How Fundamental Analysis helps Investors.
It will be an opportunity for an investor to take a trade if they know the future price of a share before they purchase it. Fundamental analysis helps to predict the future price of any share.
Investors can book profits, if they can purchase the undervalued shares on the basis of fundamental analysis and then wait for the market to reach the correct value price, to sell it.
- Fundamental analysis is the process of analyzing the current performance of a company on the basis of financial statements and industry trends.
- Fundamental analysis is a method of evaluating the fundamental performance of the company to predict the future share price.
Fundamental analysis includes the analysis of business financial statements, operational health, product competency, and market opportunity.
Below are the fundamental analysis tools or factors need to consider for an investment decision and the favorable conditions for an investor.
Market Capitalization : Higher is the capitalization, safer for investment. Face-Book-Market Value : Higher Market value compared to book value, the stock may be overvalued or stock has higher potential. EPS (TTM) -Earnings per Share : Higher the value, good for the investor. Price to Earning Ration (P/E) : Lower the value, good for investors. Industry P/E : Lower P/E compared to industry P/E, good for investors. Dividend Yield : Higher dividend yield is good for investors. Deliverable : Higher deliverable is good for investors. Promoters : Higher promoter's credibility is good for investors.
Through the fundamental analysis, an investor can understand the true value of the share and take the once of the following action. This true value on the base of analysis is called the intrinsic value.
If the intrinsic value < Market price = Buy the share. If the intrinsic value = Market price = Need to hold the share. If the intrinsic value > Market price = Need to sell the shares.
Below listed fundamental analysis details help an investor to identify the suitable stock to invest in. Fundamental analysis is an important factor, which helps to avoid the investment financial misatake.
The total market value of a company’s outstanding shares is called Market capitalization. It is calculated as below.
Market capitalization ( market cap) = (Total number of a company’s outstanding shares) X (current market price of one share).
Market capitalization in the simple terms we can say as the total market value of all outstanding shares. Companies are typically divided into 3 categories on the basis of market capitalization:
- Large-cap (Capitalization morethan Rs.20,000 crores)
- Mid-cap (5000 crores and less than Rs.20000 crores.)
- Small-cap (Less than5000 crores)
Small-cap are the companies having relatively small market capitalization.
- In India, companies with a market capitalization of less than5000 crores are classified as small-cap companies.
Mid-cap are the companies having medium-level market capitalization.
- In India, companies with a market capitalization above Rs.5000 crores and less than Rs.20000 crores are considered mid-cap companies.
Large-cap companies are the companies having large market capitalization.
- In India, company’s with a market capitalization greater than Rs.20,000 crores is classified as Large-cap companies.
Higher the market capitalization more secure for an investor to invest. As the company's business is already large, the probability of the share price goes up will be more.
Face-Book-Market Value of the company
Face Value, Market Value, and book value are the three valuations of the shares of the companies. On the basis of these values, an investor can decide the valuation of the companies share price. First, this blog will explain, what each value is and then will share, the significance of each value on the buy or sell decision.
Face value is the nominal or the original value of a security, stated by its issuer at the time of issue. For stocks, the face value is the listed value of a share in the certificate.
- A companies stock’s face value is the initial value of the unit share, which is indicated on the certificate at the time of the initial issue.
- The face value of a share remains the same until the company declares the stock split.
The market value, of a share, is determined based on principles of demand and supply of the company’s share in the market. It is defined as the price at which an investor is willing to buy or sell a particular share, in a stock exchange at a specific market time.
- The actual market value of a stock is always influenced by the forces of supply and demand.
- If demand increases, market value will go up, and if supply increases, market value will go down.
The book value means the value of a share of a company which reflected on its financial statements. Book value is the price that investors would get per share if the company decides to liquidate the company and sold all the assets and paid all its liabilities and obligations.
- Book value is the net value of a company in its balance sheet.
- Book value is roughly equal to the amount per share all shareholders will get if the company gets liqudated.
- Book value is the net asset value investors get by holding a share as it is the actual current value of a share.
In general, market value tends to be higher than book value, since the market value is influenced by the profitability and future growth prospects of a company.
If the market value is much higher, it means that the company has higher potential growth, so investors can invest in that company. If the market value is lower than the book value, it can be a positive or a negative situation for the buying decisions. Hence Price-to-book ratio is a critical factor for an investment decision.
P/B ratio is a popular way to compare the market and book value of a company.
Price-to-book (P/B) = Market value / Book value
- A lower ratio indicates it can be an ideal time for an investor to buy more shares as the current market price is near to book value.
If an investor purchases a share at a low market value, and later the company decided to liquidate, the investor will get more money as per the book value of that company.
If the market value is lower than the book valve, it is ideal to buy, but there may be a reason for lower market value, hence need to explore the following fundamental analysis, before making and buying decision.
EPS (TTM):-Earnings Per Share
EPS means Earnings per Share
TTM means Trailing Twelve Months.
