Fundamental Analysis of Stock Markets

What are stock markets? What is getting traded there? Stock markets are nothing but selling the ownership of the company. What is valued here? Here it all depends on how you evaluate a company. If you go to a grocery shop you will buy fruits. How do you decide the value of the fruit? It all depends on your needs, also relation between demand and supply. If you get more fruits in the market and if there is a less demand obviously the rate would be lesser. It is same here in stock markets too. More the buyers for a stock in company, more price of the scrip. Why there will be more buyers for a company in the stock market? It all depends on how the buyers give valuations to the company. If they think the company will get more valued in the coming years then the current prince of the company is cheaper and they want to buy.

Still a question hangs, what is the value of a company? A company is of higher value if the net assets of the company are higher. How to value the net assets of a company? Assets of a company means everything that’s owned by the company, includes land, building, infrastructure to even a smaller thing like a pen owned by the company too. So valuations of a company depends upon valuations of many other things that’s owned by the company. valuations of other things depends on the market that those goods are traded. So essentially giving value to a company needs identifying,giving valuations to each of the products that’s traded in the market. How the net assets of a company going to increase? The net assets of a company can increase if the company makes profit. What is the way of making profit? It could be by gains on the capital owned by the company or it could be operating profit. Sometimes value of the land owned by the company increases, that’s a capital gain. They gained profit just because they own that property.

What about operating profit? Each company has its own set of clients, customers. If the company serves its clients or sells its products to lots of customers very well, then the company will make more profit. That’s an operating profit. That’s highly valued in calculating valuations of a company. Higher the operating profit higher the chances of company adding more net assets. How the operating profits can be increased? As it was discussed operating profit of a company depends upon how they serve their clients or how they sell their products to their customers. How a company serve their clients? A company will serve its clients by its employees. How it can be optimized? The way a company serve its clients depends on the process or business model of the company. How those processes are built? How those business model is created? That is created by the leaders in the company.

Who are those leaders in the company? Those are the persons who are chosen to lead the company. There will be CEO, and CFO, HR and many more departments to support him. Who will choose the CEO? It is the directors of the company. Now the final question is who’ll choose the directors? It is chosen by the shareholders of the company. If the shareholders of a company are wise then they’ll choose better directors, better directors will choose better leaders in company like CEO, CFO etc. The team of CEO will make better decisions in serving clients of selling its products to customers, which results in better operating profit. and better operating profit results in adding more to net assets of a company. More the net assets of a company means more the value of scrip of that company in stock markets. It boils down to the fact that it is the persons who owns the shares of the company will decide the share value of that company in the future. It is the shareholders who decide the value of the share in the stock market. Here is another thing to note. Whoever owns more shares int the company has more rights in making decisions in the company.

Now what’s more important is share holding patterns in the company. It is very important to look at the factor who owns most in a company. The future of the company will be decided by those shareholders. What are the important qualities for those shareholders that we should look for? One of the most important thing is how much we can trust them. The trust matters everywhere. Also the person’s ability to perceive business, ability to choose right persons. Finally a fundamental analysis on stock markets needs a better analysis on the person who owns the most shares in a company. It will be more personality analysis, more about the amount of trust he generates, amount of wise decisions he makes for the company. What are stock markets? Stock markets are deciding the shareholders of the company. Essentially stock markets decide the fate of the company.

To put everything together Shareholders -> directors-> CEO and his team -> Way of serving clients and selling products -> Employees -> Operating profit -> Net asset gain -> Value of the stock in stock markets What’s most important in deciding the price of a company? It is the shareholders itself. Better the shareholders, better the prospects of the company. If you think you are better, you deserve to own more in the company Still what happens most of the time is that the most of the time the is that values of each stock deviates from its original price. Then why the fundamental analysis fails? To answer these question we have to examine the new financial instruments that are traded in the stock markets these days. These days stock markets are traded mostly on technical charts rather than the fundamental value of the stock. Let us examine few of those instruments that disturbs the value of a stock artificially. Let me explore these in short here.

