Fundamental Analysis Part Two – Tools

Even if the raw data provided by financial statements contain some useful information, the value of a stock will be easier to understand if a variety of tools is applied to the financial data.

Earnings per Share

The overall earning is not, in itself, a useful indicator of the worth of a company’s stocks. Low earnings that are coupled with low outstanding shares can actually be more valuable than high earnings that are coupled with high outstanding shares. The earnings per share is considered to be a much more useful information than the earnings itself. Earnings per share (EPS) is calculated by dividing the net earnings by the outstanding shares. Although it is useful for comparing two companies, the earnings per share is not the deciding factor to be used when it comes to choosing stocks.

Price to Earning Ratio

The financial tool that shows the relationship between stocks prices and company earnings is called the price to earning ratio (P/E). It is calculated by dividing the price per share by the earnings per share. The P/E shows just how much the investors are willing to pay for a particular company’s earnings. There are various ways to read P/E’s. A high P/E can indicate either the company’s overpricing or the investors’ expectation that the company will continue to grow and generate profits. A low P/E, on the other hand, can indicate either the wariness of investors toward a company or the overlooking of that company. Further analysis is needed to determine the true value of a particular stock.

Price to Sales Ratio

There are other tools that investors can use to judge the worth of a company that has no earnings. The lack of earnings doesn’t necessarily indicate that a company is a bad investment. It could mean that a company is still new and it is still starting to generate business. The price to sales ratio (P/S) is a useful tool that is used to judge the worth of new companies. P/S is calculated by dividing the market cap, which is the stock price multiplied by the outstanding shares, by the total revenues. An alternate method to this is to divide the company’s current share price by its sales per share. P/S indicates the value that the market places on the sales. A lower P/S indicates a better value.

Price to Book Ratio

Due to the potential for future revenue, the value of a growing company is always more than the book value. The book value can be determined by subtracting the liabilities from the assets. The value that the market places on the book value of the company is called the price to book ratio (P/B). It is calculated by dividing the current price per share by the book value per share. A company with a low P/B has a good value and it is often sought after by long term investors who see its potential.

Dividend Yield

There are some investors who look for stocks that can maximize the dividend income. One tool that is used to determine the percentage return that a company pays in the form of dividends is the dividend yield. The dividend yield can be calculated by dividing the annual dividend per share by the price per share of the stocks. Older and well-established companies not only pay a higher percentage but they also possess a more consistent dividend history than younger companies.

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