How to analyze the fundamentals of the company?
Many time we invest in company share without knowing anything about the company. Many times we heard that this company has strong fundamentals or fundamentals of this company is weak.Million dollar question arise here is how to identify fundamental of strong company. One can identify that by knowing debit status, its current valuation, its future growth prospects, its earning capacity etc.
It is very important for the investor to know all this details before investing in any company. Investment without knowledge is very risky.
Basic thing investor must know before investment:-
How to analyze Fundamental of Company?
About Company –
You should know and understand the business of the company. What is core product of the company or what type of service are provided by the company. How is the management of the company, Who are the customer of the company ? How is the current demand for their products and how the demand will be in future like in next 3 to 5 years and so? If possible take help of professional for this.
This is most important point one should consider before investing in any company. One should analyze at least 3 year earning to know if the company is posted profit or loss. Ultimately as a investor one should know that how much money company is making and how much it is going to make in the future.
To find the earning status ratios used are
- EPS – Earning per share
- Trailing EPS
- Current EPS
- Forward EPS
Earning per share
EPS plays major role in investment decision. EPS is calculated by taking the net earnings of the company and dividing it by the outstanding shares.
EPS = Net Earnings / Outstanding Shares
(This ratio are available mostly on many websites no need to do calculation).
For example –
If Company X had earnings of RS
2000 crores and 100 shares outstanding, then its EPS
becomes 20 (RS 2000 / 100 = 20).
Higher the EPS better is the stock.
Note – If you are comparing EPS than you should compare the EPS of the company in same sector/industry. Please do not compare stock of Bajaj (Auto Industry) to Stock of Infosys (IT Industry).
Trailing EPS means last year’s EPS which is considered as actual and for ongoing current year.
Current EPS means which is still under projections and going to come on current financial year end.
Forward EPS which is again under projections and going to come on next financial year end.
You can not make any prediction about company only by knowing EPS, we need to look at some more ratios as following.
Importance of Earnings –
Earnings are profits. Quarterly or yearly company’s increasing earnings generally makes its stock price move up and in some cases some companies pay out a regular dividend. This is Bullish sign and indicates that the company’s is healthy and growing in pace.
If company declares low earnings then stock price may correct (reduce) & will continue to correct further if the company doesn’t provide any sufficient justification for low earnings.
Every quarter, companies report its
earnings. There are 4 quarters.
Quarter 1 – (April to June and earnings will be declared in July)
Quarter 2 – (July to Sept and earnings will be declared in Oct)
Quarter 3 – (Oct to Dec and earnings will be declared in Jan)
Quarter 4 – (Jan to Mar and earnings will be declared in April)
Posted earning are important in order to move stock up or down but earning are not only thing that one should consider for investment or trading. One should look for other details about company and ratio’s which are described below.
Current valuation –
This is another very important factor which most of the investor forgets while doing their investments.
One must know that stock available at current price are fair enough or not, some investor invest in to stock at very high price (higher valuations) and when share prices start coming down then they will be tens, so this should not happen. Please remember that every stock that moves up will come down at certain levels.
One should do analysis and invest in to stock at right price & see that he/she is not investing in over price stock.
This is what happened in year 2008. Most of the people invested at very high valuations considering that stock price will move up only and suddenly market crashed and some stock has not come to that level again till date. One of such example is Reliance Industries or Reliance Communications.
To find the current valuation of the stock the ratios used are
- PE ratio – Price to earnings ratio
- PB ratio – Price to book value ratio
PE ratio – Price to earning ratio –
The PE ratio is calculated by taking the share price and dividing it by the companies EPS.
PE = Stock Price / EPS
PE ratio is again one of the most important ratio on which most of the traders and investors keep watch.
Important – The PE ratio tells you whether the stock’s price is high or low compared to its forward earnings.
The high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E.
This generally happen in bull in market where all people are keep on purchasing and due to which share price keeps on increasing. In this type of market investor/trader do not look for current valuation and once they start realizing that stock is now highly priced they start selling stock. This is very dangerous situation.
