Fundamental analysis is the study of analyzing a business based on certain key factors. This gives us a start to analyze and form an opinion about the financial standing and financial health of a company. Although this helps us to arrive at the best value of a stock within a reasonable level and gives us a price range, it is to be understood that the market value of the stock may vary slightly or significantly from the value that we have arrived at.
The general rule is to find out a stock which has a higher value and the current market price is lower than that. We then conclude that the stock is selling at a discount. Yet, there are other stocks which sell at a premium. In general, investors want to buy good value stocks for the long term returns and prefer the stocks selling at discount.
The factors we look into for our fundamental analysis are given below.
1. Market capitalisation
This is the size of the company, as determined by the stock market. It is the share price multiplied by the number of shares on issue.
2. Revenues including growth over previous year
These are the company’s revenues from its business activities, generally the sale of products or services. This includes the revenues from discontinued businesses. However, it does not usually include additional income from such sources as investments, bank interest or the sale of assets. If the information is available, the revenues figure has been broken down into the major product areas.
3. Profit after Tax for the financial year
The profit-before-tax figure is simply the EBIT (Earnings Before Interest and Tax) figure minus net interest payments. The profit-after-tax figure is, of course, the company’s profit after the payment of tax, and also after the deduction of minority interests. Minority interests are that part of a company’s profit that is claimed by outside interests, usually the other shareholders in a subsidiary which is not fully owned by the company. Many companies do not have any minority interests, and for those that do, it is generally a tiny figure. The figures also incorporate the profits (or losses) from discontinued businesses.
4. Long Term (Five years or more) share price return
This is the total return you could have received from the stock in the last five years. It includes reinvested dividends, bonus stock, rights issues and capital gain from the stock’s appreciation. It is expressed as a compounded annual rate of return.
5. Price-Earnings ratio (PER)
The PER is one of the most popular measures of whether a share is cheap or expensive. It is calculated by dividing the share price by the EPS (Earnings Per Share) figure. Obviously the share price is continually changing. Many newspapers publish, each morning, the latest PER for every stock based on the previous day’s closing price.
6. Dividend yield including growth over previous year
This is the latest full-year dividend expressed as a percentage of the share price. Like the PER, it changes as the share price moves. It is a useful figure, especially for investors who are buying shares for income, as it enables you to compare this income with alternative investments, such as a bank term deposit or an investment property.
7. Earnings Per share growth
EPS is the after-tax profit divided by the number of shares. As the profit figure is for a 12-month period, the number of shares used is a weighted average of those on issue during the year. This figure is provided by the company in its annual report and its results announcements.
8. Price-to-net-tangible-assets-per-share ratio
The NTA (Net Tangible Assets) per share figure tells the theoretical value of the company, per share, if all assets were sold and then all liabilities paid. It is very much a theoretical figure, as there is no guarantee that corporate assets are really worth the price put on them in the balance sheet. Intangible assets such as goodwill, newspaper mastheads and patent rights are excluded because of the difficulty in putting a sales price on them, and also because they may not, in fact, have much value if separated from the company.
Some companies may have a negative NTA, due to the fact that their intangible assets are so great, and no figure can be listed for them to a reasonable degree of accuracy.
9. EBIT (Earnings Before Interest and Tax) margin including growth over previous year
This is the company’s EBIT expressed as a percentage of its revenues. It is a gauge of a company’s efficiency. A high EBIT margin suggests that a company is achieving success in keeping its costs low.
10. Debt Equity Ratio
This ratio is one of the best-known measures of a company’s debt levels. It is the total borrowings minus the company’s cash holdings, expressed as a percentage of the shareholders’ equity. Some companies have no debt at all and this Ratio is 0.0, which means no debt and the company is worth considering for putting your money in.
11. Current Ratio
The current ratio is simply the company’s current assets divided by its current liabilities. Current assets are cash or assets that can, in theory, be converted quickly into cash. Current liabilities are normally those payable within a year. Therefore, the current ratio measures the ability of a company to repay – in a hurry – its short-term debt, should the need arise. The surplus of current assets over current liabilities is referred to as the company’s working capital.
12. Return on Equity including growth over previous year
ROE is the after-tax profit expressed as a percentage of the shareholders’ equity. In theory, it is the amount that the company’s managers have made for you – the shareholder – on your money. The shareholders’ equity figure used is an average for the year.
While the above factors are used to analyse the company in general, one should take the picture as a whole and should not consider only a factor or two in isolation. To be cautious in your analysis and actions on investments always pays rich dividends over long term.
Though we have considered the important factors, yet there are certain factors outside the scope of this analysis. Certain regulatory changes by governments of the day may change the perceived value of the company drastically or significantly at certain times.