Fundamental Analysis: Key Financial Ratios To Use
Determining the appropriate value of a stock is an important step in becoming a smart stock trader. As part of the earliest phase of stock trading, you must exercise caution so your investment will get a good start. You will avoid plenty of losses when you pay attention to perfecting your stock valuation methods.
There are different methods for valuing a stock but, in this article, we will discuss Fundamental Analysis. We aim to bring light and explain it in crystal clear description for every investor to take advantage of, especially to beginners in stock market investing.
Definition of Term: Fundamental Analysis
What does it mean? When you hear this term, the first thing you need to remember is that it is a method that financial analysts use to know the value of a security. Securities may include a stock or a bond. This method deals with the essential factors of the investment, which means measuring the financial integrity of the shares and the company offering them. In a fundamental analysis, you aim to know the security’s intrinsic value, which may or may not be equal to its current market value.
There are major factors that go hand-in-hand in fundamental analysis, namely the qualitative and quantitative aspects.
The quantitative aspect is concerned about studying actual numerical figures like the company’s revenues, profits, assets, debts, etc. You can get these values from the company’s income statements, cash flow statements and balance sheets. In the qualitative aspect, you focus on intangible factors like the company’s management background and brand recognition. It is also crucial to look at economic factors like interest rates, inflation, deficits, GDP, etc. These can all affect the general situation of the company.
Fundamental analysis tools
The following are the most widely used instruments in measuring the intrinsic value of stocks.
- Price to earnings ratio (P/E) – This measurement compares a company’s stock price to its earnings, thus the name.
The formula to get P/E:
* Earnings per Share (EPS) – net earnings of a company divided by the number of outstanding stocks
A high P/E may project a positive outcome in the future of the stock. This might mean that the stock is overpriced. A low P/E might mean that the stock is an underperformer. It can also be a stock that people often overlook. The underlying value of the P/E can be relative depending upon an investor’s confidence in purchasing a certain stock.
- Dividend Yield – This applies to stocks that offer dividend payouts to stockholders. This metric determines the ratio of how much dividend an investor receives annually in relation the stock’s price per single share.
The formula to get Dividend Yield:
- Book Value – simply put, book value is the difference left when you subtract the value of a company’s total assets to their total liabilities.
The formula to get Book value:
- Return on Equity (ROE) – is a measurement that determines the percentage of return by dividing the company’s total earnings with their Book Value.
The formula to get ROE:
As a general rule, the score of 13 to 15 per cent ROE presents an agreeable result. Though it may not be applicable to every situation, a company with a favourable ROE ratio projects a promising future.
Mastering Fundamental Analysis
In order to learn more about the valuation of stocks, it is advisable for investment newbies to enrol into stock investing training courses. Want to get a better grasp of the concepts and learn the proper application of formulas in the quantitative analysis? Learn faster with a stock market pro to discuss the procedures and give you corresponding workouts on each topic.
Ready To Become A Smart Trader?
To begin your learning process, feel free to download our FREE e-Book for stock market investing beginners. Also, we invite you to join our stock market investing course. This course is specifically tailored fit for anyone who want to invest confidently, smartly and successfully.
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