There are so many fundamental analysis parameters that can be used to ascertain the financial health

of a company. The most popular ones are geared toward growth, earnings, and market value.
Understanding these key indicators can help you make more informed buy or sell decisions.
1. Earnings per Share (EPS)

This is the portion of a company’s profit that is assigned to each share of its stock. It’s essentially the
bottom line net income, just on a per-share basis. A growing EPS is a good sign to investors because it
means that their shares are likely to be worth more.

You can calculate the earnings per share of a company by dividing its total profit by the number of
outstanding shares. For example – If the company reports a profit of $350 million and there are 100
million shares, then the EPS is $3.50.
2. Price to Earnings Ratio (P/E)

The price-to-earnings ratio measures the relationship between the stock price of a company and its
per-share earnings. It helps investors determine if a stock is undervalued or overvalued relative to
others in the same sector. Since the P/E ratio shows what the market is willing to pay today for a
stock based on its past or future earnings, investors simply compare the P/E ratio of a stock to those
of its competitors and industry standards. A lower P/E ratio means the current stock price is low
relative to earnings, which is favorable to investors.

The Price to Earnings Ratio is calculated by dividing the current price per share of a stock by the
company’s earnings per share. For example – If a company’s stock currently sells for $70 per share
with earnings per share of $5. The P/E ratio amounts to 14 ($70 divided by $5).

There are two main types of PE ratios; forward-looking and trailing PE ratio. The difference between
the two has to do with what types of earnings are used in the calculation. If the one year projected
(future) earnings are used as the denominator in the calculation, then the result is a forward-looking
PE ratio. Whereas, if the historical trailing 12-month earnings are used, then you’ll get the trailing PE
ratio as the result.
3. Projected Earnings Growth (PEG)

The P/E ratio is a good fundamental analysis indicator but is somewhat limited by the fact that it
doesn’t include future earnings growth. The PEG compensates for this by anticipating the one-year
earnings growth rate of the stock. Analysts can estimate the future growth rate of a company by
looking at its historical growth rate. This provides a more complete picture of a stock’s valuation. To
calculate Projected Earnings Growth, divide the P/E ratio by the company’s 12-month growth rate.
The percentage of the growth rate is removed from the calculation.

For example, if the growth rate is 10% and the PE ratio is 15, then the PEG formula looks like this:

PEG = PE Ratio / Earnings Growth

PEG = 15 / 10 -> notice how the 10% turns into just 10
PEG = 1.5

The general rule of thumb is that when a stock’s PEG is above 1 it is considered overvalued. Whereas,
if it’s below 1, it is considered undervalued.
4. Free Cash Flow (FCF)

In simplest terms, Free Cash Flow is the cash left over after a company has paid for its operating
expenses and capital expenditures. Cash is critical to the sustenance and amelioration of a business.
Companies with high free cash flow can improve shareholder value, fund innovation, and survive
downturns better than their less-liquid counterparts. Many investors cherish FCF as a fundamental
indicator because it shows whether a company still has enough cash to reward its shareholders
through dividends after funding operations and capital expenditures.
FCF is calculated as Operating Cash Flow minus Capital Expenditures (CAPEX) as recorded on the cash
flow statement. It can also be deduced from the Income statement as Net Operating Profit After
Taxes (NOPAT) plus depreciation, minus working capital and capital expenditure (CAPEX). Examine the
statement and formulas below. We’ll calculate the 2015 FCF:

NOPAT = EBIT – Tax

NOPAT = 1,105 – 332 = 774

Income Statement Example

Income Statement Example | Source: My Accounting Course

FCF = NOPAT + Depreciation – (Working capital and CAPEX)

FCF = 774 + 50 – (120 + 30) = 674

Free Cash Flow Formula

FCF Calculation Example | Source: My Accounting Course
5. Price to Book Ratio (P/B)

Also known as the price-to-equity ratio, the price-to-book ratio is a fundamental analysis indicator
that compares the book value of a stock to its market value. By showing the difference between the
stock’s market value and the value the company has stated in its financial books, P/B helps investors
determine whether the stock is under or overvalued relative to its book value. It is calculated by
dividing the stock’s most recent closing price by the book value per share as listed in the company’s
annual report. Book value is calculated as the cost of all assets minus liabilities. It is the theoretical
value of a company if it will be liquidated.

