Stock Trading with Fundamental Analysis

Susanto Basuki
Dec 9, 2019 · 5 min read

Introduction

online trading education

Fundamental analysis is a criterion that is used in gauging the intrinsic value of a stock by analyzing all economic and financial factors that are related to the stock. This method looks at all agents that could affect the value of the stock; these agents can be broadly categorized to external economic factors and internal economic factors.

The end point of fundamental analysis is to arrive at a final figure that the stock trader can compare with the current price of the stock and gauge whether the stock is overvalued or undervalued.

Not to be confused with technical analysis as the two are complete opposites; technical analysis only looks at the historical data in the market such as volume and price to determine the price direction of a stock.

Concept of Fundamental Analysis

As stated this analysis has the goal of determining whether a stock is appropriately valued within the market sector. The analysis is first done from the external factors that affect the price of the stock then go deeper to the internal factors thus pinpoint the stocks that are not valued appropriately.

The data used entails revenues, earnings, the potential for growth, return on equity and profit margins, just to name a few, to get a full analysis of the stock. All these data can easily be gotten from the financial statements of the individual firms.

Tools applied in Fundamental analysis of the stock security

Though most investors rely on earnings for their analysis of stock, there isn’t much that they can provide by themselves. These tools will greatly assist in building a picture of the valuation of a particular stock.

These tools are not difficult to use as they can be pre-calculated for the trader in certain business websites. However, for traders who want to analyze the data on their own, these are the factors to be considered:

1. Earnings per Share (EPS)

This tool is used to describe the amount of profit is assigned to each stock of a particular company. It can be gotten using the following formula:

EPS = [net income (less dividends) on the target stock] ÷ [number of outstanding shares]

The Earnings Per Share are of use in comparing one company’s stock to another company operating in the same sector. It, however, doesn’t inform the trader whether that particular stock is a good investment to buy nor does it give an analysis on the market’s perspective.

2. Price to Earnings Ratio (P/E)

This ratio makes a comparison between the current price sales of a firm’s stock to the per-share earnings of that particular company. It utilizes the earnings per share in the below equation:

P/E = [Stock Price] ÷ [EPS]

This ratio gives the stock trader an idea of how much the market can willfully pay regarding the earnings of a particular firm.

The higher the ratio then the more the market will be willing to pay for the earnings of the company. Some investors can observe this high ratio as an overpriced stock which could be factual, but this high ratio can also entail the high hopes for the future success of the stock thus making the market bid up the stock price.

A lower ratio essentially implies that the stock market has little to no confidence in the stock. A low ratio could also imply that the market is overlooking a stock that has the potential to be a success.

3. Projected Earnings Growth (PEG)

This tool is used to estimate the yearly earnings growth rate of stock in the market. It is given by:

PEG = [Price per Earnings] ÷ [projected growth in earnings]

The lower the projected growth earnings the less the stock trader has to pay for each unit of future growth earnings. Therefore a stock having a high price to earnings ratio with a high projected earnings growth is still a good investment to the investor. But you need to trade in a reputable forex broker like AxiTrader which you can read the review here: https://mytradingtools.com/axitrader/. AxiTrader is a recommended broker as they have two major certification from the top association.

This also implies a stock incorporating low price to earnings ratio with low to no projected earnings growth will be a stock investment that will yield fewer returns.

4. Price to Sales ratio (P/S)

This tool is used to value the stock price of a company with the revenues incurred. It is also referred to as the PSR or the sales multiple/ revenue multiples. This tool shows the value placed on sales by the stock market. It can be calculated using the below expressions:

P/S = [Market capital] ÷ [company revenues]

or

P/S = [Stock price] ÷ [Sales price per share]

The lower the ratio the better the value; the inverse also applies, the higher the ratio the worse the value gotten for the stock.

5. Price to Book Ratio (P/B)

Also referred to as the price to equity ratio, compares the book value of a stock to its market valuation. The book value is an assets’ value as it is observed in the firm’s books. The book value can be calculated as the total assets less the total liabilities.

PB is given by:

P/B = [Share price] ÷ [book value per share]

The lower the ratio the better the value; the inverse also applies, the higher the ratio the worse the value gotten for the stock.

6. Dividend Payout Ratio (DPR)

This ratio is used to compare the dividends paid to the stockholders with total net income of that firm. It accounts for the retained income used for future growth. It is given by:

DPR = [Dividends per share] ÷ [EPS]

7. Dividend yield

Is a ratio comparing the yearly dividends of a company to its share price; it is however expressed as a percentage. The measurement informs of the percentage return a company pays out to its shareholders in the form of dividends.

8. Return on Equity

It is the relation between the firm’s net income against the equity of shareholders; it is also referred to as the return on the net worth of the company. This tool, therefore, ascertains how a company utilizes its assets to get earnings.

Conclusion

Fundamental analysis is a criterion used to determine the true market value of a stock; it looks for stocks that are trading at prices deemed higher or lower than their actual valuation.

This analysis strategies the stock from the external factors to the internal factors; external factors are those that can be measured numerically while the internal relate to the quality of the company.

The tools used to verify this analysis are there to give an analytical result of the stock but do not give recommendations on the next steps to be followed. These tools should thus be factored with other considerations.

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