An Introduction to Fundamental Analysis

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An Introduction to Fundamental Analysis

• Jason OBryan
• 19 September 2006

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What is Fundamental Analysis?

• A method of valuing a security by measuring its
  intrinsic value.
• Economic Factors
• Financial Statements
• Industry Conditions
• Quantitative and Qualitative Factors
• Quantitative
• Analyzes key ratios.
• Provides concrete data for analysis.
• Qualitative
• Analyzes intangible data.
• Patents, management, talented workers, etc.
• Difficult to measure numerically.

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Why use fundamental analysis?

• The goal is to produce a value that investors can
  compare with the current price.
• If it is undervalued you should buy sell if it
  is overvalued.
• One of the most famous users of fundamental
  analysis, Warren Buffett, has successfully used
  this method to turn himself into a billionaire.

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Ratios

• Quick Ratio
• Debt to Equity
• EPS
• Revenues
• P/E
• Beta

• Current Ratio
• ROE
• ROA
• PEG
• Alpha
• Net Profit Margin

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Revenues

• Money that a company collects from customers for
  the sale of a product or service. When you
  subtract out all costs from revenues, you get
  profits or earnings.

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Market Capitalization

• The total dollar value of all outstanding shares,
  calculated by multiplying the price of a single
  share by the total number of shares outstanding.
• Mega Cap Market cap of 200 billion and greater
• Big/Large Cap 10-200 billion
• Mid Cap 2 billion to 10 billion
• Small Cap 300 million to 2 billion
• Micro Cap 50 million to 300 million
• Nano Cap Under 50 million

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Net Profit Margin

• Net income as a percentage of sales. You get this
  by dividing net income by sales. Since it's a
  percentage, it tells you how many cents on each
  dollar of sales is pure profit.
• The higher a companys profit margin compared to
  its competitors, the better.

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Earnings Per Share (EPS)

• A very important fundamental, calculated
• Basically, this will tell you if and how
  profitable the company is.
• Whats preferred stock?
• A class of ownership in a corporation with a
  stated dividend that must be paid before
  dividends to common stock holders.

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Price/Earnings Ratio (P/E)

• One of the favorite ratios, it is simply
• EPS from the last four quarters is called
  trailing P/E
• EPS taken from the estimates of earnings expected
  in the next four quarters is called forward P/E
• P/E is referred to as the "multiple," because it
  shows how much investors are willing to pay per
  dollar of earnings.
• High P/E means high projected earnings in the
  future.
• It's usually only useful to compare the P/E
  ratios of companies in the same industry, or to
  the market in general, or against the company's
  own historical P/E

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Price-to-Sales

• Price to sales is calculated by dividing a
  stock's current price by its revenue per share.
• The price-to-sales ratio can vary substantially
  across industries therefore, it's useful mainly
  when comparing similar companies. Also, it does
  not account for DEBT!

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Price-to-Book

• Price to book is calculated by dividing the
  current closing price of the stock by the latest
  quarter's book value (book value is simply total
  assets minus intangible assets and liabilities).
• A low P/B ratio could mean the stock is
  undervalued, or something is very wrong with the
  company.

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Debt-to-Equity

• A relative measure of how much debt a company
  has
• Essentially long-term funds provided by
  creditors divided by funds provided by
  shareholders.
• A higher debt/equity ratio generally means that a
  company has been aggressive in financing its
  growth with debt. This can result in volatile
  earnings.

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Current Ratio

• A good measure of liquidity of a company, or how
  easily it can cough up cash.
• AKA - Indicator of company's ability to pay
  short-term obligations calculated by dividing
  current assets by current liabilities.
• The higher the ratio, the more liquid the
  company!
• What types of companies might this ratio be VERY
  important?

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Quick Ratio

• Like current ratio, this gives a measure of a
  companys financial strength
• It is a measure of how quickly a company's assets
  can be turned in cash.
• You subtract inventories so you can check and see
  if a company has sufficient liquid assets to meet
  short-term operating needs. (Note that current
  ratio did not subtract inventories.)

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Return on Assets (ROA)

• Also sometimes called Return on Investment or
  ROI, this is a measure what earnings were
  generated from capital investment back into the
  company.
• Always given as a percentage
• Think of it as How much money (income) was
  generated from a companys investment into itself
  (capital investment or company assets)?

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Return on Equity (ROE)

• It is a measure of how much in earnings a company
  generates in four quarters compared to its
  shareholders' equity and is a good measure of
  profitability.
• It is also measured as a percentage.
• For instance, if XYZ Corp. made 1 million in the
  past year and has shareholders' equity of 10
  million, then the ROE is 10. Some use ROE as a
  screen to find companies that can generate large
  profits with little shareholder investment in the
  company.

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Beta (ß)

• A measure of a security's or portfolio's
  volatility, or systematic risk, in comparison to
  the market as a whole. (usually calculated with
  SP 500 Index)
• Think of beta as the tendency of a security's
  returns to respond to swings in the market. A
  beta of 1 indicates that the security's price
  will move EXACTLY with the market. A beta less
  than 1 means that the security will be LESS
  volatile than the market. A beta greater than 1
  indicates that the security's price will be MORE
  volatile than the market.

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Price/Earnings to Growth (PEG)

• It is
• Can give you an idea of a stock potential growth,
  since it divides by Earnings Per Share (EPS)
  annual growth rate but is based on analysts
  ESTIMATES!
• If a company has a P/E of 20 and analysts expect
  its earnings will grow 15 annually over the next
  few years, you'd say it has a PEG of 1.33.
  Anything above 1 is suspect since that means the
  company is trading at a premium to its growth
  rate.

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Others

• There are many other ratios out there to help you
  get an idea of what the financial health of a
  company is.
• What do you do if you dont know what they mean?

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Examplevs.
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Industry Comparison
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Which is better?

• Compare significant ratios and statistics.
• Read current news and annual reports to see what
  their plans are in the future.
• Look for historical growth and continued
  opportunity for growth.

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Questions?