Evaluating stock fundamentals
E*TRADE from Morgan Stanley
Fundamental analysis is the cornerstone of investing. The health of a company and its stock are important factors to consider when trading.
What are the benchmarks of fundamental analysis?
When you look at the current and future financial prospects of a company and its stock offering, there are a few tried-and-true performance measurements and benchmarks that every fundamental analyst examines.
Market cap (capitalization)
- What it means: This is the total market value of the shares outstanding of a publicly traded company. It’s equal to the share price, multiplied by the number of shares outstanding.
- Why it’s important: The size of a company may help assess risk. Although it’s certainly not always true, many market experts contend that the bigger the company, the lower the risk.
- Good to know: Stock of companies with a market cap of $10 billion or more are called “large cap” or “big cap” stocks.
Earnings-per- share (EPS)
- What it means: This is the portion of a company’s profit allocated to each outstanding share of common stock, which is often viewed as a strong indicator of profitability.
- Why it’s important: This is an important variable when determining a share’s price, but shouldn’t be the only factor. A higher EPS number indicates greater profitability.
- Good to know: This fundamental should be carefully evaluated. Investors should look at exactly how the profits were generated, future earnings outlooks, and other metrics.
Price-earnings ratio (P/E)
- What it means: This is the ratio for valuing a company based on its share price relative to its earnings-per-share. This is used to determine what investors are willing to pay for a stock, based on earnings.
- Why it’s important: Although there are many factors when assessing a stock, many investors see a P/E ratio as an indicator of whether the stock may be a good value.
- Good to know: When comparing similar stocks in the same industry and of the same size and scope, a P/E may help you narrow your choice.
- What it means: For stocks that pay an annual dividend, this indicates how much a company pays out in dividends relative to its share price. Dividends are not guaranteed—companies can suspend dividends in times of financial difficulties.
- Why it’s important: This percentage can help investors measure how much cash flow they are getting from each dollar invested in a dividend-paying stock. The higher the yield, the greater the dividend return.
- Good to know: Generally, stocks with less growth potential pay higher dividends, while stock with high growth potential don’t pay dividends (the appeal of these stocks is usually the potential for stock price appreciation).
While there are many more indicators that may be considered when evaluating a company’s overall financial picture, these fundamentals are an excellent place to start.