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If the ´intrinsic/real valueµ of a stock is above the current market price. Not only do we want our stock price to rise. Find out as much as possible about the company and their products. brand name etc. growth potential. you will be able to compare this price to the market price of the company and decide whether you want to buy it (or sell it if you already own that stock). we want it to rise FAST! So the challenge is to figure out: which stock prices are going to rise fast? Some stocks are cheap and some are costly. All this seems simple. You should analyze factors that give the firm a competitive advantage in it·s sector such as management experience. you will be in a much better position to decide whether the price of the companies stock is going to go up or down.. the investor would purchase the stock because he knows that the stock price would rise and move towards its ´intrinsic or real valueµ If the intrinsic value of a stock was below the market price. industry comparisons. When investing in the stocks. how they relate to the market and their customers. low cost producer. changes in government policies etc. What is important is how much the price of the stock is likely to rise.Fundamental Analysis Definition Fundamental analysis is a stock valuation method that uses financial and economic analysis to predict the movement of stock prices. history of performance. Do they have any ´core competencyµ or ´fundamental strengthµ that puts them ahead of all the other competing firms? What advantage do they have over their competing firms? Do they have a strong market presence and market share? Or do they constantly have to employ a large part of their profits and resources in marketing and finding new customers and fighting for market share? After you understand the company & what they do. let us go into some more details. we want the price of our stock to rise.500 and some are even worth 50paise. the fundamentalist analyzer makes an examination of the current and future overall health of the economy as a whole. and non-financial information such as estimates of the growth of demand for products sold by the company. Now the next obvious question is how do you find out what the intrinsic value of a company is? Once you know this. you have to analyze firm you are interested in. the market price of a stock tends to move towards it's ´real valueµ or ´intrinsic valueµ. and economy-wide changes. Fundamental Stock Analysis Theory Page 2 . the investor would sell the stock because he knows that the stock price is going to fall and come closer to its intrinsic value. General Strategy To a fundamentalist. To start finding out the intrinsic value. After you analyzed the overall economy. Having understood the basics of fundamental analysis. But the price of the stock is not important. The price of the stock does not make a stock good to buy. Some are worth Rs. The fundamental information that is analyzed can include a company's financial reports.
However.10.540 you will make Rs. You made a profit of Rs. If the company has more shares.500 stock becomes worth Rs.100. If the Rs. Because you do not know how many shares a company has. There is no way to compare them! So fundamental analysts use different tools and ratios to compare all sorts of companies no matter what business they are in or what they do! Next let us get into the tools and ratios that tell us about the companies and their comparison. as a comparison tool. If you understand this. This 100% rise makes us Rs. You calculate earnings per share by taking the net earnings and divide by the outstanding shares. Please note: Looking at the above paragraphs. you will have 1000 stocks. we are interested in a company whose stock price will rise by a large percentage. the point to be noted is that we are interested in stocks that will have the highest % rise in the stock price. do NOT get into them.500 in the 50paise stock and the stock price goes up to Rs.500 in one stock of Rs.540.500 you invested is now Rs. EPS = Net Earnings / Outstanding Shares Fundamental Stock Analysis Theory Page 3 . if you think about it.500 to a stock worth 50paise and figure out which one will have a higher percentage rise.. but it can also be really really bad some times! These really small stocks are very volatile and unless you know what you are doing.500 in a 50paise stock.40. However. how do you compare stocks.1000.. What is important is the rise in the stock·s price.2. but company A has 10 shares outstanding. the earnings will be divided into more parts. On the other hand when we invest the same Rs. so each share holder has in effect earned Rs. So you see it is important to know what is the total number of outstanding shares are as well as the earnings. you can see that the price of the stock is not important.100 then each shareholder has earned Rs.1 stocks hoping that their price will rise by 100% or more. if you invest Rs. Now the question is.If you invest Rs.40. companies A and B both earn Rs. Thus it makes more sense to look at earnings per share (EPS).. it may seem like a good idea to buy all the really cheap 50paise and Rs. it is a 100% rise as the stock price has doubled.500 and the price goes up to Rs.500. The point is that when picking a company.1. if company B has 50 shares outstanding and they too have earned Rs.1. Earnings will tell you nothing about how many shares the company has. On the other hand. This sounds good. then the Rs. How do you compare a stock worth Rs. you do not know how many parts that companies earnings have to be divided into. Earnings per share (EPS) ratio & what it means! Even comparing the earnings of one company to another really doesn·t make any sense.500. This 8% rise only makes us Rs. More specifically the ´percentageµ rise in the stock price is important. then that is a 8% rise. How do you compare two companies that are in different fields and different industries? How do you know which one is fundamentally strong and which one is week? If you try to compare two companies in different industries and different customers it is like comparing apples and elephants. For example. If the price of the stock goes up from 50paise to Rs.