  • Day Trading. Day traders just trade on daily basis. The basis of the trade is to either book profit or loss for the day only. Normally brokers give clients large amount of margin money up to 10 times the money they had for the day traders. How the day traders trade normally? They just buy on dips. If they cannot make profit on that day, they just convert into cash and wait for the day they are making profit. If the person has holdings in cash and if he wants to sell, he just sell it as day trade. If his day trade doesn’t make him profit he’ll just convert into cash. Thus it gives him the profit
  • Buy Today Sell Tomorrow( BTST) BTST products are like day trade but with the option of holding the stocks for margin for few days to week. Thus they can take advantage of the fluctuation in the stock markets more efficiently. In these instruments also traders get margin money from brokers
  • Futures and options. In these days futures and options play a very important role in deciding the value of stock markets. These are the instruments that used to hedge the stock market as much as possible. Using these instruments traders make huge amount of money either if the market goes upwords or goes downwords. Thus making them unexpected trade in cash market resulting in stock prices deviating away from their fundamental prices.

Every movement of stock price depends on fundamental factors as well factors that are mentioned here, These technical factors that make traders huge amount of money. So how should the investor look about it? How can he decide the right stock to invest? In these days to make money in stock markets an investor has to take positions in futures and options,even if he is a long term investor.

How Does Your Money Grow In The Stock Market?

Making money is the foundation of every investment that people engage in. There are many investment options available in the market, and the stock market is one of them. The stock market may be very risky but if done correctly, one can get great profits from it. To make the stock market a worthwhile investment, you need to have the patience, skills and the knowledge of how the business operates.

How The Money Grows

Everyone who invests in the stock market wants to know how the money grows. Your money in the stock market grows in two major ways;

1. Increase In Stock Value

Through the increase in your stock value; the stock value is usually determined by the capital appreciation. The capital appreciation is the rise in value of a stock based on the rising market price. The capital appreciation occurs when the original capital invested in the stock has increased in value. Even if the stock value has increased you cannot earn from it unless you sell the shares. When the company does not perform as expected because of the certain factors, the stock price goes down, that is the reason why you need to sell the stock while the stock value is still high.

2. Dividends

The other major investment returns is the dividends paid by the company to their shareholders. The dividends are usually calculated in terms of the company’s revenues. The dividends are usually paid in two forms; the cash or stock dividend. The cash dividends represent the earning declared by the company per stock. Stock dividend on the other hand is the additional stocks that are given to the shareholders free of charge. You can sell the shares at any time after the stocks have been issued. You can earn the dividends quarterly, semi-annually or annually. The dividends can be calculated in a fixed rate or variable rates.

Tips Of Growing Your Money In Stock Market

If you have the skills and the knowledge of the stock market, you can make money from the investment. Below are tips that you can use to grow your money in the stock market.

Choose The Right Strategy

The investing strategy you use in the stock market will determine how much growth you get from the stock market. There are different strategies that you can use to invest in the stock market. There is the buy and hold strategy; this strategy involves you buying stocks and holding them to sell them when the market value increases. Using this strategy will give you high returns from your investment. The other strategy is the market timing strategy that involves predicting the market and how the stocks will trade in the future. It is very risky to use this kind of strategy as there are other unpredictable factors that affect the stock value. Buying low and selling high is another strategy that you may use to grow you money. This strategy uses the supply and demand concept that states; when the demand for a certain stock grows, the supply that is selling of the stock will go high and when the demand (buying) of the stock the supply decreases the supply goes down.

Patience

When it comes to stock market patience, it is a very important virtue to have. This is because it takes time to make a worthwhile profit from your investment in a short period of time. You will have to exercise patience when you lose your investment. The probability of losing money in the stock market is high because the market is unpredictable. So you have to be ready to cut your losses when you lose money.

Timing

The timing on when to buy and sell your stocks may influence how your stock appreciates. There are certain times when you buy the stocks you won’t get any profit. The perfect time to buy or sell your stocks is during recessions. When the market is experiencing recessions, the value of the stock is usually down hence you can buy the stock at this time at a bargain and watch it grow. The other perfect time for buying or selling is when a new company releases its shares. The new companies usually sell their stock at a low price.

The Factors That Affect The Stock Value

Before you can understand how your money grows in the stock market, you have to understand the factors that influence the value of the prices. There are internal and external factors. The internal factors are from within the company and they directly affect the value of the stock. The internal factors include the management, new product or service, signing of new contracts etc. The external factors are factors that can affect the prices of the stocks directly or indirectly. The external factors include news such as, war, terrorism, foreign exchange, inflation and deflation and interest rates.

