?
Lower the PEG ratio the less you pay for each unit in future earning growth. So the conclusion is you can invest in high P/E stocks but the projected earning growth should be high so that companies can provide good returns.
Looking at the opposite situation; a low P/E stock with low or no projected earnings growth is not going to give you returns in future. Because its PE is low means investors are not ready to pay high and its PEG is also low because companies do not have any good future growth or expansion plans.
So investment in such stocks could prove less or no returns.
A few important things to remember about PEG:
· It is about year-to-year earnings growth
· It relies on projections, which may not always be accurate
Understanding Price to Sales Ratio
Is it that means companies that don't have any earnings are bad investments? Not necessarily, because such type of companies may be new and trying to grow and expand but you should approach such companies with caution.
The Price to Sales ( P/S ) ratio. This ratio looks at the current stock price relative to the total sales per share.
You can calculate the P/S by dividing the market cap of the stock by the total revenues of the companies.
You can also calculate the P/S by dividing the current stock price by the sales per share.
P/S = Market Cap / Revenues
P/S = Stock Price / Sales Price per Share
Conclusion - To find value stocks you can look for low P/S ratio like P/E ratio. The lower the P/S, the better the value.
Understanding Price to Book Ratio - PB ratio
Basically PB ratio is mostly utilized by value investors to find real wealth when they are at their lower prices. So investing in stocks having low PB ratio is to identify potential candidates for future.
A lower P/B ratio could mean that the stock is undervalued
Book value - It is the total value of the company's assets that share holders would receive if a company closed down.
Like the PE, the lower the PB, the better the value of the stock for future growth.
Some of the investors become quite wealthy by holding stocks for the long term of such companies whose growth is based on their businesses instead of market and one day when every one notices this stock the value investor's pockets are full of profit.
Basically PB ratio is calculated in following manner.
PB ratio = Share Price / Book Value Per Share
Understanding Dividend Yield
If you are a value investor or looking for dividend income then you should look for Dividend Yield figure of the stock.
This measurement tells you what percentage return a companies pays out to shareholders in the form of dividends. Older, well-established companies tend to payout a higher percentage then do younger companies and their dividend history can be more consistent.
You calculate the Dividend Yield by taking the annual dividend per share and divide by the stock's price.
Dividend Yield = annual dividend per share / stock's price per share
For example, if a company's annual dividend is $1.50 and the stock trades at $25, the Dividend Yield is 6%. ($1.50 / $25 = 0.06)
Understanding Return on Equity - ROE
Return on Equity (ROE) is one measure of how efficiently a company uses its assets to produce earnings. The healthy companies may produce an ROE in the 13% to 15% range. To get better view Compare Company's in the same industry/sector.
ROE - You calculate ROE by dividing Net Income by Book Value.
Note - While ROE is a useful measure, it does have some flaws that can give you a false picture, so never rely on it alone. For example, if a company carries a large debt and raises funds through borrowing rather than issuing stock it will reduce its book value. A lower book value means you're dividing by a smaller number so the ROE is artificially higher.
There are other situations such as stock buy backs that reduce book value, which will produce a higher ROE without improving profits.
It may also be more meaningful to look at the ROE over a period of the past five years, rather than one year.
Debit Ratio -
This is one the very important ratio as this tells you how much company relies on debit to finance its assets.
The higher the ratio the more risk for company to manage. So look for company's having low debit ratio.
Generally look for ratio less then 1.
If company has fewer debits then company can make more profit instead paying for its debits like interests rates, loans etc