How to analyze the company before investing
= What is Fundamental
Analysis
= Invest in Good Company
= Earnings
= Current Valuations of the Shares
= Future Earnings Growth
= Debit status of the Company
= What is Fundamental
analysis?
Fundamental analysis is basically done for long term and mid term investment
which is also called as delivery based investment or trading.
The main important aim behind is to study and understand the company in which
you are planning to invest your hard earned money and get excellent returns.
How to analyze the fundamentals of the company?
Basically one should be able to judge at least how the company has done in
past years, its debit status, its current valuation, its future growth
prospects, its earning capacity etc
So that based on these terms he can at least decide whether to invest in this
company or not.
= What you should look for in
a company to invest?
1. About Company -
What the company is doing and what are its businesses?
How is the current demand for their products and how the demand will be in
future like in next 3 to 5 years and so? (It is difficult to analyze the future
demand yourself so you can visit financial websites or contact us)
2. Earnings -
This is very important parameter. Broadly look into its last 5 or 10 years
earnings whether the company has posted profits or losses.
It’s all about earnings. The bottom line is investors want to know how much
money the company is making and how much it is going to make in the future.
To find the earning status ratios used are EPS
- Earning per share
3. Current valuation -
This is another very important factor which most of the investor forgets while
doing their investments.
Generally most of the investors invest at higher valuations of shares and when
share prices start coming down then they keep worrying, so this should not
happen.
Before investing one should check the current valuation of the share price and
invest only when the share price is at right price and not at over priced share.
This is what happened in January 2008. Most of the people invested at very high
valuations and later on the share prices started to correct (falling down).
To find the current valuation of the stock the ratios used are
PE ratio - Price to earning ratio
Book value
PB ratio - Price to book value ratio
4. Future earnings growth -
It is very important to analyze how the company is going to do in future. How
will be its returns or its profits etc?
Basically most of the investors invest in shares taking into consideration
Company’s future growth prospects.
To find the future growth of the stock the ratios used are
PEG ratio - Price to earning growth ratio
Current EPS and Forward EPS
Price to sales ratio
5. Debit status -
For any company to perform well in the future it is very important to be debt
free or less debit because if company is having large debits like borrowings,
loans then it becomes difficult for it to plan for any acquisitions, expansion
plans take over plans, dividend payout and very important its most of the net
profit goes in paying the interest and loans and other debits.
So in other words if the company is having fewer debits or no debit then they
are having lots of cash in hand and they are free to take any decision in coming
future.
To find the debit status of the company the ratios used are
Debit ratio
So to accomplish above parameters fundamental analyst follow certain ratios
which are mentioned below.
= Earnings
Earning Per Share - EPS
EPS plays major
role in investment decision.
EPS is calculated by taking the net earnings of the company and dividing it by
the outstanding shares.
EPS = Net Earnings / Outstanding Shares
(Nowadays you will get this ready made, no need for you to do calculation.)
For example -
If Company A had earnings of RS 1000 crores and 100 shares outstanding, then its
EPS becomes 10 (RS 1000 / 100 = 10).
Second example -
If Company B had earnings of RS 1000 crores and 500 shares outstanding, then its
EPS becomes 2 (RS 1000 / 500 = 50).
So what is that you have to look in EPS of the company?
Answer - You should look for high EPS stocks and the higher the better is the
stock.
Note - You should compare the EPS from one company to another, which are in the
same industry/sector and not from
one company from Auto sector and another company from IT sector.
Before we move on, you should note that there are three types of EPS numbers:
Trailing EPS - Trailing EPS
means last year’s EPS which is considered as actual and for ongoing current
year.
Current EPS - Current EPS means
which is still under projections and going to come on financial year end.
Forward EPS - Forward EPS which
is again under projections and going to come on next financial year end
But the EPS alone doesn’t tell you the whole story of the company so for this
information, we need to look at some more ratios as following.
It’s not advisable to make your investment decisions based on only single ratio
analysis.
EPS is the base for calculating PE ratio.
