Fundamental Analysis Tools
Although the raw data of the Financial
Statement has some useful information, much more can be understood about
the value of a stock by applying a variety of tools to the financial
data.
Earnings per Share
The overall earnings of a company is not in itself a useful indicator
of a stock's worth. Low earnings coupled with low outstanding shares
can be more valuable than high earnings with a high number of outstanding
shares. Earnings per share is much more useful information than earnings
by itself. Earnings per share (EPS) is calculated by dividing the net
earnings by the number of outstanding shares. For example: ABC company
had net earnings of $1 million and 100,000 outstanding shares for an
EPS of 10 (1,000,000 / 100,000 = 10). This information is useful for
comparing two companies in a certain industry but should not be the
deciding factor when choosing stocks.
Price to Earning Ratio
The Price to Earning Ratio (P/E) shows the relationship between stock
price and company earnings. It is calculated by dividing the share price
by the Earnings per Share. In our example above of ABC company the EPS
is 10 so if it has a price per share of $50 the P/E is 5 (50 / 10 =
5). The P/E tells you how much investors are willing to pay for that
particular company's earnings. P/E's can be read in a variety of ways.
A high P/E could mean that the company is overpriced or it could mean
that investors expect the company to continue to grow and generate profits.
A low P/E could mean that investors are wary of the company or it could
indicate a company that most investors have overlooked.
Either way, further analysis is needed to determine
the true value of a particular stock.
Price to Sales Ratio
When a company has no earnings, there are other tools available to help
investors judge its worth. New companies in particular often have no
earnings, but that does not mean they are bad investments. The Price
to Sales ratio (P/S) is a useful tool for judging new companies. It
is calculated by dividing the market cap (stock price times number of
outstanding shares) by total revenues. An alternate method is to divide
current share price by sales per share. P/S indicates the value the
market places on sales. The lower the P/S the better the value.
Price to Book Ratio
Book value is determined by subtracting liabilities from assets. The
value of a growing company will always be more than book value because
of the potential for future revenue. The price to book ratio (P/B) is
the value the market places on the book value of the company. It is
calculated by dividing the current price per share by the book value
per share (book value / number of outstanding shares). Companies with
a low P/B are good value and are often sought after by long term investors
who see the potential of such companies.
Dividend Yield
Some investors are looking for stocks that can maximize dividend income.
Dividend yield is useful for determining the percentage return a company
pays in the form of dividends. It is calculated by dividing the annual
dividend per share by the stock's price per share. Usually it is the
older, well-established companies that pay a higher percentage, and
these companies also usually have a more consistent dividend history
than younger companies.
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