Fundamental Analysis Part Two –
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
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.
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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