However, the price-to-book ratio of a particular company is not useful just by itself. An investor needs
to compare a company’s P/B ratio to others within the same sector or industry. Only then will it be
useful in determining which company may be undervalued or overvalued relative to others.
6. Return on Equity (ROE)

ROE is a profitability ratio that signifies the rate of return a shareholder receives for the portion of
their investment in that company. It measures how well a company generates positive returns for its
shareholders’ investments. Since profit is an actual driver of stock prices, separating out the profits
earned with shareholder equity is actually a pretty good indicator of the financial health of a company
and the fair value of its stock. You can calculate Return on Equity by dividing net income by average
shareholders’ equity.
The DuPont analysis further expands on the calculation by adding several variables to help investors
better understand the company’s profitability. This analysis looks at these main components:

ROE = Net Income / Equity, which can be further broken down into:
Profit Margin = Net Income/Revenue
Turnover Ratio = Revenue/Assets
Leverage = Assets/Equity

The expanded ROE formula when doing the DuPont analysis looks like this:

ROE = Profit Margin x Turnover Ratio x Leverage

ROE = Net Income/Revenue x Revenue/Assets x Assets/Equity
ROE = ROA x Assets/Equity

Using the DuPont analysis an investor is able to determine what’s driving the ROE. Is it a high-profit
margin and/or very quick turnover ratio and/or high leverage?

Another important part of understanding the ROE is that it’s ultimately the return on assets (ROA)
multiplied by the leverage. ROA is a financial ratio that measures a company’s profitability by
calculating the amount of profit (net income) the company generates in relation to the number of
assets it has. It is expressed as a percentage and can be calculated by taking the company’s net
income and dividing it by the company’s total assets. A higher ROA percentage indicates that a
company is using its assets more efficiently to generate profit.

Here are the formulas that tie this in with the DuPont analysis:

ROA = Profit Margin x Turnover Ratio

ROA = Net Income/Assets

This translates to:

ROE = ROA x Leverage

ROE = ROA x Assets/Equity

7. Dividend Payout Ratio (DPR)

As you know, companies pay a part of their profits to their shareholders in the form of dividends. But
it’s also important to know how well the company’s earnings support those dividend payments. This is
what the Dividend Payout Ratio is all about. It tells you what portion of net income a company returns
to its shareholders, as well as how much it sets aside for growth, cash reserve, and debt repayments.
DPR is calculated by dividing the total dividend amount by the company’s net income in the same
period. It’s usually calculated as an annual percentage.
8. Price to Sales Ratio (P/S)

The price-to-sales ratio is a fundamental analysis indicator that can help determine the fair value of a
stock by utilizing a company’s market capitalization and revenue. It shows how much the market
values the company’s sales, which can be effective in valuing growth stocks that have yet to turn a
profit or aren’t performing as expected due to a temporary setback. The P/S formula is calculated by
dividing sales per share by the market value per share. A lower P/S ratio is seen as a good sign by
investors. This is another metric that’s also useful when comparing companies in the same sector or
industry.
9. Dividend Yield Ratio

The dividend yield ratio looks at the amount paid by a company in dividends every year relative to its
share price. It is an estimate of the dividend-only return of a stock investment. Assuming there are no
changes to the dividend, the yield features an inverse relationship with the stock price — the yield
rises when the stock price falls and vice versa. This is important to investors because it tells them how
much they are getting back from every dollar they’ve invested in the company’s stock.

The dividend yield ratio is expressed in percentage and is calculated by dividing the annual dividend
per share by the current share price.
For example, 2 companies (X and Z) pay an annual dividend of $3 per share. Company X’s stock trades
at $60 per share, while Company Z’s stock trades at $30 per share. This means Company X’s dividend
yield is 5% (3/60 x 100) and Company Z’s dividend yield is 10% (3/30 x 100). As an investor, you would
likely prefer Company Z’s stock over Company X’s all else being equal, since it has a higher dividend
yield.
10. Debt-to-Equity Ratio (D/E)

The debt-to-equity ratio is the last fundamental analysis indicator on this list. It measures the
relationship between a company’s borrowed capital and the capital provided by its shareholders.
Investors can use it to determine how a company finances its assets. The debt-to-equity ratio (D/E)
helps investors evaluate the financial leverage of a company, signalling just how much shareholder’s
equity can fulfil obligations to creditors should the business encounter financial hardship.

