Aug 14, 2008
The Advantages of the Fundamental Analysis
by Bi3ard / General
Which stocks to buy or how to analyze their value and prices are the common questions that investors often ask. The fundamental analysis in the stock market is the important step in revealing this answers.
Fundamental analysis is actually a stock valuation method that uses economic and financial analysis to predict movement of stock prices.
The fundamental information analyzed within this type of valuation, can include a companies’ financial reports or/and non-financial information such as various estimates of the growth (for example of demand for products sold by the company), industry comparisons, and economy-wide changes, changes in government policies etc.
General Strategy in the Fundamental Analysis
According to the ‘fundamentalists’, the market price of stocks tends to move towards its “real value” or “intrinsic value”. If the “intrinsic” or “real” value of a stock is above the current market price, the investor would purchase the stock because of the fact that the stock price would probably rise and move towards its intrinsic or real value.
For example, if the intrinsic value of a stock is below the market price, smart move for an investor would be to sell the stock because the stock price will probably fall and come closer to its intrinsic value.
But question is how to find out what the intrinsic value of stocks of certain company is? Once that value is revealed, investor would be able to compare this price to the market price of the company and decide whether to buy it or sell it (if investor already owns that stock).
First important step in finding out the intrinsic value of the stock through the fundamental analysis is an examination of the current and future overall health of the economy as a whole.
After analyzing the overall economy state, analysts should analyze the company they are interested in, where the special attention should be given to the analyzing factors that give the company a competitive advantage in its branch, also to the management, experience, history, growth potential, costs, brand name, etc.
These are several questions that anyone who performs fundamental analysis, particularly examination of the company in question:
- Does the company have any competency?
- What advantage the company has over their competitors?
- Does the company have a strong market presence and market share?
- Does the company have to deploy often a large part of their profits and resources in marketing and finding new customers and fighting for market share?
After the analysis of the company and their production, efficiency, market and customer relations, investor will be in a far better position to decide whether the price of the company’s stocks will go up or fall down.
Next step would be analysis of the stocks. There are few tips what shouldn’t be overlooked.
When investing in the stocks, the main goal is to find stocks which price will rise. Moreover, stocks which prices will rise fast.
Important thing to know is that the price of the stock is not important. Some stocks are cheap and some cost more. But, the price of the stock does not make a good stock to buy. What is important is how much the price of the stock is likely to rise.
What is often overlooked in stock prices is the percentage of their rise.
To simplify this:
If the one $500 stock becomes worth $540, then that is 8% rise. This 8% rise only makes $40 to the investor. On the other hand when the same amount is invested in the 50 cent stock and the stock price goes up to $1, that means basically a 100% rise as the stock price has doubled. This 100% rise gives $500 to investor.
But, which is the good way to compare the value of stocks?
The price-to-sales ratio (Price/Sales or P/S) provides a simple approach: taking the company's market capitalization (the number of shares multiplied by the share price) and dividing it by the company's total sales over the past 12 months.
The lower the ratio, the more attractive is the investment. As easy as it sounds, price-to-sales provides a useful measure for sizing up stocks. But investors need to be careful of the ratio's potential pitfalls and possible unreliability.
Tips for P/S ratio
A company with no debt and a low price-to-sales metric is more attractive investment than a company with high debt and the same price-to-sales ratio.
At some point, the debt will need to be paid off and there is always possibility that the company will issue additional equity. New shares will expand market capitalization and drive up the price-to-sales ratio.
So how can investors tell the difference?
There is a method that helps distinguishing "cheap" sales and less healthy ones, burdened with debt. That is a use of enterprise value/sales rather than market capitalization/sales. By adding the company's long-term debt to the company's market capitalization and subtracting any cash, investors get at the company's enterprise value (EV).
EV can be considered as the total cost of buying the company, including its debt and leftover cash, which would offset the cost. EV actually shows how much more investors pay for the debt.
Those were the few basic tips for the fundamental analysis in the stock market.
However, this article has informational purpose only. Before making any decision on investing or self analyzing of market or its trends, it’s recommended that you should consult broker or financial expert.
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