EPS (TTM) means the total profits a company has made over the last 12 months divided by the outstanding total shares, I.e. earnings made per share. TTM can be any last consecutive 12 months, it is not necessary the company’s last financial year. Below is the earnings per share calculation formula.
EPS = Total profit in last 12 months / Total no of shares.
Earnings per Share= (Net Income − Preferred Dividends ) / End-of-Period Common Outstanding Shares of the company.
Consider the below example:
The company's net profit in last 12 months is: 1000 crores The number of shares outstanding is: 100 Crores EPS = 1000 crores/ 100 Crores = 10
EPS indicates the company’s profitability. The higher EPS value of the company represents the company is under the more profitable condition.
- EPS shows, how much money an organization makes for each share.
- EPS is widely used to estimate the companies corporate value. Higher the EPS, the more the value.
For an investor, if the companies EPS is higher, it is ideal for an investor to make a buying decision, as the profitability of the company is more.
The price-to-earnings ratio (P/E ratio) is the ratio that indicates the value of a company, it is measured by dividing the current share price by its earnings-per-share (EPS). P/E ratios are used by investors to determine the relative value of a company’s shares.
P/E Ratio= Current market price of share / EPS of the company.
- P/E ratio shows whether a company’s stock price is undervalued or overvalued.
- The Price-to-earnings ratio indicates how much cash an investor needs to invest in a company in order to earn one rupee profit from that company’s earnings.
I.e. P/E of 5 indicates that investors need to pay 5 INR to earn one INR in a year.
Lower the value of the P/E is good for the investor to make a buying decision, as it gives more return on investment.
A high P/E ratio means either of below
- Either the company’s stock is over-valued or the Investors are expecting high growth rates in the near
A low P/E might indicate either of below
- Either the current companies stock price is undervalued or the Investors are expecting low-growth rates in the near
P/E ratio indicates the price which investors are willing to pay for a stock of companies, based on its future and past earnings.
Two kinds of P/E ratios are derived
- Forward P/E:- Calculate based on the forecast earnings.
- Trailing P/E:- Calculated based on the past performance.
PE ratios could depend upon the industry performance.
The industry P/E is calculated by taking the median of P/E of all the companies in the industry or sector.
- Industry P/E performance is decided on the basis of the historical P/E average of all the companies in the industry.
If the P/E of a company is a lower value compared to the industry P/E, that means, the performance of that particular company is better than the average industry performance. I.e. it is ideal to invest in that company.
The dividend yield is the ratio of total dividends paid to shareholders to the market value per share. The dividend is a corporate action and the dividend yield is expressed in a percentage.
Dividend yield = (Annual dividend per share / Current share price ) X 100.
The dividend yield is also calculated by dividing the company’s total annual dividend payout by the total market capitalization.
As the higher value of dividend yield indicates, investors will get more money as dividends, for the shares they are holding. It is advisable to buy and hold more shares
Deliverable is the percentage of the number of shares taking delivery into Demat or selling from Demat account, out of the total quantity traded in a day in the trading account.
Below is the example shows the deliverable quantity to traded quantity.
The total traded quantity of a Stock of a company in a day is 100 lakh. In that 80 lakh quantity is for Intraday trading and remaining quantity of 20 lakh are the delivery order, these 20 lakhs of share is called the deliverable quantity. It is represented in percentage, hence the deliverable is 20%.
Deliverable = ((Total trade quantity - Total Intraday quantity) / Total trade quantity ) X 100.
- If the Deliverable percentage increases, it means, more investors are taking the delivery for holding it, which in turn means, the stock is bullish.
- If more buyers are coming, automatically demand will increase, and prices will increase. If Deliverables reducing, the price will reduce.
If the deliverable is increasing, it is advisable to buy and hold more shares as the chance of the market price getting increase is more.
A corporate promoter is a firm or person who worked for the formation of a company. A promoter is a person who played a major role in making the business plan, raising capital from various sources to start the business and incorporate a company. promoters’ duties and liabilities are endless and their efficiency and capability decide the companies future performance.
A promoter can be referred to as the founder of a business.
- If the credibility of the promoter is more, investors can invest in the company with more confidence as the chance of getting a return will be more.
As per SEBI rules, promoters’ shareholding in listed companies should be a maximum of 75% of the total no of shares. If the holding is more than 75 percent, the promoter needs to bring down the holding below 75% within three years from the date of listing.
Investors can invest in a company with confidence if the credibility of the promoter is more.
Fundamental analysts are concerned with a stock’s valuation and the price at which it is trading. Technical analysis is concerned with the performance of the stock price movement on the basis of stock’s supply and demand. If an investor chooses a stock that is fundamentally strong, which will in-turn gives a guaranteed return in the long run. It is ideal to select a fundamentally strong stock for meeting the financial goals in the long run.
This article covers the basic fundamental analysis techniques and the following article will cover the Fundamental analysis vs Technical analysis. There are many share market learning books available in the market which covers the Technical analysis and charts, fundamental analysis methods, and tools in detail.
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