Stock Market – How to Use Fundamental Analysis to Make Trading Decisions

Stock Analyzing

Investors come in many shapes and forms, so to speak, but there are two basic types. First and most common is the more conservative type, who will choose a stock by viewing and researching the basic value of a company. This belief is based on the assumption that so long as a company is run well and continues turning a profit, the stock price will rise. These investors try to buy growth stocks, those that appear most likely to continue growing for a longer term.

The second but less common type of investor attempts to estimate how the market may behave based purely on the psychology of the market’s people and other similar market factors. The second type of investor is more commonly called a “Quant.” This investor assumes that the price of a stock will soar as buyers keep bidding back and forth (often regardless of the stock’s value), much like an auction. They often take much higher risks with higher potential returns-but with much higher potential for higher losses if they fail.

Fundamentalists

To find the stock’s inherent value, investors must consider many factors. When a stock’s price is consistent with its value, it will have reached the target goal of an “efficient” market. The efficient market theory states that stocks are always correctly priced since everything publicly known about the stock is reflected in its market price. This theory also implies that analyzing stocks is pointless since all information known is currently reflected in the current price. To put it simply:

  • The stock market sets the prices.
  • Analysts weigh known information about a company and thereby determine value.
  • The price does not have to equal the value. The efficient market theory is as the name implies, a theory. If it were law, prices would instantly adapt to information as it became available. Since it is a theory instead of law, this is not the case. Stock prices move above and below company values for both rational and irrational reasons.

Fundamental Analysis endeavors to ascertain the future value of a stock by means of analyzing current and/or past financial strength of a particular company. Analysts attempt to determine if the stock price is above or below value and what that means to the future of that stock. There are a multitude of factors used for this purpose. Basic terminology that helps the investor understand the analysts determination include:

  • “Value Stocks” are those that are below market value, and include the bargain stocks listed at 50 cents per dollar of value.
  • “Growth Stocks” are those with earnings growth as the primary consideration.
  • “Income Stocks” are investments providing a steady income source. This is primarily through dividends, but bonds are also common investment tools used to generate income.
  • “Momentum Stocks” are growth companies currently coming into the market picture. Their share prices are increasing rapidly.

To make sound fundamental decisions, all of the following factors must be considered. The previous terminology will be the underlying determining factor in how each will be used, based upon investor bias.

1. As usual, the earnings of a particular company are the main deciding factor. Company earnings are the profits after taxes and expenses. The stock and bond markets are mainly driven by two powerful dynamisms: earnings and interest rates. Harsh competition often accompanies the flow of money into these markets, moving into bonds when interest rates go up and into stocks when earnings go up. More than any other factor, a company’s earnings create value, although other admonitions must be considered with this idea.

2. EPS (Earnings Per Share) is defined as the amount of reported income, per share, that the company has on hand at any given time to pay dividends to common stockholders or to reinvest in itself. This indicator of a company’s condition is a very powerful way to forecast the future of a stock’s price. Earnings Per Share is arguably one of the most widely used fundamental ratios.

3. Fair price of a stock is also determined by the P/E (price/earnings) ratio. For example, if a particular company’s stock is trading at $60 and its EPS is $6 per share, it has a P/E of 10, meaning that investors can expect a 10% cash flow return.

Equation: $6/$60 = 1/10 = 1/(PE) = 0.10 = 10%

Along these same lines, if it’s making $3 a share, it has a multiple of 20. In this case, an investor may receive a 5% return, as long as current conditions remain the same in the future.

Example: $3/$60 = 1/20 = 1/(P/E) = 0.05 = 5%

Certain industries have different P/E ratios. For instance, banks have low P/E’s, normally in the range of 5 to 12. High tech companies have higher P/E ratios on the other hand, generally around 15 to 30. On the other hand, in the not too distance past, triple-digit P/E ratios for internet-stocks were seen. These were stocks with no earnings but high P/E ratios, defying market efficiency theories.

A low P/E is not a true indication of exact value. Price volatility, range, direction, and noteworthy news regarding the stock must be considered first. The investor must also consider why any given P/E is low. P/E is best used to compare industry-similar companies.

The Beardstown Ladies suggests that any P/E lower than 5 and/or above 35 be examined closely for errors, since the market average is between 5 and 20 historically.

Peter Lynch suggests a comparison of the P/E ratio with the company growth rate. Lynch considers the stock fairly priced only if they are about equal. If it is less than the growth rate, it could be a stock bargain. To put it into perspective, the basic belief is that a P/E ratio half the growth rate is very positive, and one that is twice the growth rate is very negative.

