Fundamental Analysis for Beginners

Fundamental analysis is the detailed assessment of a firm's future or growth which gives a fair idea about its worth in the stock market. It involves careful study of the revenue, expense, sales, asset management tools, liabilities, and all the financial aspects dealing with a company's performance and survival.

Just as your health is dependent on certain fundamental factors such as diet, mental and physical well-being, and the environment, similarly a company is analyzed with respect to the above factors. It is the best way to determine whether the stock in question is valued, undervalued or trading at a fair price.

Need for Fundamental Analysis

The elements that decide the value of a stock keep fluctuating due to a variety of reasons. Ideally, the market value of a stock or its current rate should be almost the same as its real value. But it has been seen that the market price is more or less than its original value. This deviation prompts one to buy or sell a share. If the price is less than the intrinsic value or the real value of the stock, we ideally buy it and if the stock is overpriced, we sell it. This is exactly where fundamental analysis comes in picture. In order to determine the real value of a stock, a number of parameters have to be scrutinized. Thus, this is all about evaluating a security's value based on an authentic set of information.

Stock Fundamental Analysis

Consider an investment of $100 in a stock which rises to $120. The profit gained is $20 or 20%. Now consider another company's stock which is a $1 stock (market price) and rises to $2 in the same stock trading session. This is a 100% rise in the value. If you invest in 10 stocks of this company, the earnings would be double, in this case $20. Thus, it can be seen that a lower-valued tax can fetch better on a relatively small investment. But, the underlying point to understand is how to determine which investment will fetch the best results? There are many companies in a wide variety of sectors that have very little in common. All companies listed on the market have the factors mentioned in the beginning as their 'investment friendliness' measures. Revenue, assets or liabilities are some common aspects of any firm across different business segments. All such factors give us a broader perspective to compare the companies, highlighting the best deal on offer.

Technical analysis v/s fundamental analysis is another area of confusion for many small investors. Technical analysis is a type of stock research based on only the market prices, their volatility, trends of a company's performance graph - whether its stocks will rise or fall. The most important difference between them is that technical analysis never deals with the real value of a stock. It is essentially a study limited to the market positioning and behavior of a firm. The concept of fundamental analysis can be applied to many different areas. For example, its scope can extend to bonds and their assessment based on the economic factors that govern it such as credit ratings or the condition of the parent economy.

Fundamental Analysis Techniques

• EPS ratio: Net earnings/Outstanding shares - If a firm earns $20 per share and the outstanding shares or the divisions of earning is 4, each investor will earn $5. But, if the outstanding share is 2, then the earnings per share for an investor is $10. Thus, higher EPS ratio can be a basic analysis tool.
• P/E ratio: This stands for the price per share/earnings per share ratio. The price of a single share of a company as compared to its earnings on that share is decided by the market acceptability of that organization. If a firm's share is valued much more than its earning on that share, it signifies a rising stock. This factor clearly states the relative earnings of a company as compared to the other listed firms.
• PEG or Projected Earnings Growth: The P/E ratio divided by the percentage future growth over a defined period gives the projected earnings. A share with P/E ratio 20 and a growth percent of 10 for, say next 1 year, has a PEG of 2.
• P/S: Price of a share/ Sale price of that share - This factor is the market's designated value for the sale of one share.
• P/B: Price of a share/ Book value of a company share. The book value states the theoretical value calculated for a share.
• Dividend yield and dividend payout ratio: Earnings of a firm/ stock value of the share gives the yield for the stipulated period whereas a payout ratio is the Annual dividends paid by a firm to its EPS.

These are the tools which are incorporated in this procedure. A successful investment involves detailed market observation based on these factors. Warren Buffet of Berkshire Hathaway or Peter Lynch of Fidelity Magellan Mutual fund are prime examples of what role fundamental analysis could play in a person's wealth creation. This is a world of glorious uncertainties, the more informed you are the better are your chances of scaling those dizzy heights.