Fundamental Analysis

Chapter 3

Fundamental Analysis is a method of evaluating a security in an attempt to measure its intrinsic value, by examining related economic, financial and other qualitative and quantitative factors.

Capitalisation or sector wise classification of stocks

Listed companies are classified based on there market capitalization. 

Capitalization= Total number of stocks multiplied by current market price

1.LARGE CAP>100000 Cr

2.MID CAP>1000Cr<100000 Cr

3.SMALL CAP<1000 Cr

Using fundamental analysis, you can identify outstanding number of shares of a company.

To identify number of shares follow this.

  • Look for share capital in balance sheet
  • It is in crores
  • Now divide that value by face value
  • The output is no of shares.
  • To get market capitalization –multiply no of shares by stocks price.

Keys to successful investment through fundamental analysis

  • Invest in public companies
  • Understand how the company makes money
  • Invest at a reasonable price
  • Invest in companies that could last forever
  • Find a company with limited debt
  • Look for high barriers to entry
  • Invest in a company immune to extrinsic factors
  • Invest in a company with low reinvestment cost
  • Avoid business with controlling shareholders

Price to book value

It is calculated by dividing the current closing price of the stock by the latest quarter’s book value per share

  • If its less than 5-stock is expensive
  • If its between 2 and 5 its normal
  • And if its less than 2 stock is undervalued

Book Value=Total Asset/CMP

Now lets look at few more key ratios used in fundamental analysis.

Debt to equity ratio : D/E

It is calculated by dividing a company’s total liabilities by its stockholders’ equity

Debt to equity ratio less than 1 is preferred.

Stock holder equity-Total Asset-Total Liabilities=Net Assets

Other Important fundamental analysis factors:

  1. Interest coverage ratio-greater than 3 is preferred-The higher the better
  2. Operating profit of 5 years-Should be greater than price to earnings by two times
  3. Quarterly net profits-should have steady growth
  4. Price to earnings multiple-Market price divided by EPS

Using Peg Ratio to identify intrinsic value of a stock

If peg ratio is,

  • 0-1 -Stock is undervalued
  • 1-2 -It is normal
  • Greater than 2 -It is overvalued

Higher Peg Ratio=Lower The Growth

Lower Peg Ratio=Higher The Growth

Peg ratio should not be less than zero i.e. it should not be in negative

Formula for intrinsic value of stock based on peg ratio is 

Fair Market Value Based On Peg Ratio=CMP Divided By Peg Ratio

Now you have a good knowledge about how fundamental analysis can improve your investment decisions in picking good stocks and avoiding bad stocks.Lets learn further with out next chapter i.e trading guide for beginners.

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