There are 9 terms to know in fundamental analysis. Whether you are into fundamental analysis or technical analysis, stock analysis involves evaluating stocks to make informed investment decisions. Fundamental analysis focuses on a company’s financial health and intrinsic value. As such, fundamental analysts search for stocks that are currently trading at prices that are higher or lower than their real value.
Do you know what is intrinsic value? Intrinsic value is the actual value of a company, or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as its current market value. Intrinsic value is a key concept in value investing and is used to determine whether a particular asset is overvalued or undervalued.
There are various methods to calculate intrinsic value, such as discounted cash flow analysis, earnings multiples, and asset-based valuation. Investors who follow the value investing approach seek to buy assets that are trading below their intrinsic value, with the expectation that the market will eventually recognize the true worth of the asset and drive up its price.
I am not an expert in the above analysis. However, as an investor, below are 9 terms to know in fundamental analysis:
1. Earnings Per Share (EPS)
Earnings Per Share (EPS) is a financial metric used to measure a company’s profitability. It is calculated by dividing a company’s net income by the number of outstanding shares of its common stock.
This metric is important for investors as it indicates how much of a company’s profit is allocated to each outstanding share of stock. A higher EPS is generally seen as a positive sign for a company’s financial performance, as it suggests that it is able to generate more profit per share.
Investors often use EPS to compare the profitability of different companies within the same industry, or to track a company’s performance over time.
2. Price-to-Earnings Ratio (P/E Ratio)
The Price-to-Earnings Ratio, often referred to as the P/E ratio, is a financial metric used to evaluate a company’s current share price relative to its earnings per share (EPS). It is calculated by dividing the market price per share by the earnings per share.
The P/E ratio provides investors with a quick way to gauge whether a stock is overvalued or undervalued based on its earnings potential. A high P/E ratio may indicate that investors are expecting high future growth, while a low P/E ratio may suggest that the stock is undervalued.
However, it’s important to consider other factors and not rely solely on the P/E ratio when making investment decisions.
3. Price-to-Book Ratio (P/B Ratio)
The Price-to-Book Ratio is a financial metric used to compare a company’s market value to its book value. It is calculated by dividing the current market price per share by the book value per share.
A P/B ratio below 1 indicates that the stock may be undervalued, while a ratio above 1 suggests that it may be overvalued. Investors use the P/B ratio to assess whether a stock is trading at a reasonable price relative to its intrinsic value.
It can be a useful tool for evaluating investment opportunities and making informed decisions in the stock market.
4. Dividend Yield
Dividend Yield is a financial ratio that indicates the percentage of a company’s annual dividend payments relative to its stock price. It is calculated by dividing the annual dividend per share by the stock price per share.
A high dividend yield may indicate that a company is returning a significant portion of its profits to shareholders, making it attractive to income-seeking investors. However, a very high dividend yield could also signal that the company’s stock price has fallen significantly, possibly due to financial difficulties.
Investors often consider both the dividend yield and the company’s overall financial health when making investment decisions.
I use Stocks Café Stock Screener to screen for a list of REITs with high dividend yield.
5. Return on Equity (ROE)
Return on Equity is a financial ratio that measures a company’s profitability by showing how much profit a company generates with the money shareholders have invested. It is calculated by dividing net income by average shareholder equity.
A high ROE indicates that a company is utilizing its shareholders’ funds efficiently to generate profits, while a low ROE may suggest that the company is not effectively using its equity to generate returns.
ROE is a key metric for investors to assess a company’s financial performance and compare it with industry peers.
6. Debt-to-Equity Ratio (D/E)
The debt-to-equity ratio is a financial metric that indicates the proportion of a company’s debt relative to its shareholders’ equity. It is calculated by dividing total liabilities by total shareholders’ equity.
A high debt-to-equity ratio suggests that a company is using more debt to finance its operations, which can be risky as it may indicate financial distress. Conversely, a low debt-to-equity ratio indicates a conservative financing strategy.
Investors use this ratio to assess a company’s financial health and risk profile before making investment decisions.
7. Revenue Growth
Revenue growth is a crucial metric for businesses to measure their success and financial health. It represents the increase in a company’s top-line income over a certain period of time.
A consistent and healthy revenue growth indicates that the company is generating more money from its core business operations. This increase in revenue can be achieved through various strategies such as acquiring new customers, expanding into new markets, introducing new products or services, and improving existing offerings.
Companies with strong revenue growth are more likely to attract investors, improve their market position, and reinvest in their business for future growth.
8. Free Cash Flow (FCF)
Free Cash Flow is a measure used by investors and analysts to evaluate a company’s financial performance. It represents the cash that a company has left over after accounting for all capital expenditures needed to maintain or expand its asset base.
FCF is considered a more reliable indicator of a company’s financial health compared to just looking at net income, as it shows how much cash the company actually generates. A positive FCF indicates that the company has enough cash to invest in growth opportunities, pay dividends, reduce debt, or make other strategic investments.
9. Market Capitalization
Market capitalization refers to the total value of a company’s outstanding shares of stock. It is calculated by multiplying the current market price of a single share by the total number of outstanding shares.
Market capitalization is used by investors to determine the size of a company and is often used as an indicator of a company’s worth in the stock market. Companies with a higher market capitalization are typically viewed as more stable and less risky investments, while companies with lower market capitalization are seen as more volatile.
Overall, market capitalization is an important metric that helps investors gauge the value and performance of a company in the stock market.