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Fundamental Analysis Part Two –
Tools
Although the raw data of the Financial Statement has some
useful information, much more can be understood about the value
of a stock by applying a variety of tools to the financial
data.
Earnings per Share
The overall earnings of a company is not in itself a useful
indicator of a stock's worth. Low earnings coupled with low
outstanding shares can be more valuable than high earnings with
a high number of outstanding shares. Earnings per share is much
more useful information than earnings by itself. Earnings per
share (EPS) is calculated by dividing the net earnings by the
number of outstanding shares. For example: ABC company had net
earnings of $1 million and 100,000 outstanding shares for an
EPS of 10 (1,000,000 / 100,000 = 10). This information is
useful for comparing two companies in a certain industry but
should not be the deciding factor when choosing stocks.
Price to Earning Ratio
The Price to Earning Ratio (P/E) shows the relationship between
stock price and company earnings. It is calculated by dividing
the share price by the Earnings per Share. In our example above
of ABC company the EPS is 10 so if it has a price per share of
$50 the P/E is 5 (50 / 10 = 5). The P/E tells you how much
investors are willing to pay for that particular company's
earnings. P/E's can be read in a variety of ways. A high P/E
could mean that the company is overpriced or it could mean that
investors expect the company to continue to grow and generate
profits. A low P/E could mean that investors are wary of the
company or it could indicate a company that most investors have
overlooked.
Either way, further analysis is needed to determine the true
value of a particular stock.
Price to Sales Ratio
When a company has no earnings, there are other tools available
to help investors judge its worth. New companies in particular
often have no earnings, but that does not mean they are bad
investments. The Price to Sales ratio (P/S) is a useful tool
for judging new companies. It is calculated by dividing the
market cap (stock price times number of outstanding shares) by
total revenues. An alternate method is to divide current share
price by sales per share. P/S indicates the value the market
places on sales. The lower the P/S the better the value.
Price to Book Ratio
Book value is determined by subtracting liabilities from
assets. The value of a growing company will always be more than
book value because of the potential for future revenue. The
price to book ratio (P/B) is the value the market places on the
book value of the company. It is calculated by dividing the
current price per share by the book value per share (book value
/ number of outstanding shares). Companies with a low P/B are
good value and are often sought after by long term investors
who see the potential of such companies.
Dividend Yield
Some investors are looking for stocks that can maximize
dividend income. Dividend yield is useful for determining the
percentage return a company pays in the form of dividends. It
is calculated by dividing the annual dividend per share by the
stock's price per share. Usually it is the older,
well-established companies that pay a higher percentage, and
these companies also usually have a more consistent dividend
history than younger companies.
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