You can calculate the ratio by dividing the total liabilities by the total shareholder equity. Check out
the consolidated balance sheet below. It shows that Apple Inc. recorded a total of $241 billion in
liabilities (highlighted in red) and total shareholders’ equity of $134 billion (highlighted in green).
Based on these figures, debt-to-equity ratio = $241,000,000 ÷ $134,000,000 = 1.80
Apple Balance Sheet

The first step in fundamental analysis is to analyse the company qualitatively. For this purpose, the
answers to the following questions are determined.

How efficient is the company in terms of operations?

What is the quality of its key management personnel?
How does the brand value of a company appear?
Does the company use any exclusive (proprietary) technology?
What socially responsible initiatives is the company undertaking?
What is the company’s vision for the future?

After determining the answers to these questions and considering the answers are good, you move
on to the next step.
Quantitative analysis

There are various factors that are analysed in quantitative analysis. Let’s look at all of them step-by-
step.
Check financial statements

There are numerous financial statements of a company. However, there are three primary financial
statements that a company presents to display its performance.
1. Profit and loss statement
P&L statement of ITC on Tickertape

The profit and loss statement is commonly referred to as the income statement, P&L statement,
operation statement, and earnings statement. It usually consists of –

The revenue of the company for a certain time period (quarterly or yearly)
Tax and depreciation
The Earnings Per Share (EPS) number
The expenses incurred to generate the revenues

It gives you insight into a company’s profitability and articulates the company’s bottom line. There are
various parameters in a P&L statement. Depending on the industry, we measure different parameters.
However, the main parameters that we measure for all companies to check the profitability are
revenue, Profit Before Interest and Tax (PBIT), and net income.

For a successful company, these three factors should always appreciate. After analysing these three
factors, you can also analyse the trend in net profit for the last 5-10 yrs and operating profit to have a
deeper understanding of the P&L statement.
2. Balance Sheet
Balance Sheet of ITC on Tickertape

A balance sheet displays a company’s assets, liabilities, and shareholder’s equity at a specific point in
time. In a balance sheet, at any point in time, the total assets of a company should always be equal to
the company’s liabilities, including shareholder’s equity. Hence, the name ‘balance sheet’.

If they are not balanced, there may be some issues, including incorrect or misplaced data,
miscalculations, or exchange rate or inventory errors. Hence, in a balance sheet,

Assets = Liabilities + Shareholders’ Equity

A balance sheet tells what a company owns, what it owes, and what it is worth as a company. To
determine if a company is worth investing in, we look at the total assets and total liabilities of the
company.

If a company’s assets are higher than the liabilities, you can mark the company as ‘good for further
assessment’. However, if the liabilities are higher, it is usually considered ‘not worth investing’. For a
deeper analysis of the balance sheet, various financial ratios, such as debt to equity ratio, return on
equity, etc., are used.
3. Cash-flow Statement
Cash flow statement of ITC

A cash flow statement shows the movement of money in and out of business. A cash-flow statement
determines a company’s financial health. It helps you in analysing a company’s liquidity. The cash flow
statement shows the net change in cash, which is usually divided into cash from operating activities,
investing activities and financing activities.

For the analysis purpose, we check the factor ‘Free Cash Flow’. A positive cash flow indicates that the
company’s assets are growing from where they started. In contrast, a negative cash flow indicates
otherwise.

You can check all these financial statements of a company on Tickertape. Using the search bar, enter
the company you wish to analyse. Click on ‘Financial Statements’ from the stock page to access the
income statement, balance sheet, and cash flow.
Annual Report and Investors’ Presentation

An annual report is a comprehensive document that a company must provide to all its shareholders
annually. It describes their operations throughout the year. You can determine the company’s
financial health with the help of an annual report.

The intent of a company’s annual report is to provide public disclosure of its operations and financial
activities over the past year. There are numerous components of an annual report. As an investor, you
should look for the business overview, financial/performance highlights, Management Discussion and
Analysis (MD&A), Director/Board’s report, notes to accounts, auditor’s report, Chairman’s statement,
and debt scenario. The annual report provides valuable information which you can use to analyse the
company thoroughly.

Investors’ presentation consists of facts about the company, immediate sales growth opportunities,
industry analysis, management team, all-round performance, innovations, future plans and more. It is
important to note that not every company provides investors presentations to its shareholders.
Investors’ presentation is a brief, clear, informative resource to understand the business.