Importance of Earnings -
Earnings are profits. Quarterly or yearly company’s increasing earnings
generally makes its stock price move up and in some cases some companies pay out
a regular dividend. This is Bullish sign and indicates that the company’s is in
growth.
When the company declares low earnings then the market may see bearishness in
the stock price and hence its share price starts deceasing and corrects further
if the company doesn’t provide any sufficient justification for low earnings.
Every quarter, companies report its earnings. There are 4 quarters.
Quarter 1 - (April to June and earnings will be declared in July)
Quarter 2 - (July to Sept and earnings will be declared in Oct)
Quarter 3 - (Oct to Dec and earnings will be declared in Jan)
Quarter 4/final - Also called as financial year end - (Jan to Mar and earnings
will be declared in April)
Now by this time you would have understood how earnings are important for a
stock price to move up or down. But depending only on earnings one should not
make investment or trading decision. To make decision more risk free you should
look into more tools as mentioned below so that your investment decision becomes
more solid and you should get excellent returns in future.
Conclusion - Keep a close
watch on quarterly earnings and trade or invest accordingly or manipulate your
investing.
Following are the most popular and important tools/ratios to find excellent
growth stocks which focuses on earning, growth, and value of the company’s.
To make you understand more easily we have explained in very simple steps.
= Current Valuations of the
shares
Price to Earnings Ratio - PE ratio
PE ratio is again
one of the most important ratio on which most of the traders and investors keep
watch.
Important - The PE ratio tells you whether the stock’s price is high or low
compared to its forward earnings.
The high P/E suggests that investors are expecting higher earnings growth in the
future compared to companies with a lower P/E. This generally happen in bull
market and share price keeps on increasing. Basically in bull market share
prices keep increasing without giving more importance to its current valuation
and once market realizes that it is over priced then they start selling.
In bear market the low PE stocks having high growth prospects are selected as
best investment options.
But, the P/E ratio doesn't tell us the whole story of the company.
Generally the P/E ratios are compared of one company to other companies in the
same sector/industry and not in other industry before selecting any particular
share.
The PE ratio is calculated by taking the share price and dividing it by the
companies EPS.
That is
PE = Stock Price / EPS
For example
A company with a share price of RS 40 and an EPS of 8 would have a PE ratio of 5
(RS 40 / 8 = 5).
Importance - The PE ratio gives you an idea of what the market is willing to pay
for the companies earning.
The higher the P/E the more the market is willing to pay for the companies
earning.
Some investors say that a high P/E ratio means the stock is over priced on the
other side it also indicates the market has high hopes for such company’s future
growth and due to which market is ready to pay high price.
On the other side, a low P/E of high growth stocks may indicate that the market
has ignored these stocks which are also known as value stocks. Many investors
try finding low P/E ratios stocks of high value growth companies and make
investments in such stocks which may prove real diamonds in future.
Which P/E ratio
to choose?
If you believe that
the companies has good long term prospects and good growth then one should not
hesitate to invest in high P/E ratio stocks and if you are looking for value
stocks which prove real diamonds in future then you can go with low PE stocks
provided that companies has good growth and expansions plans.
At all if you would like to do PE ratio comparison then it has to be done in
same sectors/industry stocks and not like one stock from banking sector and
other stock from pharmacy sector.
So now you would have come to know how to choose stocks based on PE ratio.
What is book
value?
Book value is
the total value of the company's assets that shareholders would theoretically
receive if a company were liquidated (closed).
By being compared to the company's market value, the book value can indicate
whether a stock is under priced or overpriced.
So in other words if the share price is trading below its book value then it
is considered as under priced and good for value investing.
Price to Book Ratio - PB ratio
Basically PB ratio is mostly utilized by smart investors to find real
wealth in shares, so investing in stocks having low PB ratio is to identify
potential shares for future growth.
A lower P/B ratio could mean that the stock is undervalued.
Like the PE, the lower the PB, the better the value of the stock for future
growth.
Some of the investors become quite wealthy by holding stocks for the long term
of such companies whose growth is based on their businesses instead of market
and one day when every one notices this stock the value investor’s pockets are
full of profit.
