The Top 8 Tools of Fundamental Analysis
The most popular tools of fundamental analysis focus on earnings
Fundamental analysis is the process of looking at a business at the most basic or fundamental financial level. This type of analysis examines the key ratios of a business to determine its financial health and it can give you an idea of the value of its stock. It takes several factors into account, including revenue, asset management, and the production of a business as well as interest rate.
Many investors use fundamental analysis alone, but it can be particularly helpful to use it in combination with other tools to evaluate stocks for investment purposes. The goal is to determine the current worth of the stock, and, perhaps more important, to identify how the market values the stock.
Even if you don't plan to do an in-depth fundamental analysis yourself, understanding the key ratios and terms can help you follow stocks more closely and accurately.
It's the Earnings
It's all about earnings. That's the bottom line that investors want and need to know: How much money is the company making and how much is it likely to make in the future?
Earnings are profits. They can be complicated to calculate, but that's what buying a company is all about. Increasing earnings generally leads to a higher stock price and, in some cases, a regular dividend.
When earnings fall short, the market can hammer the stock. Companies report earnings every quarter, and analysts follow major companies closely. They sound the alarm when and if those companies fall short of projected earnings.
Fundamental Analysis Tools
Although earnings are important, they can't really tell you anything by themselves. They don't identify how the market values the stock on their own. You'll also need some fundamental analysis tools to begin building a picture of how the stock is valued.
These ratios aren't difficult to calculate and, in fact, you can find most of them already completed for you on websites like CNN Money or MSN MoneyCentral. But if you want to wade in yourself, keep in mind that some of the most popular tools of fundamental analysis focus on earnings, growth, and value in the market. These are some of the factors you'll want to identify and include:
- Earnings per Share (EPS): How much of a company's profit is assigned to each share of stock? Earnings per share is calculated as net income fewer dividends on preferred stock divided by the number of outstanding shares.
- Price to Earnings Ratio (P/E): This ratio compares the current sales price of a company's stock to its per-share earnings.
- Projected Earnings Growth (PEG): PEG anticipates the one-year earnings growth rate of the stock.
- Price to Sales Ratio (P/S): The price to sales ratio values a company's stock price as compared to its revenues. It's also sometimes called the PSR, revenue multiple, or sales multiple.
- Price to Book Ratio (P/B): This ratio, also known as the price to equity ratio, compares a stock's book value to its market value. You can arrive at it by dividing the stock's most recent closing price by last quarter's book value per share. Book value is the value of an asset as it appears in the company's books. It's equal to the cost of each asset less cumulative depreciation.
- Dividend Payout Ratio: This compares dividends paid out to the stockholders to the company's total net income. It accounts for retained earnings, income that is not paid out but rather retained for potential growth.
- Dividend Yield: This, too, is a ratio: yearly dividends compared to share price. It's expressed as a percentage. Divide dividends paid in a one-year period per share by the value of a share.
- Return on Equity: Divide the company's net income by shareholders' equity to find its return on equity. You might also hear this expressed as the company's return on net worth.
There Are No Magic Bullets
Remember, these numbers are tools and no single ratio or number is a magic bullet. They can't give you buy or sell recommendations by themselves. They must be weighed in tandem with other considerations and ratios.
As you begin to develop a picture of what you want in a stock, these numbers should become benchmarks to measure the worth of potential investments.