Stepping before checking for landmines and investing in a stock without fundamental stock analysis is the same thing.
Essentially, it is how you determine if a stock will go up or down. But let’s face it, many investors are still unaware of how it works, despite the fact that it is the backbone of long-term investing.
Which is why we have decided to make things simple. We have decided that we’ll tell you some core metrics that would allow you to execute the fundamental stock analysis flawlessly.
Building Blocks of a Company’s Financial Health
But before you start investing, let’s take a look at the building blocks of a company’s financial health. To put it simply, what metrics decide the financial condition of a company?
The three main financial statements that make up the basis of financial reporting are:
- Income statement: shows how well the company did financially over a certain period of time. It lists the money that came in, the money that went out, and the net income or loss that came from it.
- Balance Sheet: This report shows how the company is doing financially at a certain point in time. It lists the company’s assets, debts, and the value of the shareholders’ stock.
- Cash Flow Statement: This statement shows how much money the company brought in and spent over a certain period of time. It helps you figure out how much money the company has on hand and how much it can get in cash flow.
5 Metrics Every Stock Investor Should Know
Now, if you’re a stock investor, these are the 5 fundamental stock analysis metrics you need to be aware of. These metrics determine whether the stock is worth investing in or not.
1. Price to Earnings (P/E) Ratio
A P/E ratio is the ratio of the current price of a share to the company’s earnings per share. You can use this ratio to see if the market thinks the company is worth more or less than it is.
Let’s imagine that a business makes ? 1000 in total. It also contains 100 shares that people can buy and sell.
So, it makes ? 10 for every share it sells.
Let’s also imagine that the company’s shares are selling for ? 100 each. So, we have
P/E Ratio = 100 divided by 10, which is 10.
This means that you are paying ? 10 to gain ? 1 from the company’s profits. So, it’s easy to see that a company is overvalued if its P/E ratio is larger.
2. Return on Equity (RoE) Ratio
The RoE Ratio is a way to figure out how much money a company’s stock is making. In other words, it shows investors how well the company can make money from stock investments.
In maths,
RoE = Net Income / Total Shareholders’ Equity
This ratio is crucial because it illustrates how well the company can make money from equity investments.
Let’s imagine you are the promoter of a company and you put in ? 100 in equity. The company’s entire equity is ? 100.
If the company makes ? 20 with this equity, the RoE is 20%. If another company has the same amount of stock but makes ? 40, its RoE will be 40%. People think that the company with the higher RoE is superior, which is mostly the case.
3. Price-to-Book (P/B) Ratio
The price-to-book ratio is a simple way to compare a company’s market value (market capitalisation) to its book value. It looks at the company’s stock price and book value per share.
4. Dividend Yield or the Dividend-Price ratio
The dividend yield, also known as the dividend-price ratio, is the amount of money or dividend that a firm pays its shareholders in a year divided by the current price of its stock. It shows you what kind of profits you may expect on your investment.
5. Debt-to-Equity (D/E) Ratio
The name of this ratio tells you what it is: it shows you the company’s debts and equity. To get this number, you divide the company’s entire liabilities (debts) by its total shareholder equity.
It can show you how much of the company’s money comes from loans and how much comes from its own funds.
The D/E ratio isn’t always the same; it might change depending on the industry or area.
Most of the time, people think that a firm with a lot of debt will have a hard time paying it back.
Also, because debt accrues interest, it will have a direct effect on the company’s profit and loss statement and lower its net income, which will cause the cash flow to plummet.
Conclusion
The above-discussed ratios might provide you with a quick look at a firm’s finances, but you should also do a full fundamental stock analysis of the organisation. It is also vital to keep in mind that these ratios change throughout time.
