Fundamental analysis is like a toolkit for checking if a company’s stocks or bonds are a good investment. It involves looking at lots of different things, like the company’s money situation, the economy, and other important factors. The main aim is to figure out how much an Stock is really worth and then decide if it’s a good idea to invest in it. There are some important points to this analysis, like studying financial statements (like the balance sheet and income statement), calculating earnings per share (EPS), looking at the price-to-earnings ratio (P/E), and considering other financial and economic details. All of this helps investors make decisions based on the fundamental, or basic, qualities of the investment.
Here are key components and concepts associated with fundamental analysis:
1. Financial Statements:
- Balance Sheet: This financial statement provides a snapshot of a company’s financial position at a specific point in time. It consists of assets, liabilities, and equity. Example: If a company has $500,000 in assets (like cash, property, and equipment) and owes $200,000 in liabilities (such as loans and accounts payable), the equity would be $300,000 ($500,000 – $200,000).
- Income Statement: This statement shows a company’s revenues, expenses, and profits over a specific period. Example: If a company earned $1 million in revenue and incurred $700,000 in expenses, the net income would be $300,000 ($1,000,000 – $700,000)
- Cash Flow Statement: This statement tracks the inflow and outflow of cash from operating, investing, and financing activities. Example: If a company generated $400,000 in cash from its operations, spent $150,000 on new equipment, and paid $50,000 in dividends, the net change in cash would be $200,000 ($400,000 – $150,000 – $50,000).
2. Earnings Per Share (EPS): EPS is calculated by dividing the company’s net income by the number of outstanding shares. Example: If a company has a net income of $1 million and 500,000 outstanding shares, the EPS would be $2.00 ($1,000,000 / 500,000).
3. Price-to-Earnings Ratio (P/E): P/E ratio compares the market price of a stock to its earnings per share. Example: If a stock is trading at $40 per share, and the EPS is $2.00, the P/E ratio would be 20 ($40 / $2.00).
4. Dividend Yield: Dividend yield is the annual dividend payment expressed as a percentage of the stock’s current market price. Explained: Dividend yield tells you how much money you get back in dividends compared to the price you paid for the shares. It’s like asking, “If I bought these shares, how much extra money would I make from dividends?”
Example: If a company pays $2 in dividends for every share you own, and the shares cost $50 each, the dividend yield is 4%. It means for every $100 you invested in shares, you get $4 back as dividends each year.
Also Read: What is Dividend Investing
5. Book Value: Book value represents the net asset value of a company and is calculated by subtracting liabilities from assets. Example: If a company has total assets of $800,000 and liabilities of $400,000, the book value would be $400,000 ($800,000 – $400,000).
6. Market Capitalization: Market cap is calculated by multiplying the current market price of a stock by the total number of outstanding shares. It provides an indication of a company’s size in the market. It’s the total value of all the company’s shares in the stock market.
Example: If a company has 1 million shares, and each share is worth $50, the market cap would be $50 million (1,000,000 shares * $50 per share).
Note: Consideration of macroeconomic indicators such as interest rates, inflation, and GDP growth can provide insights into the overall economic environment that may affect and help to make investment decisions.
Fundamental analysis is often used by long-term investors to identify investment opportunities based on the underlying financial health and prospects of a company. It contrasts with technical analysis, which focuses on historical price and trading volume patterns to predict future price movements. Investors often use a combination of both approaches for a comprehensive understanding of potential investments.