One way to evaluate stocks and other investments is to use fundamental analysis.
Fundamental analysis is one way to determine an investment’s “intrinsic” value. When using fundamental analysis, investors attempt to figure out whether a stock is undervalued or overvalued compared to its price. If you decide the stock is undervalued, buying it can be a good choice. On the other hand, an overvalued stock might not be a good addition to your portfolio.
Let’s take a look at how to use fundamental analysis in your investment decisions.
What is Fundamental Analysis?
Fundamental analysis focuses on the underlying factors that impact a stock. It’s different from technical analysis, which looks at historical data and tries to find patterns. Many long-term, buy-and-hold investors prefer fundamental analysis.
When using fundamental analysis, you should focus on where the company fits into broader industry and economic trends. You’ll also look at things that might impact the overall running of the company.
Some items to consider when you use fundamental analysis include:
- How the company is managed
- Balance sheet and financial statement information, including profits, losses, debt, and equity
- P/E ratio, earnings per share, and other measures to compare the company to the industry
- How the company is positioned relative to economic conditions
4 Measures to Use in Fundamental Analysis
While you can look at qualitative information, such as management, you might also want to review more qualitative measures. Here are four different measures to consider using in fundamental analysis. Use them together to get a picture of a stock. Then, consider other external and internal factors.
Earnings per share (EPS)
Look at the profits of the company and divide it by the number of outstanding shares. Often you can find EPS information on the internet for different companies. Compare the EPS to similar companies in the same industry or sector. This will give you an idea of how well the company is performing relative to its peer companies.
Price to earnings (P/E) ratio
This is one of the most popular measures to use in fundamental analysis. To calculate, you just divide the price of the stock by earnings per share. There are different ways to use P/E ratio. Because stocks change price, this can change regularly. But it provides a snapshot of the moment.
A high P/E ratio might indicate the stock is overvalued. A low P/E ratio could indicate a good buy. Again, comparing to other companies provides additional context.
Debt to equity ratio
Divide the total debt (liabilities) by total shareholder equity to get this ratio. While most companies carry debt, the idea is to keep it under control. A ratio below one is consider relatively safe. Anything above two is thought risky. Use debt to equity for a quick overview of how safe a company might be.
Return on equity (ROE)
You’ve head of return on investment (ROI). Return on equity looks at how profitable a company is with its shareholder investments. Divide net income by shareholder equity to get this number. This is another way to see how a company compares to similar companies. In general, choosing a stock with better ROE is likely better for your portfolio.
Do You Need to Use Fundamental Analysis?
Not every successful investor evaluates every stock this way. In some cases, investors prefer index funds. This offers diversity with minimal effort. Even stock pickers might want other tools. For example, an app like Giselle Intel might help identify likely stocks.
Tools like Giselle Intel and stock screeners allow you to research stocks without doing all the calculations yourself. An app like Giselle Intel uses concepts of fundamental analysis to make recommendations. You end up with research to improve your portfolio. But without doing all the work yourself.
Using fundamental analysis is a way to gain context about investments. However, you don’t need to analyze every stock yourself. In fact, you might not have time to that.
No matter how you choose investments, though, a fundamental approach can help. When you choose an analysis style, it helps you:
- Create a plan for choosing investments and deciding when to buy and sell
- Reduce the emotion involved with investing
- Stick to your portfolio strategy
- Avoid trying to time the market
Once you choose a style, use tools to make it easier to research stocks. Most brokers offer screeners. There are apps that can help you use measures like P/E ratio and ROE to narrow down a search.
The key is to understand how fundamental analysis works and how it can be used to identify investments that will help you reach your portfolio goals.