What is Fundamental Analysis? How to do Fundamental Analysis of the Stock? These questions were asked to me by many blog readers.
Well, before getting the answers to your query. Let me ask you one simple question – How you select stock for investment? Your answer could be –
- I make investments based on the advice of friends and relatives
- I follow Stock Broker Tips for investing in the stock market
- I invest in a stock based on news associated with stock
- I do proper research and study about a stock before making an investment
I am 100% sure most of you would select option 1 to 3. Only few will select option 4. If you have selected option 4 you are in the right direction. Whatever you are doing in terms of research and study is known as fundamental analysis of the stock.
The synonym of fundamental is basic or essential. Whenever we purchase any product including food and vegetable we check the basic or essential elements of the product. We also check the price of the product before buying. It is nothing but fundamental analysis.
I hope you have got the answer to the question what is fundamental analysis? Now, let’s take a look at the second question.
How to do Fundamental Analysis of the Stock?
Fundamental analysis means checking the basic and essential elements of the company. In other words, you need to check the financial condition, the health of the business and analyze various other critical parameters before investing your money. I usually check the following factors as a part of fundamental analysis.
#1 Net Profit
The first thing you need to check is the net profit margin of the company. Net profit margin means profit that is generated after all types of deductions. It is profit after tax and after deduction of operating cost and overhead. Please note that Net Profit is not gross profit. A Gross profit is a difference between sales and the direct cost of goods sold before making any deduction. The net profit margin of the company should be consistent. In case the net profit margin is low or not growing it is not advisable to invest in such companies.
#2 Profit Margin
Checking the net profit of the company is not enough. You also need to check the profit margin. Profit margin is calculated on net income and revenue. The logic here is the increase in earnings of the company is good but it should not increase revenue cost. The profit margin shows how much money the company earns on its revenues. This analysis is more useful in comparing the similar type of companies.
The formula of Profit Margin is given below.
Profit margin= Net income/Revenue
The company should show a higher profit margin. A higher margin indicates the company is controlling costs incurred against competitors. This is usually calculated in percentages.
#3 Return on Equity Ratio
The return on Equity ratio is one of the critical factors to consider while doing a fundamental analysis of the company. ROE is the ratio of revenue and profit to the shareholders. To be more specific it shows how much profit a company can earn with the money invested by its shareholder.
The formula for calculating Return on Equity Ratio is given below.
Return on equity = Net Income / Shareholder’s Equity
The outcome of this ratio is in the form of rupees. This ratio contains important information about leverage, revenue, profits, margins, and returns to the shareholders. The ROE value should be higher.
#4 PE Ratio
PE ratio is also known as the price to earning ratio. It is commonly used to know the valuation of share.
The formula for calculating PE ratio is given below.
PE = Price per Share / Earnings per Share
The PE ratio is always calculated on the current price of the share. The PE ratio helps in understanding the valuation of the stock. Higher the PE ratio that means the share price is high compared to its earning. This ratio is used in comparing with other companies in the same sector or to its own historical PE.
#5 Price-to-Book (P/B) Ratio
The price to book value is another important ratio to consider while doing a fundamental analysis of the stock. This ratio is used to compare the stock market value with its book value.
The formula of calculating price to book value is given below.
P/BV Ratio = Current Market Price per Share / Book Value per Share
Book Value per Share = Book Value / Total number of shares
If the price to book value ratio is higher than 1 it denotes that the share price is higher compared to its book value. This ratio is generally seen to know the future prospects of the company.
Earnings per share is one of the important parameters to check. The EPS shows the amount of money earned by the company per share. Higher the EPS better is the company. The EPS of the company should be increasing in a consistent manner.
The formula of EPS is given below.
Earning Per Share = (Net Income – Preference Dividend)/Weighted Average Number of Shares Outstanding
You should also compare the EPS of one company with another company in the same industry. The EPS of the company should increase steadily.
How to get data for doing fundamental analysis?
The data/information for doing fundamental analysis of the stock can be easily obtained from the financial statement of the company.
I generally make use of screener.in to get the stock-specific information.
You just need to visit the screener.in site and enter stock name. You will be able to see all financial information including balance sheet, P&L, financial ratios, peer comparison etc.
You can also export this stock information in excel for doing further analysis.
How you do financial analysis of the stock? Share your views and experience in the comment section given below.