What is Fundamental Analysis of Stocks?
The Fundamental Analysis is a technique through which the real value of the company’s stocks (whether overvalued, undervalued, or correctly valued) is determined by assessing the factors that affects the company’s business model and its future prospects. The fundamental analyst uses several valuation models such as dividend models (focus on expected dividends), earnings models (focus on expected earnings) and assets models (focus on the company’s assets) to forecast the future value of the company’s stocks.
Factors assessed in Fundamental Analysis
- Net profit margin: The Net profit margin is also known as a profitability ratio of a company which indicates that how much profit a company is able to squeeze out of each dollar of sales. It is calculated by dividing the net income by total sales. The company having net profit margin 25% means $0.25 of every $1.00 in sales is realized in the profits.
- P/E Ratio: The P/E Ratio is also known as Price/Earnings Ratio which indicates that how much an investor must pay to buy $1 of the company’s earnings. It is calculated by dividing the current stock prices by the previous four quarter’s earnings per share. If current stock price is $10 and last four quarter’s earnings is $2 then the P/E Ratio is $5 (i.e.10/2=5).
- Book Value per Share: The Book Value per Share is a price ratio which indicates whether a stock is overpriced or underpriced. It is calculated by dividing total new assets (i.e. total assets except liabilities) by total shares outstanding.
- Current Ratio: The Current Ratio is also known as the liquidity ratio of a company which is used to measure the company’s ability to meet current debt obligations. Current Ratio is calculated by dividing current assets by current liabilities. A company’s current ratio of 4.0 indicates that the company’s current asset (if liquidated) is sufficient to pay for four times the company’s current liabilities.
- Debt ratio: The Debt ratio is also known as the leverage ratio of a company which is used to measure to what extent the total assets of the company is financed with debt. It is calculated by dividing the total liabilities by the total assets. A company’s debt ratio of 30% means 30% of the company’s assets have been financed with borrowed capital.
- Inventory turnover: An Inventory turnover is also known as an efficiency ratio which indicates how effectively the company manages its inventories. It is calculated by dividing the cost of goods sold by inventories.