Other studies suggest that a stock’s P/E ration has little effect on the decision to buy or sell stock (William J. O’Neal, founder of the Investors Business Daily, in his studies of successful stock moves). He says the stock’s current earnings record and annual earnings increases, however, are vital.

It is necessary to mention that the value as represented by the P/E and/or Earnings per Share are useless to investors prior to stock purchase. Money is made after stock is bought, not before. Therefore, it is the future that will pay, both in dividends and growth. This means that investors need to pay as much attention to future earnings estimates as to the historical record.

4. Basic PSR (Price/Sales Ratio) is similar to P/E ratio, except that the stock price is divided by sales per share as opposed to earnings per share.

  • For many analysts, the PSR is a better value indicator than the P/E. This is because earnings often fluctuate wildly, while sales tend to follow more dependable trends.
  • PSR may be also be a more accurate measure of value because sales are more difficult to manipulate than earnings. The credibility of financial institutions have suffered through the Enron/Global Crossing/WorldCom, et al, debacle, and investors have learned how manipulation does go on within large financial institutions.
  • The PSR by itself is not very effective. It is effectively used only in conjunction with other measures. James O’Shaughnessy, in his book What Works on Wall Street, found that, when the PSR is used with a measure of relative strength, it becomes “the King of value factors.”

5. Debt Ratio shows the percentage of debt a company has as compared to shareholder equity. In other words, how much a company’s operation is being financed by debt.

  • Remember, under 30% is positive, over 50% is negative.
  • A successful operation with ascending profitability and a well marketed product can be destroyed by the company’s debt load, because the earnings are sacrificed to offset the debt.

6. ROE (Equity Returns) is found by dividing net income (after taxes) by the owner’s equity.

  • ROE is often considered to be the most important financial ration (for stockholders) and the best measure of a company’s management abilities. ROE gives stockholders the confidence they need to know that their money is well-managed.
  • ROE should always increase on a yearly basis.

7. Price/Book Value Ratio (a.k.a. Market/Book Ratio) compares the market price to the stock’s book value per share. This ratio relates what the investors believe a company (stock) is worth to what that company’s accountants say it is worth per recognized accounting principles. For example, a low ratio would suggest that the investors believe that the company’s assets have been overvalued based on its financial statements.

While investors would like the stocks to be trading at the same point as book value, in reality, most stocks trade either at a value above book value or at a discount.

Stocks trading at 1.5 to 2 times book value are about the limit when searching for value stocks. Growth stocks justify higher ratios, because they grant the anticipation of higher earnings. The ideal would be stocks below book value, at wholesale prices, but this rarely happens. Companies with low book value are often targets of a takeover, and are normally avoided by investors (at least until the takeover is complete and the process begins anew).

Book value was more important in a time when most industrial companies had actual hard assets, such as factories, to back up their stock. Sadly, the value of this measure has waned as companies with low capital have become commercial giants (i.e. Microsoft). Videlicet, look for low book value to keep the data in perspective.

8. Beta compares the volatility of the stock to that of the market. A beta of 1 proposes that a stock price moves up and down at the same rate as the market overall. A beta of 2 means that when the market drops the stock is likely to move double that amount. A beta of 0 means it does not move at all. A negative Beta means it moves in the opposite direction of the market, spelling a loss for the investor.

9. Capitalization is the total value of all of a company’s outstanding shares, and is calculated by multiplying the market price per share by the total number of outstanding shares.

10. Institutional Ownership refers to the percent of a company’s outstanding shares that are owned by institutions, mutual funds, insurance companies, etc., which move in and out of positions in very large blocks. Some institutional ownership can actually provide a measure of stability and make contributions to the roll with their buying and selling, respectively. Investors consider this an important factor because they can make use of the extensive research done by these institutions before making their own portfolio decisions. The importance of institutions in market action cannot be overstated, and accounts for over 70% of the dollar volume traded daily.

Market efficiency is a marketplace goal at all times. Anyone who puts money into a stock would like to see a return on their investment. Nevertheless, as before-mentioned, human emotions will always drive the market, causing over- and undervalue of common stocks. Investors must take advantage of patterns using modern computing tools to find the stocks most undervalued as well as develop the correct response to these market patterns, such as rolling within a channel (recognizing trends) with intelligence.