Today I will discuss, how to decide which stock you want to buy and which stock you want to sell. I will guide you on the basics of fundamental analysis. As well as how to value a stock and how to judge the current growthand future growth of companies. So that you will get a clear view on the stocks that you want to invest in.
Frequently asked questions about Basics Of Fundamental Analysis
Fundamental analysis helps you to predict future price movement and gauge whether a stock is undervalued or overvalued.
Yes, it helps you analyze a company’s strength and its ability to beat its competitors. That will help you to rate the particular company’s stock.
Fundamental analysis has two aspects- i) Qualitative analysis, ii) Quantitative analysis.
Quantitative analysis includes the company’s balance sheet, cash flow, P&L analysis. That is why quantitative analysis is more effective while you searching for a good stock to invest in.
What Is Fundamental Analysis?
Fundamental Analysis can simply be thought of as an extensive health check of a company. It is a 360-degree check on various parameters.
1) The financials.
2) The quality of its management.
3) The overall economy and the industry conditions that might affect the performance of a company.
Basics of Fundamental Analysis
You should first focus on the earnings of the company. As well as how has the company performed over the past few years and what are the future earnings expectations from the company. Fundaental analysis help us to have a clear view upon the stock which we intend to invest in.
So let’s start understanding the basics of fundamental analysis. Through this post we shall quickly discuss some popularly used terminologies of the basics of fundamental analysis like Profit, Debt, P/E, P/B, DoE, RoE, EPS.
1) EPS or Earning Per Share
You can measure a companies profitability by looking at its Earnings Per Share OR EPS. As we divide Profit by the Number of Outstanding Shares, the number that we get is the EPS. Suppose a companies Profit is 100 crores and it has 10 Crore outstanding shares then EPS = (100 crores / 10 crores) = Rs. 10.
The greater the EPS the stronger the company. See the example above though Company B has more profit still its EPS is only Rs. 4 and hence Company A is the stronger company. In such a manner, you can compare any listed companies on the stock market. Not only that you can also gain deep knowledge about the companies financial condition.
2) PE Ratio
Let us now discuss, the Price to Earning also consider as PE Ratio. Suppose a company’s EPS is 4 rupee and their current stock price is 500 rupee. It suggests that Investors or traders shall earn 125 rupees per share of that company. Investors and traders often use the ratio to analyze a company’s present market situation. Wether the company is overvalued or undervalued. PE Ratio = (Price of the company / Earnings per share). See in the example below:
Company B has a higher PE. Company-A’s high PE denotes that investors are expecting higher earnings in the future. In case the company can’t meet up the expectations the price will correct severely.
3) Book Value
It is the total value the investors will receive if the company closes down. Now, you divide the total Book Value by the total number of outstanding shares you will get Book Value per Share. Generally, this value should be closer to the current market price of a company. Suppose the companies current market price defers from book value. That also suggests that the company is overpriced or underpriced.
4) Price to Book Value OR P/B Ratio
As we have discussed most of the terminology previously. Now we shall understant the Price to Book Value OR P/B Ratio. It is very important when you are doing fundamental analysis. If we divide the Current Market Price by Book Value per Share the answer will be Price to Book Value. Suppose, the P/B Ratio is below 1 then it considered as a value investment.
Another important terminology in the basics of fundamental analysis is Debt. A company can take debt that they can afford to pay off from their earnings. Hence business balances between debt and equity to keep the average cost of capital at its lowest. The debt to equity ratio is obtained by dividing the companies Total Liabilities by Total Equity.
6) Return on Equity
In the last term, we will discuss the basics of fundamental analysis is Return on Equity OR RoE. This measures the companies profitability also. By showing how much profit a company generates with the money shareholders have invested. RoE is obtained by dividing the Net Income of the company by Total Equity and is expressed in percentage. Investors as well as traders tends that higher the RoE, the better is the company.
I hope, the basic fundamental analysis and its important termanology is clear to you now. Because through this post I have defined and calculated each the terminology with example. So doing fundamental analysis of any company wont be a problem for you anymore.