How to do Fundamental Analysis of Stocks?

Introduction and how to perform Fundamental Analysis of Stocks

 

Fundamental Analysis of Stocks

Fundamental Analysis of Stocks is a method which is employed to determine the value of a stock. In the fundamental analysis, the industry to which the stock is related is analyzed. Analyzing the financial statements of the corporation is the way to do. This approach usually looks at the overall health of the economy in which that industry is operating. In the fundamental analysis of stocks, there are again two approaches used to analyze the industry under study. One approach is zoomed in or top down analysis and the other is known as zoom out or bottom-up analysis. This analysis should not be mixed with technical analysis or quantitative analysis.

Fundamental Analysis of stocks is based on the assumption that markets do not reflect all the available information on the stock prices of different companies. For that matter, there must be corrected seen in each of these stocks after some time and whosoever positions himself in time would get benefit from that correction. Top down or zoom in approach mainly focuses first on the national or international economies health. Then they relate economic performance with that of the industry and then they go to the specifics of the firm under consideration. For the bottom-up method, the approach is totally inverse to that of the top-down approach. In this method, the analyst starts from the firm (no matter how small is the size of the firm) and goes up to study the industry and the economic factors that are affecting the firms’ performance.

Before doing actual investment one must study following things.

Equity – Initially an amount of capital is invested or used to start the company to run its operations by issuing shares or the equally divided parts as per the amount of investment.

Holding pattern – Every Company has some shareholding pattern.

a. Promoter’s holdings.
b. Domestic financial institutions like UTI, LIC, GIC, Banks etc.
c. Foreign Financial Institutions (FII).
d. Individual big shareholders.
e. Trusts.
f. The public in general.

 

Face Value
It can be 100 or 50 or 10 or 5 or 2 or 1.

E.P.S (Earning Per Share)
It is the net profit calculated on trailing twelve-month basis. Aggregate net profit for four consecutive quarters divided by fully diluted equity capital. E.g. If the company has issued 2 Crore shares and if net profit is Rs. 4 crores. The E.P.S becomes Rs 2/- per share.

P. E. Ratio (Price to Earnings)

Price to earning ratio: P.E is calculated by dividing the day’s closing price of a share by its EPS – Earning per share. The whole industry P/E is aggregate market capitalization of total industry divided by the aggregate net profit of the last four quarters after excluding loss-making companies. E.x..x.. If the price of the share is Rs 20 and EPS is Rs 4 then the PE ratio becomes Rs. 5.

Using Financial Ratios

• Current Ratio – customary investigation recommends 2 or more prominent, however, a high number may mirror a powerlessness to lessen stock.prominent however a high number may mirror a powerlessness to lessen stock.

• Operating Cash Flow = EBITDA.

• Tobin’s Q is a proportion of the estimation of the firm to substitution cost and some think it’s a superior measure than Book Value.to substitution cost and some think it a superior measure than Book Value.

Products ought to be utilized alongside their buddy variable:

  • PE with Earnings Growth;
  • PBV with ROE;
  • Price Sales Ratio with Net Margin;
  • EV/Sales with Operating Margin.

Each multiple should be compared with the average for the sector. If the difference cannot be explained by the fundamentals, then the firm can be classed as undervalued.

Firms in the same sector are presumed to have similar risk, growth, and cash flow profiles.

  • Price Earnings/EPS Growth rate = Growth Adjusted Price Earnings Ratio;
  • Price Sales Ratio/Net Margin = Margin adjusted Price Sales Ratio.
  • Price to Books Value/ROE = Value Ratio;

Comparing with firms outside the sector can be done as follows:

  • Price Earnings = Actual + EPS Growth + Payout Ratio (cash flow) + Risk (Beta);
  • Price Sales Ratio= Actual + EPS Growth + Payout Ratio (cash flow) + Risk (Beta) + Net Margin.
  • Price to Book Value = Actual + EPS Growth + Payout Ratio (cash flow) + Risk (Beta) + ROE;

A Few more points for finding Best stocks to buy.

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