the P/E tells you what the market thinks of a stock. it is always looking for some way to figure out what is going to happen in the companies future.40 and an EPS of 8 would have a P/E of: (40 / 8) = 5 What does P/E tell you? Some investors read a high P/E as an ´overpriced stockµ. The next ratio will make everything you read till now make sense. However. although it is not the only one you should consider.) The P/E looks at the relationship between the stock price and the company·s earnings. PEG = (P/E) / (projected growth in earnings) Fundamental Stock Analysis Theory Page 4 y y y .. Of course. Conversely. You calculate the P/E by taking the share price and dividing it by the company·s EPS (Earnings Per Share that we saw above) P/E = Stock Price / EPS For example: A company with a share price of Rs. it doesn·t tell the whole story (if it did. Price to earning (P/E) ratio & what it means? If there is one number that people look at than more any other number. For that information. A ratio that will help you look at future earnings growth is called the PEG ratio. but it is one of the methods used. Many investors made their fortunes spotting these overlooked but fundamentally strong stocks before the rest of the market discovered their true worth. If things are vague and unclear to you.So looking at the EPS ratio. which are obviously projections EPS doesn·t tell you whether it·s a good stock to buy or what the market thinks of it. you should go buy Company A with an EPS of 10.. You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings. PEG (Price to future growth ratio!) and what it tells you! The market is usually more concerned about the future than the present. which are still projections Forward EPS ² future numbers. we need to look at some other ratios next. right? EPS is not the only basis of comparing two companies. It tells you whether the market likes or dislikes the stock. In conclusion. it can also indicate the market has high hopes for this stock·s future and has bid up the price. The P/E is the most popular stock analysis ratio. Note that there are three types of EPS numbers: Trailing EPS ² last year·s numbers and the only actual EPS Current EPS ² this year·s numbers... do not worry. The P/E is a ratio that investors throw around with confidence as if it told the complete story. it is the ´Price to Earning Ratio (P/E)µ. we wouldn·t need all the other numbers. a low P/E may indicate a ´vote of no confidenceµ by the market or it could mean that the market has just overlooked the stock.
Having understood these basic three ratios. you look at the PEG ratio. you probably have started to understand how these ratios help you understand a stock and what is valuable and what is not.. if the PEG ratio is small (or very small as compared to the P/E ratio. ´I am sorry sir. This is the kind of stock that the stock market thinks is of not much value.75. the less you pay for each unit of future earnings growth.400 and over he years it has now become Rs. a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 30 / 15 = 2. This tells us two important things. you start do wonder why the stock has a low P/E. My dads first salary for the month was Rs. that one day when he becomes big. when my father was a kid. you have a stock with a low P/E.400 also. Fundamental Stock Analysis Theory Page 5 . The year now is 2006.50. These earnings are not always accurate and so the PEG ratio is not always accurate. On the other hand. The worth of money has reduced! If this is still not clear consider this.For example. You will not be able to even buy a ´paanµ with the 50paise!!µ The moral of the story is that. "Inflation" & how it eats your money silently & affects your investments! Inflation. consider this situation. the worth of the 50paise reduced dramatically. A movie ticket was for a few paise in my dad·s time. He offers the ticket-booth-guy at the theater 50paise and asks for a ticket. This is what inflation is. Important note: You must understand that the PEG ratio relies on the projected % earnings. Many years pass. So. Because the price goes up. the salaries go up. 50paise can buy nothing. What you could buy in my dad·s time for Rs. inflation makes the worth of money reduce. You know that this is the kind of fundamentally strong stock that the market has overlooked for some reason. Now. 50paise could buy a whole lot when my dad was a kid. What is important to us is the effect of inflation! The effect of inflation is the prices of everything going up over the years. Now. is an economic