Fundamental Analysis - continued

Earnings Per Share

Earnings per Share is calculated by dividing a company's net income by the weighted average of outstanding common shares. This calculation is used in fundamental analysis for valuation purposes. The Earnings per Share measurement works well for reviewing the past, but it can also be used to predict the future by calculating the EPS according to future expected outstanding shares.

Price to Earnings

While you are checking the fundamentals of a company, you should pay close attention to the following things.

Price to Earnings = Current Stock Prices / Earnings per Share.


When evaluating a company's P/E ratio, you should be looking for a company with a price/earnings (P/E) ratio that is low in comparison to similar companies. To calculate the price-earnings ratio of a company, divide the stock's current price by its earnings per share. If a stock is selling for $60 now and its earnings last year were $10 a share, the P/E ratio would be 6 (60/10=6). That means that for every dollar the stock earns, investors are currently willing to pay $6. However, investors also pay for future earnings. If the same $60 stock is expected to earn $12 a share next year, then the P/E ratio would be 5.0 ($60/$12 = 5.0). The idea is to find a stock with a significantly lower P/E ratio than others in its category.

Cash-Flow

Cash Flow is an important measure for investors because it is a way of determining a company's ability to pay dividends and more. Generally, cash-flow is defined as a company's net income (the difference between how much the company sold and how much it spent that quarter), plus depreciation (an accounting method which spreads out the cost of a fixed asset over several years), plus the value of other non-cash assets, including intangible assets such as copyright patents, trademarks, licenses, goodwill, and franchises.

Economic Indicators

You should also take into account what the economic indicators are telling you. These are some of the questions you should be asking when conducting fundamental analysis: Are the indicators showing continued economic growth, or are they suggesting that a pullback is coming? How will it affect this company? Do the economic indicators tip the scale to my side?

Analysts

A market research analyst's job is to study publicly traded companies and make buy or sell recommendations on those companies' securities. The recommendations and reports of an analyst can influence the price of a company's stock. The slightest mention of a company by a "well-known analyst" can cause that company's stock price to rise or fall – even if nothing has changed!

Although analysts provide an important source of data in today's markets, it is important to understand that conflicts of interest among analysts can and do exist. For example, some analysts work for firms that underwrite or own the securities of the companies about which they make recommendations. Analysts themselves sometimes own stocks in the companies they cover!

Owning stock in companies that they analyze does not necessarily mean that analysts' recommendations are flawed or unwise. However, this is an issue that you should think about when assessing whether a particular recommendation is wise for you.

As a rule, you should not rely on an analyst's recommendation when deciding whether to buy, hold, or sell a stock. Make sure that any investments you choose fundamentally match your goals and tolerance levels, and use technical indicators to pick your buy and sell points.