Fundamental Analysis of a Stock
The fundamental analysis of a company is done before investing the money to know the potential of a company and expected returns over time. Investors depend on stock analysis to find potentially profitable stocks. Common ways to analyse stock include technical and fundamental analysis. Several components fall under fundamental analysis, including examination of a company’s price-to-earnings ratio, earnings per share, book value and return on equity. Many investors also use the recommendations of financial analysts to analyse a stock. The type of stock analysis you implement is based on personal preference. Understand the different ways to analyse a stock to find the method that best fits your financial objectives.
A popular and most common method to analysing a stock is studying its price-to-earnings ratio. You calculate the P/E ratio by dividing the stock’s market value per share by its earnings per share. To determine the value of a stock, investors compare a stock’s P/E ratio to those of its competitors and industry standards. Lower P/E ratios are seen as favourable by investors. If the P/E ratio of a company is lower than its industry P/E ratio it’s favourable for an investor.
A company’s earnings per share show how efficiently its revenue is flowing down to investors. An increasing EPS is taken as a good sign by investors. The higher a company’s EPS, the more your shares are worth because investors seek to purchase a company’s stock when earnings are high.
The price-to-earnings-growth ratio takes the P/E ratio a step further by considering the growth of a company. To calculate the PEG, you divide the P/E ratio by the 12-month growth rate. You estimate the future growth rate by looking at the company’s historical growth rate. Investors typically consider a stock valuable if the PEG is lower than 1.
Another method used to analyse a stock is determining a company’s price-to-book ratio. Investors typically use this method to find high-growth companies that are undervalued. The formula for the P/B ratio equals the market price of a company’s stock divided by its book value of equity. The Book value of equity is derived by subtracting the book value of liabilities from the book value of assets. Investors view a low P/B ratio as a sign that the stock is potentially undervalued.
Investors use return on equity to determine how well a company produces positive returns for its shareholders. Analyzing ROE can help you find companies that are profit generators. ROE is calculated by dividing net income by average shareholders’ equity. A continual increase in ROE is a good sign to investors.
Promoter holding signifies the percentage of shares that are held by the promoters of a company. However, if promoters are buying more shares of their company, this means that they actually believe in the future path that the company is expected to take and want to benefit from that.