concept. but high projected earnings growth may be a good value.. This is inflation. Is it that the stock market does not like the stock? Or is it that the stock market has overlooked a stock that is actually fundamentally very strong and of good value? To figure this out.10. the price of everything goes up. now a days you will not be able to buy for Rs. My dad goes to the theater and asks for a ticket. If you really thing about it. So even a stock with a high P/E. Now it is worth Rs. you can understand that this is probably because the ´projected growth earningsµ are low. the ticket is worth Rs. just for the sake of understanding assume that my dad decided in his childhood to save 50paise thinking. is not important to us from the point of view of this article. he used to get 50paise pocket money. he will go for a movie. He used to use this money to go and watch a movie (At that time you could watch a movie for 50paise!) Now. What does the ´2µ mean? Technically speaking: The lower the PEG number.000. then you know that it is a valuable stock) you know that the projected earnings must be high. In the next section we shall look at some of the things that every investor must know about. we are interested in stocks with a low PEG value. Just for the sake of understanding. if the PEG ratio is big (or close to the P/E ratio).50. Since the stock is has a low P/E. What the cause of inflation is. The ticket booth guy says. Something that SILENTLY eats into the profits of each and every investor and how to beat it. to put it very simply.
In effect. If you can·t think where to invest your money.104 a year from now. you have to make sure that the rate of return on your investment is higher than the rate of inflation. inflation eats into your money. Secondly: When investing. it will be worth a lot less after 10 years. you make Rs. there are other things too that eat into you money. But inflation is not the only thing you should be considering.1000 in your safe today and you keep it there for 10years or so.100. But whatever you do. If the price of something is Rs.103.120. This rate keeps changing every year. Let it grow by gaining interest. you are loosing money! So in conclusion.100 in the market and over a year.2 So.04) = 83. If you have Rs. have to be higher than the rate of inflation. you will probably require Rs. you will be loosing money without even knowing it. do not just lock your money up in your safe and keep it stagnant. for the year 2005-2006 the rate of inflation was 4% (Which is really low and amazing!).103. If you invest Rs. But now. So what you can buy with today·s Rs. If you just save money by putting it your safe it will loose value over time. What is the rate of inflation? As we said earlier. What is the rate of return? The rate of return is how much you make on an investment. If you can buy something for Rs. an item costing Rs.1500 to buy it 10 years from now.104 a year from now. you will only be able to buy with Rs. You would not even know about it an your money would sit loosing value for no fault of yours. So do not keep money locked up in your safe.Firstly: Do not keep your money stagnant. From the above paragraphs you can note how silently. the prices of everything goes up over time and this phenomenon is called inflation. If you do this. The first thing is ´brokerageµ and the second thing is ´taxationµ. In our county India. when you make an investment.100 today will cost Rs. Suppose you invest Rs. But the Rs. then put it in a bank.1000 today. since the rate of inflation is at 4%. Always invest money.100 that you invested has grown only at a 3% rate of return and so it is worth Rs. then you rate of return is 20%. The more money you keep stagnant the more money you will be loosing.100 in the market today and you make money at a 3% "rate of return" in one year you will have Rs.100 this year and next year the price becomes approximately Rs. The question is: By how much do the prices go up? At what rate do the prices do up? The rate at which the prices of everything go up is called the "rate of inflation".104 then the rate of inflation is 4%.80 then after a year with a rate of inflation of 4% the price go up to (80 x 1. if the price of something is Rs. The finance minister generally gives the official statement on the inflation rate of the country for a particular year. the rate of return on your investments. Fundamental Stock Analysis Theory Page 6 . For example. make sure that your rate of return on the investment is higher than the rate of inflation in your country.
