In the current Artificial Intelligence investing world, understanding and knowing the right information is the often the difference between being an investor in the driver’s seat of your investments and a helpless passenger.
The maxim ‘Knowledge is Power’ gets completely justified in this case.
There are ample number of ways to gauge the value and growth potential of a stock, fundamental analysis, of course, remains one of the best ways to help you establish a benchmark of a stock’s performance in the market.
Which thereby results in informed investing decisions.
Fundamental Analysis
Fundamental analysis involves digging deep into business at its most basic or fundamental financial levels.
The aim here is to analyse the business model, financial statements, profit margin, and other key indicators to determine the financial situation of a business and the intrinsic value of its stock.
By arriving at a forecast of future stock price movements, informed investors can profit from them accordingly.
Such Fundamental analysts quote that the price of a stock alone is not enough to accurately reflect all available information. That’s why they typically study economic, industry, and company analysis to derive the current fair value and forecast the future value of a stock.
If the fair value and current stock price are not as expected, the expectation is that the market price will ultimately gravitate towards fair value.
They then capitalize on these perceived price discrepancies and profit from the price movements.
For instance,
If the stock’s current market price is higher than the fair value, then it is considered overvalued which results in a sell recommendation.
However, if the stock’s current market price is lower than the fair value, then is deemed to be undervalued.
This means that the price is expected to go up eventually, so it is a good idea to buy it now.
There is an ocean of parameters available for fundamental analysis, which can be used to acknowledge the financial health of a company.
The most popular ones are geared towards growth, earnings, and market value.
Understanding these key indicators can help you make more informed buy or sell decisions.
Top fundamental tools indicator
- Price to Earning ratio (P/E)
This ratio measures the relationship between the stock price of a company and its per-share earnings.
It helps investors determine if a stock is undervalued or overvalued relative to others in the same sector.
P/E ratio provides a rough idea of what is market is willing to pay today for a particular stock based on its past or future earnings, investors simply compare the P/E ratio of a stock to those of its competitors and industry standards.
A lower P/E ratio means the current stock price is low relative to earnings, which is favourable to investors.
The Price to Earnings Ratio is calculated by dividing the current price per share of a stock by the company’s earnings per share.
- Projected earnings growth rate (PEG):
The P/E ratio is one of the good fundamental analysis indicator but is somewhat limited by the fact that it doesn’t include growth factor.
Using PEG analyst anticipate earnings growth rate by almost a year.
Analysts estimates the future growth rate of a company by backtracking the historical growth rate.
Here the stock valuation picture of a particular stock is complete.
It is represented in the form of percentage.
- Return to Equity (ROE):
This ratio signifies the rate of return a shareholder receives for the portion of their investment in that company.
It measures how well a company generates returns to its shareholders’ investment.
Since profit is an actual driver of stock prices, separating out the profits earned with shareholder equity is actually a pretty good indicator of the financial health of a company and fair value of its stock.
- Debt-to-Equity Ration:
This ratio is crucial because it helps investors evaluate the financial leverage of a company, signalling just how much shareholder’s equity can fulfil obligations to creditors should the business encounter financial hardship.
It quantifies the relationship between a company’s borrowed capital and the capital provided by its shareholders.
This ratio is calculated by dividing the total liabilities by the total shareholder equity.
- Price to Book ratio (P/B):
This ratio is a fundamental analysis indicator that compares the book value of a stock to its market value.
By showing the difference between the stock’s market value and the value the company has stated in its financial books, it assists investors determine whether the stock is under or overvalued relative to its book value.
It is calculated by dividing the stock’s most recent closing price by the book value per share as listed in the company’s annual report.
Book value is calculated as the cost of all assets minus liabilities. It is the theoretical value of a company if it will be liquidated.
However, the price-to-book ratio of a particular company is not useful just by itself.
An investor needs to compare a company’s P/B ratio to others within the same sector or industry.
Only then will it be useful in determining which company may be undervalued or overvalued relative to others.
- Earnings per Share (EPS):
In simplified context this ratio denoted the portion of a company’s profit that is assigned to each share of its stock.
It’s essentially the bottom line net income, just on a per-share basis.
A growing EPS ratio is a good sign to investors because it means that their shares are likely to be worth more.
You can calculate the earnings per share of a company by dividing its total profit by the number of outstanding shares.
- Free cash flow (FCF):
This is the cash left over after a company has paid all its expenses (operating expenses and capital expenditures) expenses.
Cash is critical element for the survival of business.
Companies with high free cash flow can improve shareholder value, fund innovation, and survive downturns better than their less-liquid counterparts.
Many investors cherish FCF as a fundamental indicator because it shows whether a company still has enough cash to reward its shareholders through dividends after funding operations and capital expenditures.
- Price to Sales ratio (P/S):
The price-to-sales ratio helps to determine the fair value of a stock by utilizing a company’s market capitalization and revenue.
It shows how much the market values the company’s sales, which can be effective in valuing growth stocks that have yet to turn a profit or aren’t performing as expected due to a temporary setback.
The P/S formula is calculated by dividing sales per share by the market value per share.
A lower P/S ratio is seen as a good sign by investors.
This is another metric that’s also useful when comparing companies in the same sector or industry.
- Dividend Payout Ratio:
When a company performs well in the market, it pays a part of their profits to their shareholders in the form of bonus, this bonus is termed as dividend.
Here it is important to know how well the company’s earnings support those dividend payments.
This ratio provides insights on what portion of net income a company returns to its shareholders, as well as how much it sets aside for growth, cash reserve, and debt repayments.
DPR is calculated by dividing the total dividend amount by the company’s net income in the same period. It’s usually calculated as an annual percentage.
- Dividend yield Ratio:
Dividend yield ratio looks at the amount paid by a company in dividends every year relative to its share price.
It is an estimate of the dividend-only return of a stock investment.
Assuming there are no changes to the dividend, the yield features an inverse relationship with the stock price the yield rises when the stock price falls and vice versa.
This is important to investors because it tells them how much they are getting back from every dollar they’ve invested in the company’s stock.
The dividend yield ratio is expressed in percentage and is calculated by dividing the annual dividend per share by the current share price.
Conclusion:
All the fundamental analysis indicators discussed above are significant in their own right.
This set of parameters help you determine the value and growth potential of a stock, it is important to understand that there are several other factors that affect stock prices, most of which are not so easy to measure.
That’s why when it comes to evaluating a company’s stock for investment purposes, fundamental analysis is best used in tandem with other tools, such as technical analysis, macroeconomic news, and industry-specific data.
This helps you develop a clearer picture of what you want in a stock while using the indicators as benchmarks to measure the worth of potential investments.