Fundamental analysis basically stock centered in that it concentrates on all financial data and management processes that come from the running of individual companies. In particular this relates to the financial statements, the earnings from sales revenue and all other accounting variables. Because they impact upon all businesses, other variables such as market share, management changes, structure of debt and equity, asset usage, sales and marketing are included in fundamental analysis.
Most investors will use some if not all parts of fundamental analysis before making stock market trades.
The price to earnings ratio is a key element of fundamental analysis. Calculating P/E ratio is simply the face value of a single share of stock divided by the company’s allocation of earnings per share.
Fundamental analysis demands comparison of the current P/E ratio with the historical P/E ratios. If it is consistently lower than 1, warning bells should ring over a business that isn’t growing. Alternatively it may indicate a business where the share price is a bargain currently. It may also imply that the stock is reasonably priced now.
A fundamental analysis of the company’s balance sheet will help to see the liquidity position, a key concept when considering buying any stock. It can show how leveraged the company is and reveal specific asset types and quantities.
The debt-asset ratio is another key concept in a fundamental analysis. It can reveal how much of the company’s assets are not yet in full ownership but rather are bought with debt. It is calculated by dividing the total liabilities by total assets. When this ratio is less than 1 then the majority of company assets are paid for by owners’ money, or equity. Greater than 1 and the debt could be an issue.
The so-called ‘current ratio’ is the converse of the debt-asset ratio. To calculate it is to divide the total assts by the total liabilities. A number greater than 1 is a positive indicator because the company can cover short-term repayments of debt from its current assets. A current ratio less than 1 could indicate a possible cash flow problem. While a number very much higher than 1 could be telling you that assets are somewhat inaccessible and perhaps not being properly utilized.
A fundamental analysis is a very far-reaching audit of company performance and includes other rations such as the ‘acid test’, the ‘shareholder equity’, the ‘working capital’, the ‘turnover’ and the ‘leverage’ ratios.