In our last piece, we addressed what fundamental analysis is. We know it is a system of analysis where traders evaluate the intrinsic value of an asset, but also takes into account peoples’ attitudes. As is, it is quite a speculative type of analysis. However, we did not get to go through any more details in terms of how this analysis works. This type of analysis has a whole slew of factors, and it takes a while for one to get their head around it all. Therefore, here, we plan to introduce prospective traders to all the elements in fundamental analysis one must keep an eye on.
Understanding a business with fundamental analysis
When you want to understand what the possible future price of a stock will be, you better first understand the business underlying it. Once you understand how well a business function, you can know where its price will likely go. The benefit of a higher price for a stock is twofold. For one, an investor can sell a stock for a higher price later on. Two, a trader can receive higher dividends with better performance. So, what kind of information can you know about a company to better understand its stock? What is the fundamental analysis that needs to be done?
One needs to know how well a business is performing, profits wise. They need to also know about the quality of the product they sell as well as how reliable their business model is. Then traders can make up their minds about what they think the value of a stock will be and behave accordingly.
For a quick understanding of how a company is doing profit-wise, it is best to look at their financial statements. These are the facts and figures that every company releases themselves, some by law.
An income statement informs traders of how well a company is currently doing is the first piece of information one should consider. Usually, companies release these reports on quarterly and annual bases. This tells traders on the current financial performance of a company. This is their total earnings, losses, and overall profits.
This includes several pieces of information. Income, production cost, expenses, gross profit, tax, and net income or loss are included in such articles.
This tells several important figures to the interested parties. It shows the total assets of a company. This is a combination of two factors. The liabilities of a company, what is owed. Another essential piece of information is the shareholders’ equity. This is the total investment a company receives from investors, along with any earnings they made. This then makes up the assets, all that said the company owes.
Cash flow statement
The next piece of information for fundamental analysis is the cash flow statement. This gets more specific with certain details, about how a company spends and receives money. This, for example, could be information on operations, financing, and investing, and the purpose of every transaction.
Supplementary information for fundamental analysis
This type of information we have told you about now strictly revolves around finances. This can help fundamental analysis in different ways. There are other areas you can look into to update yourself as well. The information certainly does not lack for information. This could be blog posts, news articles, and press releases you can find, etc. Another alternative is looking on forums online. This could directly inform any traders on real-time public opinion on a stock.
However, how exactly does company performance relate to your stocks? How can you tell how much profit a stock will give you according to the financial statements we just spoke of? There are, in fact, a few very informative figures you can look at.
Earnings per share (EPS)
This is a simple calculation. It is the profits a company has made over a certain period of time over the total number of shares. Thus, it calculates how efficiently a company makes profits for its investors.
This is the growth in a company’s earnings relative to its final earnings. Most investors want to see companies progressively earning more and more over time. This increases the worth of their shares as well. Of course, it is not the end of the world if there has been no growth, but it is usually not too beneficial either.
Price-to-earnings growth ratio (PEG)
The PEG is another simple ratio. It compares the price to earnings ratio of a company with its growth rate. Any stock over 1 according to this ratio is quite