Fundamentalists buy and sell shares based on pragmatic analysis and common sense. Share market greats like Warren Buffet through their company new letters and media releases have given considerable insight into the way they approach the share market. They made their money by going against the trend. When greed and fear rules the market, fundamentals of the companies are ignored. This provides great opportunity for making money for the fundamentalists. Because market always return to the basics, when reality strikes. Below are some of the factors considered in fundamental analysis of shares
This ratio shows how many times the share price is to the earnings per share. For example if P.E Ratio is 25, it means that share price is 25 times the earnings per share. This is a good indication on whether the share is overvalued or undervalued. If the P.E ratio is high it could be because investors are expecting that the company’s future prospects are good. Buying stocks with low P.E ratio has better chances of making money especially when one can get blue chip stocks.
Companies have low P.E’ s for a variety of reasons. It could be because the industry the company is in , is out of favour at the moment. Or it could be because company decided not to give dividend in the financial year. A dip in projected earnings in the future could be a most likely reason .
If the long term prospect of the company is good , look for stocks with P.E ratio under 15 . When I am writing this article the world is recovering from the worst financial crisis and most of the blue chips traded in Australian stock exchange has P.E ratio below 15 . This is a good indication that these stocks will outperform anybody’s expectation in the near future.
This does not mean that companies with Higher P.E ratio are not investment materials. It may only mean that these companies are considered as secure bets by the investing community. So other factors also need to be considered before buying a stock.
Some companies exhibit good record of consistent profit and a potential for future growth . Another indicator to consider is the profit growth of the company each year and the relative positioning of the company in its field. For example Woolworths with good management has consistent profit growth over the years and expanded their business considerably . At the same time Coles on the other hand, had minimal profit growth and an outdated marketing strategy before the take over .
Check the net asset backing of the companies you plan to invest. For example if the company’s share price is $5 and net asset backing is $2 per share, P.A ratio is 2.5 . If the net asset ratio is below 1 it means that you are buying into the company at a discount price.
Investing in penny stocks
Fortescue Mining was once a penny stock, which made many millionaires when the share price picked up, but these things happen only once in five year or ten years . If you are not someone who can get share market information before hand, it is best to avoid buying into penny stocks especially in mining exploration companies. These companies may go bust at any time. Your money will be safer with Blue chips. But if you are a large scale investor, a small percentage of money could be invested in these stocks, because if you gambled right your money could become even 1000 times in the flick of an eye .
Long term investors expect the share price to grow over the years and get a dividend from the companies they invest. Dividend yield is a good indication of the returns you can get from your investment. There are companies that outperform the bank interest rates consistently.
Debt to equity ratio
All companies borrow to expand. There was a time taking risk was considered as a no go zone for companies. Now a days is it risk management rather than no risk. Debt to equity ratio also shows the long term sustainability of the business . Highly geared companies struggle when interest rates go up or when refinancing becomes an issue. The recent examples are ABC learning and Babcock and Brown
Debt to equity ratio = Total Liabilities/ Share holder equity
The ideal ratio is any where near 50%
Current ratio = Current assets / Current Liabilities
This ratio shows the company’s ability to pay current liabilities. This ratio is considered good when it is 2 or more
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