Some traders ignore fundamental analysis in their stock trading. We don’t. Understanding the fundamental economic outlook of a company is vital part of our trading strategy.
Using fundamental analysis helps you compare a company against similar companies in terms of earnings growth and profit potential.
Essentially fundamental analysis is a comparison between two or more stocks in the same sector with a view to identifying the top potential performer.
Time to access the company’s reports! Much of this information will be available from your online stock broker.
Broadly we are looking at three main areas: The Income Statement (or Profit & Loss); The Cash Flow; The Balance Sheet.
The Income Statement
This in turn is made up several key areas:-
Revenues or sales – the turnover of the company and here you are looking for growth or signs of weakness.
Cost of Sales – includes the direct costs of goods sold.
Expenses – all the costs associated with running the business.
Dividends – You will also see if the company paid any dividend and obviously compare that with previous payments or a similar company
Profit – Finally what it’s all about. You can use a number of indicators to compare a company’s profitability such as the net profit margin = earnings after taxes / gross profit.
Cash flow statements are important to assess the ongoing viability of a company. The income statement will include sales and expenses that have not as yet been paid for and is therefore not a reliable indicator of the company’s cash strength.
The Balance Sheet
The balance sheet gives a snapshot of the company’s assets and liabilities.
The Earning Growth Rate is probably the most important indicator of a companies health and you won’t find this on the company’s report. Rather it is provided by analysts and you will find it quoted online.
The best way to compare two companies is via their respective Price / Earning Ratio (P/E Ratio) The P/E Ratio is a comparison of the stocks earnings with its share price. Calculated as follows:-
P/E Ratio = stock price / earnings per share.