Fundamental Analysis: Key Metrics for Informed Investing
While investors throughout Reddit, Instagram, or even Twitter always claim to have the “next big trade,” the question in mind should always be “how’d they figure this out?” And more times than not, it’s as simple as doing a tiny bit of fundamental analysis. At Equities Lab, we’re BUILT on fundamental analysis and hope to share some of our favorite indicators.
What’s Fundamental Analysis?
Put simply, fundamental analysis is a method of evaluating the value of a stock by checking up on a few factors (economic or financial) that would be related to the stock. The goal that we have going into fundamental analysis is to see if the current price of the stock is of fair value. Remember, we might also find that the stock is overvalued or undervalued.
To conduct the review of the stock, an investor would look at both the quantitative and qualitative factors that might affect the price. Some key components might include:
Fundamental analysis is a method of evaluating the intrinsic value of a security, such as a stock, bond, or commodity, by analyzing various financial and economic factors related to the underlying asset. The primary goal of fundamental analysis is to assess whether the current market price of the asset is overvalued, undervalued, or fairly valued.
This analysis involves examining both quantitative and qualitative factors that can impact the asset’s value. Some of the key components considered in fundamental analysis include:
- Earnings Per Share (EPS):
The earnings per share of a stock indicates how profitable a company is. It’s calculated by dividing the company’s NET earnings by the number of outstanding shares. Investors use this specific metric in order to understand how much profit is generated by a single share of the stock.
Using our common lemonade stand, we can draw a real-life example. Let’s suppose that the lemonade stand generated $10,000.00 USD and since it’s such a big hit, it went public, and has 5,000 outstanding shares. Using those numbers, the EPS would be $2 ($10,000/$5,000).
When using EPS as a driving force in your financial decisions, we warn you to be weary of stock buybacks, dilutions of the stock, or other factors that might play a role in limiting the company’s performance. - Price-to-Earnings Ration (P/E):
For this, you can definitely reference our P/E blog HERE. Or, you can hear me out… This ratio is the comparison between a company’s current stock price and the earnings per share (discussed above). It shows a potential investor how much other investors are willing to pay for each dollar of earnings reported.
If our lemonade stand has it’s shared trading at $50 per share, and it’s EPS is $2, we know the P/E ratio would be equal to 25x ($50/$2).
When using P/E to make your next investment decision, be on the lookout for some indications. A high P/E may show that the stock is overvalued or it has a high growth expectation. A low P/E can show that the stock is undervalued or has a very low growth expectation. - Dividend Yield:
A dividend yield is a ratio measuring the annual dividend income a company pays out to its shareholders relative to the current stock price.
The lemonade stand pays $2 per share annually on its dividends, and its stock is priced at $50 per share. The dividend yield would be calculated as 4% ($2/$50 * 100).
While dividend yield can be a golden opportunity to long-term investors, it’s important to make sure the company in question can sustain the dividend payments long-term (which is usually driven by the growth expectation). - Book Value:
Assets are something we all strive for, even company’s that are on the public trading boards. What proves this is the book value of a stock which is the NET asset value of a company. It’s usually calculated by subtracting liabilities from the total assets. When used, investors are usually looking for the company’s equity if all the assets were sold with all liabilities being paid off.
Our lemonade stand has $200 million worth of goods on its asset list (holy moly for a lemonade stand) and it has $80 million of liabilities (loans don’t come with good rates anymore…). Our book value would be $120 million which is calculated just by doing a simple subtraction of the liabilities from the assets.
When using book value to determine your investments, remember this measurement doesn’t consider the company’s intangible assets, branding value, or the potential of future growth. What we are trying to say is that the book value may not determine the company’s actual intrinsic worth. - Debt-to-Equity Ratio:
This ration will allow an investor to measure the company’s financial leverage by comparing its total liabilities to the shareholders’ equity. In simpler terms (maybe), it’s the measure of how much debt is used to finance the company’s assets.
The lemonade stand can have total liabilities totally $50 million and the shareholders’ hold an equity of $100 million. The calculation would total out to being 0.5 ($50 million/$100 million).
When using debt-to-equity ratios, be aware that higher calculations would indicate a higher financial risk while a low calculation will indicate conservative financing used within the company. - Return on Equity:
ROE is a profitability ratio that measures a company’s ability to generate profits from the equity held by shareholders’.
The lemonade stand has a NET income of $20 million after lemonade season, and its shareholders hold $200 million worth of equity. The ROE would be calculated as 10% ($20 million/$200 million * 100).
Equities Lab was designed for those looking to implement fundamental analysis into their investing strategies. Our platform offers a wide-range of tools and features that can aid anyone in their investing journey. By leveraging fundamental analysis techniques, you can always gain a competitive edge by getting a deeper understanding of the companies you’d be investing in. Why wait? Start working on your investments by making more informed, data-driven decisions.
Happy investing!