Generally the P/E ratios are compared of one company to other companies in the same sector/industry and not in other industry before selecting any particular share.
A company with a share price of RS 40 and an EPS of 8 would have a
PE ratio of 5 (RS 40 / 8 = 5).
Importance – The PE ratio gives you an idea of what the market is willing to pay for the companies earning.
The higher the P/E the more the market is willing to pay for the companies earning. it indicates that market has high hopes for such company’s future growth and due to which market is ready to pay high price for stock.
Low P/E ratio for high growth stock is one should look for in market which will provide high returns in future.
Price to Book Ratio – PB ratio
PB ratio = Share Price / Book Value per Share.
Basically PB ratio is utilized by smart investors to find real wealth in shares, so investing in stocks having low PB ratio is to identify potential shares for future growth.
A lower P/B ratio could mean that the stock is available at low cost. Like the PE, the lower the PB, the better the value of the stock for future growth.
Some of the investors become quite wealthy by holding stocks for the long term whose growth is based on their businesses instead of market and one day when every one notices this stock the value investor’s pockets are full of profit.
Generally, if the ratio comes below 1 then it is considered as value investing because share price is same as that of book value.
Future earnings growth –
Future earnings growth is most important which will provide details that how the company is going to do in future. How will be its returns or its profits etc?
To find the future growth of the stock the ratios used are
- PEG ratio – Projected to earnings growth ratio
- Current EPS and Forward EPS
- Price to sales ratio
Projected Earnings Growth ratio – PEG ratio
Because the market is usually more concerned about the future than the present, it is always looking for companies projected plans, financial ratios, and other future announcements.
The use of PEG ratio will help you look at future earnings growth of the company. PEG is a widely used indicator of a stock’s potential value.
Similar to the P/E ratio, a lower PEG means that the stock is more undervalued.
To calculate the PEG the P/E is divided by the projected growth in earnings.
PEG = P/E / (projected growth in earnings)
For example –
A stock with a P/E of 50 and projected earnings growth for next year is 25% then that
stock would have a PEG of 2
(50 / 25 = 2).
Lower the PEG ratio the less you pay for each unit in future earnings growth. So the conclusion is you can invest in high P/E stocks but the projected earnings growth should be high so that companies can provide good returns.
Price to Sales Ratio
P/S = Market Cap / Revenues
P/S = Stock Price / Sales Price per
Some of company which are new have no current earnings in order to do analysis of such company one must take precaution.
The Price to Sales (P/S) ratio looks at the current stock price relative to the total sales per share.
It is very important for investor to know that how much money has been borrowed by company from market which is known as debit status of company. It is better to invest in company which is debt free or has taken less loan/borrowing from market, because company need to pay back this loan so its profit will be going in paying this loan.
This loan may be for expansion plan for new business or for other financial needs. Company who has few debit has more cash in hand and can survive and do business well.
Debt Ratio = Total Liabilities / Total Assets
The debt ratio compares a company’s total debt to its total assets, which is used to gain a general idea as to the amount of leverage being used by a company.
This ratio should be low as low is ratio company is less loaded by debt. In general, the higher the ratio, the more risk that company is considered to have taken on.
Many investor invest in stock by considering dividend payout by company. Dividend yield will tell you that how company has paid to shareholder in terms of dividends.
One can refer to dividend history to know more about dividend payout given by company.
Dividend Yield = Annual dividend per share / Stock’s price per share
If a company’s annual dividend is RS
15 and the stock trades at RS 1225, the Dividend
Yield is 1.2%. (RS 15 / RS 1225 = 0.012).
Things to Remember before investing in any Stock:-
- Understand Business of company.
- Higher is the EPS better is the Stock.
- Higher the P/E the more the market is willing to pay for the companies earning.
- Lower the PB, the better the value of the stock for future growth.
- PEG of company should be High.
- Debt Ratio of company should be low.