If you've been building your investment portfolio without examining stock fundamentals, you may be overlooking important information. Here's why:
Looking beyond the Surface
Buying a stock is like lending someone money. You need to do your homework.
Think for a moment about all the things you can determine about a person from the outside. You can look at what kind of car they drive, judge how well-spoken they are and see how bright and shiny their smile is. But, you probably wouldn't’t loan someone a large sum of money just based on the things you could easily see – you’d want to take a look at things like how much money the person makes, what kind of assets they own and whether they have a lot of debt already. You’d need to see their financial's before making a decision.
Looking at a stock’s fundamentals is very much the same concept. Before you invest money in a company, you’ll want to take a look at key indicators of the company’s financial health. By doing so, you can better determine whether they’re well-positioned for future growth and success.
Examining the Stock Fundamentals
Now that you understand the concept behind stock fundamentals, we’d like to look at a few of the stock fundamentals that are commonly examined by investors. While the world of stock fundamentals is full of abbreviations and ratios (which can be confusing at first), with a little effort, most fundamentals are relatively easy to understand.
Earnings Per Share (EPS)
For example, one metric is earnings per share, or EPS for short. Earnings per share is simply a figure expressing how much profit a company makes, divided by the number of outstanding shares of that stock. It’s easy to see why EPS is a metric many investors care about, as it helps you see how much profit the company makes relative to the number of shares it has outstanding. In simpler terms, EPS lets you see, “How much earning power can one share of stock buy me?”
Price-to-Earnings Ratio (P/E Ratio)
An important stock fundamental that’s closely related to EPS is Price-to-Earnings ratio, or P/E ratio. We looked at how EPS can be used to assess the earning power of one share of stock. By making the stock’s price part of the equation, P/E helps investors see how much earning power they can buy relative to the price. P/E ratio helps you to compare apples to apples – to see, in a way, how much bang for the buck a particular stock offers.
Return on Assets (ROA)
Another commonly used stock fundamental is Return on Assets (ROA). Rather than simply look at the value of a company’s assets or equity, investors often prefer to see how well a company uses its assets to generate an ongoing stream of profits. While ROA will vary across industries, a higher ROA is generally considered better, all other things being equal. This metric is also called Return on Equity, or ROE.
Debt to Equity Ratio
Although we’re not going to cover every stock fundamental here, it’s worth giving one more example. The metric commonly used to assess company debt levels is Debt to Equity Ratio. Instead of just looking at debt as an absolute figure, investors want to see it in relative, not absolute terms. Again, the Debt to Equity ratio is highly dependent on what industry a company is in, but can give some indication of how risky or aggressive a company’s growth strategy is. Investors typically look for stocks with a debt to equity ratio that is neither too high nor too low, meaning that its growth trajectory is neither too risky nor too cautious.
The Big Picture - Where Stock Fundamentals Fit In
While stock fundamentals are an important part of any buying and selling decisions, it’s important to mention that there are many important considerations that are not quantifiable and don’t show up in the fundamentals. For example, investors may also solidify their investment decisions by looking at qualitative factors such as: How good is the company’s product line? How strong is their brand? Does their management team have a successful track record? How much of a competitive advantage do they have over their competitors? What new products are in the pipeline and do they show any promise?
By using stock fundamentals together with qualitative information, skillful investors are able to make buying and selling decisions based on the best body of information available.
Summary
There is much more to stock fundamentals than the brief intro given here. There are dozens of other metrics worth knowing and exploring, such as market capitalization , projected earnings growth (PEG), price to sales (P/S), price to book (P/B) and many more. You’ll want to understand these in detail as you become a stronger, more knowledgeable stock market investor. Stock trading software , like High Growth Stock Investor, incorporates these stock fundamentals, making it easy to filter and compare based on a number of these factors.
So, start learning about stock fundamentals and how to interpret them. With a strong understanding of fundamentals, you’ll be able to see a more complete picture, avoid unwise investment decisions and even earn a superior rate of return of your investment portfolio.
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