To get annual reports and investors’ presentations of a company, click on ‘Financial Statements’ of
stock on Tickertape and scroll down to the bottom. You will get the company’s annual reports and
investors’ presentations.
Annual reports and investors’ presentations on Tickertape
Growth over the period of 3 and 5 yrs
Stock page of Hindustan Unilever Ltd on Tickertape

After analysing the financial statements and annual reports, you can analyse the growth in the share
price of a stock for 3-yr and 5-yr periods. If a company has shown positive growth in all the previous
steps, it is highly likely that it has had an upward trend in its stock price for the previous 3 yrs and 5
yrs. For the purpose of fundamental analysis, we always analyse the long-term growth of the share
price.
Financial ratios

Financial ratios are helpful in determining the performance of a company. They are the best ways to
analyse financial statements. Benjamin Graham, popularly known as the father of fundamental
analysis, has made the use of financial statements popular. The ratios help in the competitive analysis
of a company. Further, you can also analyse a company’s performance by analysing its financial ratios
trend.
A. Profitability ratios

As the name suggests, profitability ratios determine the profitability of a company. The ratios reveal
the performance of a company in terms of generating profits. They also convey the competitiveness
of the management. There are various profitability ratios. For the purpose of fundamental analysis,
here are four profitability ratios.
1. PAT margin

Profit After Tax (PAT) margin is calculated by deducting all company expenses from its total revenue.
It identifies the overall profitability of a company. The formula to calculate the PAT margin is,

PAT margin = [PAT / Total revenue]*100

The higher the PAT margin, the better the profitability of a company. It is referred to as Net Profit
Margin (NPM). It should be compared with the previous years’ trends or competitors to understand
more deeply.
2. Return on Equity (ROE)

It is a critical ratio that assesses the return earned by the shareholders on every unit of capital
invested. ROE is useful in measuring the company’s ability to generate profits from the shareholders’
investments. It represents the efficiency of a company in generating profits for its shareholders. It is
calculated as,

ROE = [ Net income / Shareholders’ equity ] * 100

To calculate the shareholders’ equity, subtract a company’s total liabilities from its total assets. You
can get this information from the balance sheet.

Shareholders’ equity = Total assets – Total liabilities

High ROE signifies good cash generation by the company, conveying a good performance by
management, whereas low ROE indicates otherwise. ROE of a company can also be compared with its
competitors and past years’ trends to get a better understanding.
3. Return on Assets (ROA)

It is a profitability ratio that measures the profitability of a company in relation to its total assets. It
shows if the company is using its assets efficiently to generate profits. To calculate the ROA, divide a
company’s net income by its total assets.

ROA = Net income / Total assets

The higher the ROA, the more efficient management is in utilising the economic resources. Both ROE
and ROA reflect how well a company utilises its resources. However, there is one key difference which
is the way they treat a company’s debt. ROA captures how much debt a company carries as its total
assets include all kinds of capital. On the other hand, ROE leaves out all the liabilities and only
measures the return on a company’s equity.

If a company has more debt, its RoE would be higher than its ROA.
4. Return on Capital Employed (ROCE)

It is useful in understanding how well a company is utilising its capital to generate profits. It takes into
consideration all kinds of capital, including debt. To calculate ROCE, divide Profit Before Interest and
Tax (PBIT) by the total capital employed.
ROCE = PBIT / Total capital employed

Where the total capital employed = Equity + short-term debt + long-term debt

PBIT is also known as Earnings Before Interest and Tax (EBIT). You can find this information in the
income statement of a company.

A higher ROCE suggests efficient management in terms of capital employed. However, a lower ROCE
may indicate a lot of cash on hand as cash is included in total assets. As a result, high levels of cash
can sometimes skew this metric.
B. Leverage ratios

Often referred to as solvency ratios, leverage ratios measure a company’s ability to sustain its day-to-
day operations in the long term. It measures a company’s financial health by determining its ability to
meet its long-term debt obligation. Let’s look at two leverage ratios that will help us determine the
potential company to invest in:
1. Debt-to-equity ratio

It is one of the prominent ratios in fundamental analysis and is often referred to as the risk ratio. The
debt-to-equity ratio calculates the weight of a company’s total debt against total shareholders’
liabilities. It is calculated as

Debt-to-equity ratio = Total debt / Shareholders’ equity

Where the total debt = short-term debt + long-term debt + fixed payment obligations