PB ratio is calculated as
PB ratio = Share Price / Book Value per Share.
Generally, if the ratio comes below 1 then it is considered as value
investing. But this doesn’t mean that the ratio coming to 1.2 or 1.5 is not
value investing. It also depends on its future growth prospects.
=
Future earnings growth
Projected Earning Growth ratio - PEG ratio
Because the market
is usually more concerned about the future than the present, it is always
looking for companies projected plans, financial ratios, and other future
announcements.
The use of PEG ratio will help you look at future earnings growth of the
company.
PEG is a widely used indicator of a stock's potential value.
Similar to the P/E ratio, a lower PEG means that the stock is more undervalued.
To calculate the PEG the P/E is divided by the projected growth in earnings.
That is PEG = P/E / (projected growth in earnings)
For example -
A stock with a P/E of 30 and projected earning growth for next year is 15% then
that stock would have a PEG of 2 (30
/ 15 = 2).
In above example what does the “2” mean?
Lower the PEG ratio the less you pay for each unit in future earning growth. So
the conclusion is you can invest in high P/E stocks but the projected earning
growth should be high so that companies can provide good returns.
Looking at the opposite situation; a low P/E stock with low or no projected
earnings growth is not going to give you good returns in future because its PE
is low means investors are not ready to pay high and its PEG is also low because
companies do not have any good future growth or expansion plans so investment in
such stocks could prove less or no returns.
A few important things to remember about PEG:
It is about year-to-year earnings growth.
It relies on projections, which may not always be accurate.
It’s forward earning estimation which market analyst or company calculates.
Following two ratios are again the projection or estimation done by either
market analyst or by company resources.
Current EPS - Current EPS means
which is still under projections and going to come on financial year end.
Forward EPS - Forward EPS which
is again under projections and going to come on next financial year end.
Price to Sales Ratio
The question is, is
it that companies having no current earnings are bad investments?
Answer is Not necessarily, because such companies may be new and trying to grow
and expand but you should approach such companies with precaution.
The Price to Sales (P/S) ratio looks at the current stock price relative to the
total sales per share.
You can calculate the P/S by dividing the market cap of the company by the total
revenues of the company.
You can also calculate the P/S by dividing the current stock price by the sales
per share.
That is
P/S = Market Cap / Revenues
or
P/S = Stock Price / Sales Price per Share
Conclusion - To find under
valued stocks you can look for low P/S ratios.
The lower the P/S ratio the better is the value of the company.
= Debit status of the Company
Debit Ratio
This is one the very important ratio as this tells you how much company relies
on debit to finance its assets.
The higher the ratio the more risk for company to manage going forward. So look
for company’s having low debit ratio.
Generally it is considered that debit ratio less then 1is good investment
option. But even some investor considers higher debit ratio provided the company
is having good growth prospects.
If company has fewer debits then company can make more profit instead paying for
its debits like interests rates, loans etc.
Dividend Yield
If you are a value investor or looking for dividend income then you should
look for Dividend Yield figure of the stock.
This measurement tells you what percentage return a companies pays out to
shareholders in the form of dividends. Older, well-established companies tend to
payout a higher percentage then do younger companies and their dividend history
can be more consistent.
You calculate the Dividend Yield by taking the annual dividend per share and
divide by the stock’s price.
That is
Dividend Yield = annual dividend per share / stock's price per share
For example
If a company’s annual dividend is RS 1.50 and the stock trades at RS 25, the
Dividend Yield is 6%. (RS 1.50 / RS 25 = 0.06).
Important Note -
Any single tool or ratio should not be used to make your investment or trading
decision nor will they provide you any buy or sell recommendation. All tools
should be used to find growth and value stocks.
After making use of above all tools you will get excellent stocks which will
give you excellent returns in mid term to long term.
You will find all these ratios in any financial website or you can contact us.
Final and last - very important
Check out company’s PAT (profit after tax) of every quarterly if you are short
term to mid term trader and if you are long term investor then check out its
yearly PAT. The company should have posted consistent growth.
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