Fundamental analysis is a method of evaluating a stock by analyzing various financial and economic factors that could affect its intrinsic value. Investors use fundamental analysis to make informed decisions about whether a stock is overvalued or undervalued. Here’s a simple explanation of each metric along with an example:
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Market Valuation:
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Market Capitalization: The total market value of a company’s outstanding shares of stock. It is calculated by multiplying the current stock price by the total number of outstanding shares.
- Example: If a company has 1 million shares outstanding, and the current stock price is $50, the market capitalization would be $50 million.
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Price-to-Earnings Ratio (P/E): The ratio of a company’s stock price to its earnings per share (EPS). It provides an indication of how much investors are willing to pay for each dollar of earnings.
- Example: If a stock is trading at $100 and has an EPS of $5, the P/E ratio is 20 (=$100/$5).
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Price-to-Book Ratio (P/B): Compares a company’s market value to its book value (total assets minus total liabilities).
- Example: If a company has a market capitalization of $200 million and a book value of $100 million, the P/B ratio is 2 (=$200 million/$100 million).
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Financial Performance:
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Revenue Growth: The percentage increase in a company’s revenue over a specific period.
- Example: If a company’s revenue was $100 million last year and $120 million this year, the revenue growth rate is 20%.
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Profit Margin: The percentage of revenue that turns into profit after expenses.
- Example: If a company has a net profit of $10 million and revenue of $50 million, the profit margin is 20% (=$10 million/$50 million).
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Return on Equity (ROE): Measures a company’s profitability by calculating how much profit it generates with shareholders’ equity.
- Example: If a company has a net income of $15 million and shareholders’ equity of $100 million, the ROE is 15% (=$15 million/$100 million).
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Debt and Solvency:
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Debt-to-Equity Ratio: Compares a company’s total debt to its shareholders’ equity.
- Example: If a company has $50 million in debt and $100 million in equity, the debt-to-equity ratio is 0.5 (=$50 million/$100 million).
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Interest Coverage Ratio: Measures a company’s ability to cover its interest expenses with its earnings.
- Example: If a company has $20 million in earnings before interest and taxes (EBIT) and $5 million in interest expenses, the interest coverage ratio is 4 (=$20 million/$5 million).
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Dividend Yield:
- Dividend Yield: The annual dividend income expressed as a percentage of the stock’s current price.
- Example: If a stock pays an annual dividend of $2 per share and the stock price is $50, the dividend yield is 4% (=$2/$50).
- Dividend Yield: The annual dividend income expressed as a percentage of the stock’s current price.
Here’s a table summarizing the metrics:
| Metric | Formula | Example |
|---|---|---|
| Market Valuation | ||
| Market Capitalization | Stock Price x Outstanding Shares | $50 x 1 million = $50 million |
| Price-to-Earnings Ratio (P/E) | Stock Price / Earnings per Share (EPS) | $100 / $5 = 20 |
| Price-to-Book Ratio (P/B) | Market Cap / Book Value | $200 million / $100 million = 2 |
| Financial Performance | ||
| Revenue Growth | [(Current Revenue – Last Year’s Revenue) / Last Year’s Revenue] x 100 | [(120 – 100) / 100] x 100 = 20% |
| Profit Margin | (Net Profit / Revenue) x 100 | ($10 million / $50 million) x 100 = 20% |
| Return on Equity (ROE) | Net Income / Shareholders’ Equity | $15 million / $100 million = 15% |
| Debt and Solvency | ||
| Debt-to-Equity Ratio | Total Debt / Shareholders’ Equity | $50 million / $100 million = 0.5 |
| Interest Coverage Ratio | EBIT / Interest Expenses | $20 million / $5 million = 4 |
| Dividend Yield | ||
| Dividend Yield | (Annual Dividend per Share / Stock Price) x 100 | ($2 / $50) x 100 = 4% |
Note: All examples are simplified and for illustrative purposes only. Real-world financial analysis requires a more comprehensive evaluation.