A value of one on this ratio signifies that there is an equal amount of debt and equity capital. A higher
ratio (more than 1) indicates higher leverage, whereas a lower than 1 signifies a relatively bigger
equity base with respect to debt. The maximum acceptable debt-to-equity ratio for many companies
is between 1.5-2 or less. For larger companies, debt to equity ratio of 2 or higher is acceptable.
Ultimately, an ideal debt-to-equity ratio varies across companies based on the sector they belong to.
2. Interest coverage ratio

Often referred to as the debt service ratio or the debt service coverage ratio, it gives insights into how
easily a company can repay the interest on its outstanding debt. The interest coverage ratio
determines the time (typically number of quarters or years) for which interest payment can be made
with the company’s current available earnings. It is calculated as

Interest coverage ratio = EBIT / Interest expense

The lower the ratio, the more the company has a debt burden. The company’s ability to pay back the
debt is questionable when the interest coverage ratio is only 1.5 or lower. The analysts usually prefer
an interest coverage ratio of 2 or more.
C. Operating ratios

Often referred to as activity ratios, they measure the efficiency at which a business can convert its
assets into revenues. Operating ratios help us understand the efficiency of a company’s management.
Profitability ratios convey the company’s efficiency, which is generally determined by measuring the
operating ratios. Hence, it is difficult to classify these ratios.
1. Working capital turnover

To run a company’s day-to-day operations, working capital is required. The working capital turnover
ratio measures how much revenue a company generates for every unit of working capital. It is
commonly referred to as net sales to working capital. The formula to calculate it,

Working capital turnover ratio = Revenue / Average working capital

The higher the working capital turnover ratio of a company, the better sales it can generate in
comparison with the funds they have used to execute the sales.
2. Total assets turnover

This ratio indicates a company’s ability to generate revenues with the given amount of assets. It is a
ratio of the total sales or revenue of a company to its average assets. The total assets turnover ratio is
calculated annually. It is calculated as

Asset turnover ratio = Operating revenue / Average total assets

A higher total assets turnover ratio conveys that a company is using its assets efficiently to generate
more sales, whereas a lower ratio indicates a company’s inability to use its resources effectively.

This ratio tends to be higher in certain sectors. For example, sectors like retail usually have small asset
bases but higher sales. Hence, they have the highest asset turnover ratio. Conversely, sectors like real
estate and utilities have large asset bases, thus, low asset turnover.
D. Valuation ratios

Valuation ratios measure a company’s worth. It analyses whether a company’s current share price is
perceived as its true value. It compares the cost of security with the perks of owning the stock. Let’s
explore some valuation ratios.
1. Price to Earnings ratio (P/E ratio)

It is a popular ratio that analyses a company’s share price to its earnings per share. Due to its
popularity, it is often called a ‘financial ratio superstar’. It helps in determining if a stock is
undervalued or overvalued.

P/E ratio = Market value per share / Earnings per share

To determine if a stock is undervalued or overvalued, the P/E ratio of that stock is compared with
other stocks of the same industry and/or with the sector P/E. A high P/E ratio could mean that the
stock price is relatively higher than its earnings and possibly overvalued. In contrast, a low P/E ratio
might indicate the stock’s price is low relative to earnings and perhaps undervalued.
2. Price to Sales ratio (P/S ratio)

It compares the stock price of a company to its revenue. It helps in determining how much an investor
is willing to pay per rupee of sales. The formula for the P/S ratio is

P/S ratio = Current share price / Sales per share

Where the sales per share = Total revenues / Total number of shares

It is better to compare the P/S ratio of similar companies in the same industry to get a deeper
understanding of how cheap or expensive the stock is. The higher the P/S ratio, the higher the
valuation of the company. Conversely, a low ratio indicates the stock is undervalued.
3. EV/EBITDA ratio

Enterprise Value (EV) measures a company’s total value. It is compared with a company’s EBITDA to
determine how often an investor has to pay EBITDA if they were to acquire the entire business.

Similar to the P/E ratio, the lower the EV/EBITDA, the lesser the company valuation. A high EV/EBITDA
signifies that a company is highly likely to be overvalued. This ratio is used in comparison with other
companies in the same sector. Hence, cross-sector comparison won’t be helpful. It is commonly used
to figure out what multiple a company is currently trading at.