Fundamental Analysis for Beginners

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Fundamental analysis is the detailed assessment and analysis of a company’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 an organization’s performance and survival. It’s the best way to determine whether the stock in question is valued, undervalued, or being traded at a fair price.

Need for Analysis

The elements that decide the value of a stock, keep fluctuating due to a variety of reasons. Ideally, it’s market value or current rate should almost be the same as its real value. But, the market price is either more or less than its original value. This deviation may prompt people to buy or sell a share. If the price is less than the intrinsic 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. Hence, it is all about evaluating a security’s value, based on an authentic set of information.

Stock Fundamental Analysis

Consider an investment of USD 100 in a stock which rises to USD 120. The profit gained is USD 20 or 20%. Now consider another company’s stock which has USD 1 as market price and it rises to USD 2 in the same trading session. This is a 100% rise in the value. If you invest in 10 stocks of this company, the earnings would double, in this case USD 20. Thus, it can be seen that a lower-valued tax can fetch better profit on a relatively small investment. There are many companies in a wide variety of sectors which don’t have much in common. All organizations listed on the market have some factors mentioned in the beginning as their ‘investment friendliness’ measures. Revenue, assets, and liabilities are some common aspects of any firm across different business segments. These factors gives us a broader perspective for comparison between various firms, and also highlighting the best deals on offer.

Technical analysis is many a time confused with fundamental analysis by the beginners. The former one is a type of stock research, which is based only on the market prices, their volatility, and the trends of a company’s performance graph concerning the rise or fall of its stocks. The most important difference between both 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 in 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.

Techniques

  • EPS ratio (Net earnings/Outstanding shares): If a firm earns USD 20 per share, and the outstanding share or divisions of earning is 4, each investor will earn USD 5. But, if the outstanding share is 2, then the earnings per share for an investor is USD 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 the firm’s share is valued much more than its earning, it signifies a rising stock. This factor clearly states the relative earnings of a company as compared to the other listed firms.
  • Projected Earnings Growth (PEG): 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 of 10% for say next one year, has a PEG of 2.
  • Price of a share/ sale price of that share (P/S): This factor is the market’s designated value for the sale of one share.
  • Price of a share/ Book value of a company share (P/B): This 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 a stipulated period; whereas, a payout ratio is the Annual dividends paid by a firm to its EPS.

A successful investment involves detailed market observation based on the above factors, which are incorporated in the analysis procedure. Warren Buffet of Berkshire Hathaway and Peter Lynch of Fidelity Magellan Mutual fund, are prime examples which tell us that fundamental analysis could play an important role in a person’s wealth creation.

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