you must make large profit gains. If I make Rs.2060 then you have not made any money because the total amount you invested was Rs. How much % tax you have to pay. even when you sell the stocks. Tax!!! Please note: We are not in any way encouraging you to not pay tax! We are just educating you about it. The broker will give you ´hot tipsµ etc.6!! So in effect even though you made a profit of Rs.60 you made on the transaction is gone. you have to pay the broker Rs.6 so the profit of Rs. if the price of the stocks you invested in goes up to Rs.2060/So after sometime.1. Whether you buy or sell.Investors beware of: Brokerage and taxation! You probably know the concept that all your transactions in the stock market are done though a "stockbroker". Suppose you make a transaction of Rs. you have to pay the broker brokerage of 3%. They don·t really care about whether you make a profit or loss. brokers will make money.2060. then you have to pay the stockbroker Rs.2000) for the transaction. The total investment in the transaction is Rs. depends on which "tax bracket" you fall in. not because they are looking out for you and your profit. the more they will make. it would be wise to not blindly follow your brokers advise. brokers tend to encourage you to trade. It have to pay Rs. This means that. Conclusion: As a general rule. since I fall in the 33% tax bracket. your investments must grow at a minimum rate of 15% per year to stay ahead of inflation. The more money you are using for trading. just for the sake of simplicity.2060/What is more. the you do not have to pay any tax on the money you make.2000µ.61.60 because your stock price went up. They just care about whether you are trading.2000. Because brokers basically make money on transactions. Just to give you an idea. tax and brokerage!! Remember this when making all your investments. There is a ´short term capital gain taxµ in our country. So your total investment in the transaction in ´not Rs. You will almost make nothing on a small profit gains! If you want to make money out of the stock market. For a short term (less than one year) you have to pay tax on any capital gain you make though the stock market trading. Now combine this short term capital gain tax with brokerage and inflation! Think about it for some time. when you sell the stocks for Rs. Fundamental Stock Analysis Theory Page 7 . in fact you actually make a loss of Rs. but because they are thinking about their own personal profit! There is even one more factor that eats into your money.60 (3% of Rs. If combine this with the fact that inflation reduces the value of money over time. you have actually made a loss. Important note about brokerage: Brokers make money on whatever transaction you make. Because of this.33 of that to the government!! Please note: The government encourages you to be a long term-investor by having no long term capital gain tax. you are just loosing money if you do not invest wisely without understanding brokerage and inflation.100 though a transaction in the stock market. and the stockbroker charges you a 3% commission. A stockbroker earns a commission on whatever transaction you make. If you make a capital gain by investing for a period greater than one year. Because of this.
P/E Ratio: (Price/ EPS) Also called its "earnings multiple". Book Value The book value of an asset or group of assets is sometimes the price at which they were originally acquired ( historic cost ). P/E gives investors an idea of how much they are paying for a company's earning power. Fundamental Stock Analysis Theory Page 8 . in many cases equal to purchase price. Some expressions of Stock Fundamental Analysis EPS: (Earnings Per Share) The portion of a company's profit allocated to each outstanding share of common stock. Price of a stock divided by its earnings per share. There is lot more to learn! And the best way to do it is to start investing! (Don·t invest too much in the beginning but do start!) Once you have your money in the market. To be classified as a growth stock. a high P/E ratio might show an overvalued stock. some of this money is typically reinvested in the business and called retained earnings. The P/E ratio may either use the reported earnings from the latest year or employ an analyst's forecast of next year's earnings. Analysts compute ROE by taking the company's net income and dividing it by the company's equity. or it might reflect a company with high potential for growth. Growth Stocks Growth Stocks in finance are stocks that appreciate in value and yield a high return on equity (ROE). a corporation that earned $10 million last year and has 10 million shares outstanding would report earnings per share of $1. The amount is computed by dividing net earnings by the number of outstanding shares of common stock. An important notice here is that the P/E ratio is ultimately not an objective measure. For example. When a company earns a profit. analysts expect to see at least 15 percent ROE.This concludes our basics of the stock market guide. and some of it can be paid to its shareholders as a dividend. Dividend Dividend is an amount of the profits that a company pays to people who own shares in the company. you will start to understand things a whole lot better! Best of luck! Jai Hind.
Japanese Candlestick Charting Techniques By Steve Nison. Pring.References on Stock Analysis Mastering Fundamental Analysis By Michael C. Value Investing Today By Charles Brandes. Thomsett. Fundamental Stock Analysis Theory Page 9 . Technical Analysis Explained By Martin J. Reminiscences of a Stock Operator By Edwin Lefevre.
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