Fundamental Analysis is a technique that attempts to determine a company’s value by focusing on underlying factors that affect its actual business and its future prospects. Many people are asking on what are the best stocks to buy, fundamental analysis could be the answer.
On a broader scope, you can also perform fundamental analysis on industries or the economy as a whole.
Fundamental analysis serves to answer questions, such as:
- Is the company’s revenue growing?
- Is it actually making a profit?
- Does it have a competitive edge among others in the future?
- Is it able to repay its debts?
- Is it strong enough to stand during economic crisis?
The most successful in investing using Fundamental Analysis is no other than Warren Buffett. He is an American businessman, investor, and philanthropist who serves as the chairman and CEO of Berkshire Hathaway.
Now, lets take a look on some of his milestones:
- By the end of 2013, Buffett had a net worth of $59 billion. On average, he made $37 million a day in 2013, which was fueled by rising stock prices.
- Nearly 94% of his wealth was earned after he turned 60. At 60, he was worth more than $3.8 billion.
- Out of all investing legends, Buffett has the best track record for beating the market. He has crushed the market over the years.
- Warren Buffett has a net worth of more than $87 billion today. His net worth is greater than the economy of the country of Uruguay.
1. P/E Ratio
Price to earnings ratio or what is popularly known as P/E ratio is the most common way of valuating a stock. It is a formula that measures its current price relative to its earnings per share. It simply means, how much investors are willing to pay for a 1 peso earning of a company.
It is also a good strategy to spot an opportunity for an undervalued company which might signal for a good buy or to see an overvalued company that might trigger for investors to sell their shares.
Standard rule, buy a stock that is near or below the P/e ratio of Philippine Stock Exchange Index (PSEI) to consider it as a good buy. Currently, PSEI is at 16.50x P/e and the average range of our market in terms of an average valuation is at 16x P/e – 18x P/e.
THIS IS THE FORMULA:
P/E= current price÷ earnings per share
(4 quarters/12 months)
You can also check the “earnings per share” of a stock by going to PSE Edge website or you can just go to Wall Street Journal to get the information without calculating them yourself.
When our stock market was going down last year, we were looking for the bottom level to see when would it possibly drops further. Around September 2018, we noticed that even though it keeps on dropping it was still overvalued on 17x P/e at that time, than most Asian stock markets that were at 15x P/e.
So we expected that 6,800 level could be the bottom, because it might follow the whole Asian market’s valuation.
True enough, it went down that level and it went up after that.
THINGS TO REMEMBER:
1. P/E ratio is good when you compare one company to another on its similar sector such as banking, holdings, property, mining, etc.
One way to know when it is overpriced is when the average P/E ratio in that sector climb far above the average.
2. Growth stocks like Double Dragon (DD) normally has higher P/E.
3. Companies that are losing money do not have P/E ratio or has a negative P/E.
4. A low P/E ratio doesn’t always mean that the stock is already cheap.
It can also mean that people are not yet interested in the stock. Many investors made their fortunes spotting these ignored but fundamentally good stocks before the rest of the market discovered their true worth.
5. A high P/E ratio doesn’t always mean that the stock is already expensive or overpriced.
It can also mean that investors are anticipating for a future significant earnings and they are willing to pay the price.
2. Book Value
An asset’s book value is equal to its carrying value on the balance sheet and companies calculate it netting the asset against its accumulated depreciation. Book value is the net asset value of a company calculated as total assets minus intangible assets and liabilities.
To make it simple, when the company is liquidating its assets, shareholders will get paid through its current book value.
Many people used this as a “fair value” of a certain stock to know if the stock is currently cheap or it is already expensive to buy.
Calculation:
(Assets-Liabilities-Preferred Stocks)/Outstanding Shares
Looking on the chart below, we can see that Philippine Infradiv Holdings (IRC) at Php 2.19 is very cheap compared to its current book value at Php 6.94. If you buy this stock from its current price and you set your selling price at its book value, you could possibly have more than 200% return of profit to anticipate.
3. Current Earnings
Revenue is very important factor in Fundamental Analysis. A good and growing company should have a profit that is accelerating quarterly. An outstanding quarterly income is also very attractive for both quick traders and long term investors.
For example, when Alliance Food Select (FOOD) posted a 436.50% net income on the second quarter in August 14,2018, the stock price became the top gainer that day and it was up 38.21% the same day.
4. Par Value
Par value is a per share amount appearing on stock certificates. In the case of common stock the par value per share is usually a very small amount such as 0.10 or 0.01 or 1.00 and it has no connection to the market value of the share of stock. It is also called the “face value” of the stock because it will determine how much you really own.
For example, if you own 100 shares of Ayala Land (ALI) at a Par value of 1.0, it means that you own 100 shares. However, if you own 100 shares of Ayala Land at a Par value of 0.50, it only means that you just own 50 shares. This is important because Par value is commonly used in substantial transactions such as an acquisition or a tender offer.
For instance, On the acquisition of Chealsea Logistics Holdings Corp. (CLC) to Starlite Ferries, Inc., the transaction was quiet overpriced since the purchase amount (400/share) was 3x higher than its Par value (Php 100). As much as possible, an ideal transaction should be nearest to its Par value.
As we can see, starting from when the deal was disclosed (since we considered it as a substantial transaction), market reacted negatively and it did not go well with CLC’s stock price as investors were selling down their shares.
YOU CAN ALSO READ THIS BLOG TO START INVESTING IN STOCKS: GETTING STARTED IN THE STOCK MARKET
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