Fundamental analysis is the process of looking at a business at the basic or fundamental financial level. This type of analysis examines key ratios of a business to determine its financial health and gives you an idea of the value its stock.
Many investors use fundamental analysis alone or in combination with other tools to evaluate stocks for investment purposes. The goal is to determine the current worth and, more importantly, how the market values the stock.
This article focuses on the key tools of fundamental analysis and what they tell you. Even if you don’t plan to do in-depth fundamental analysis yourself, it will help you follow stocks more closely if you understand the key ratios and terms.
It’s all about earnings. That is what investors want to know. How much money is the company making and how much is it going to make in the future.
Earnings are profits. It may be complicated to calculate, but that’s what buying a company is about. Increasing earnings generally leads to a higher stock price and, in some cases, a regular dividend.
When earnings fall short, the market may hammer the stock. Every quarter, companies report earnings. Analysts follow major companies closely and if they fall short of projected earnings, sound the alarm.
While earnings are important, by themselves they don’t tell you anything about how the market values the stock. To begin building a picture of how the stock is valued you need to use some fundamental analysis tools. These ratios are easy to calculate, but you can find most of them already done on various financial websites.
Fundamental Analysis Tools
Below are the most popular tools of fundamental analysis. They focus on earnings, growth, and value in the market.
Earnings per Share – EPS
Price to Earnings Ratio – P/E
Projected Earning Growth – PEG
Price to Sales – P/S
Price to Book – P/B
Dividend Payout Ratio
Book Value - BV
Return on Equity - ROE
No single number from the above list is a magic bullet that will give you a buy or sell recommendation by itself, however as you begin developing a picture of what you want in a stock, these numbers will become benchmarks to measure the worth of potential investments.
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