Fundamental Stock Analysis

Fundamental Analysis

Investment analysts, research firms, and investment managers use fundamental analysis to analyze a companies business, and the factors that could drive or impact future growth. The balance sheet and cash flow statements are scrutinized, inventory is reviewed, channel checks might be conducted with suppliers or resellers to determine if there is a potential for a pickup or slowdown in sales. In addition, analysts will listen in on conference calls, meet with management, obtain customer feedback, review insider stock transactions, industry conditions, competitors, and anything else they feel will give them additional insight into the companies prospects.

Once the fund managers find a company they like, they will begin to accumulate shares over time. It is difficult for mutual funds for purchase large quantities of small cap or micro cap stocks because their buying alone could impact the stock price. Instead, they will usually make many smaller purchases over time.

The tabs on the right cover a few of the areas analysts research. There are far to many terms to cover them all however you can at least get an idea of what analysts look at when it comes to fundamental analysis.

Fundamental Analysis areas

Earnings and SalesProfitabilityValuationsOther

Earnings Per Share net profits attributable to each common share as originally reported by the company, but adjusted for all subsequent stock splits and stock dividends; may be based on weighted average shares outstanding (Basic EPS) or weighted average shares including all shares reserved for conversion of convertible securities (Diluted EPS). Earnings per share is calculated by taking the companies net earnings and dividing it by the number of outstanding shares. If a company has $10 million in net earnings for the previous year and 5 million shares of stock outstanding, then the company would have earnings per share (EPS) of $2.00.

Smaller companies (small-cap or micro-cap) have the potential grow at a much faster rate than large companies (large-cap). This is because smaller companies do not have as many shares outstanding, and as a result, higher institutional demand for these shares can have a bigger impact on the stock. Many of the biggest winning stocks only had 3 or 4 million shares outstanding with very fast earnings and sales growth.

Regardless of whether you own a small company or a large companies stock, the company should have three to five years of earnings and sales growth.

Example: Small cap. vs. Large cap. earnings growth

Large company

$1.00

$1.19

$1.27

$1.38

Small company

$1.00

$1.65

$2.00

$2.37

Year

2004

2005

2006

2007

Example of quarterly earnings acceleration

Earnings 20% 27% 49% 68%

Quarter 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.

Below are just a few of the areas analysts will look at when researching a company.

PE Ratio. Many investors look at a companies PE or Price to Earnings Ratio when they are considering investing in a company. Sometimes you will also hear the terms high or low multiple used as well. If a company was publicaly traded and there was only 1 share outstanding, the shareprice was $20.00, and the earnings were $1.00 per share, the price to earnings ratio would be 20. Price of $20.00 divided by earnings of $1.00. If a company has a high PE Ratio (25 or higher), it can mean that there are a lot of high expectations built into the current shareprice. This could be because the company has a unique business concept, they are growing earnings at a very fast pace, or there is a high level of euhporia built into the shareprice (similar to technology stocks in 2000). When a company has a low price to earnings ratio, there usually isn't as much future expectation built into the shareprice. Tobacco, U.S. automakers, and homebuilders are some examples of companies with low PE ratios or low multiples.
Book value is the net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill) and liabilities.
Cashflow is the measure of financial performance that looks at the company's ability to generate cash flow through its operations. It is important to investors because it gauges a corporations ability to pay dividends. The higher the cash flow, the more likely the company is to make its distributions. Cashflow is also another way to measure a companies financial health over a period of time.
Current Assets are assets that may reasonably be expected to be converted into cash, sold, or consumed during the normal operating cycle of a business, usually 12 months or less. Current assets usually include cash, receivables, and inventories.
Current Liabilities are obligations that will have to be satisfied within the next 12 months. Current liabilities include accounts payable, taxes, wage accruals, and total short-term debt, or Debt Due (the sum of notes payable and the portion of long-term debt maturing in the operating year).
Debt to Equity is a measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. A high debt/equity ratio usually means that a company has been aggressive in financing its growth with debt. This has the potential to lead to volatile earnings. A company might accumulate more debt in order to expand their operations, hire salespeople, or even pay down existing debt. Like the P/E Ratio, the debt/equity ratio can depend on the industry in which the company operates.
Price-to-Sales Ratio is a ratio for valuing a stock relative to its own past performance. It is calculated by dividing a stock's current price by its revenue per share for the trailing 12 months. This is most useful when comparing similar companies. It does not take any debt or expenses into account.