Fundamental analysis of stocks using key stock metrics
Fundamental & technical analysis

Fundamental Analysis Of Stocks Using Key Stock Metrics

Before you start investing your money in any stock, you should do proper research about the company you are investing your money in. But what do you need to consider for that? There are 3 main topics that you need to focus on:

  1. Fundamental analysis of a company’s income statement & balance sheet.
  2. Technical analysis of stock price charts, to identify trends or trend reversals.
  3. The news flow about and reputation of a company.
  4. The long-term perspective and overall trend of the company’s market segment.

In this post, I am going to show you how to dive deeper into the fundamentals of a company and what are the most important key metrics.

Important stock metrics

A quick look on the income statement and balance sheet of a company will provide you a broad overview about the company’s key metrics and its success. It is important not only to look on these metrics of the current year, but also to review them in relation to the last 5-10 years. By doing so, you will get a feeling for the growth rate of the company, and how well it is managed. In the following you will find an overview of the most important key metrics to consider.

Total revenue

The total revenue reflects the total amount of money a company brings in by its sales activities, either from goods or services they sell. To identify, if the company was able to expand its businesses and increase its total revenue over time, it can be reviewed in the perspective of 5-10 years. But an increase of the total revenue does not always lead to higher earnings, e.g. in case higher costs are related with expanding a company’s business.

Gross profit

Gross profit is calculated by deducting all costs from the total revenue, that are associated with producing / making and selling a company’s goods or services. These costs are e.g. material costs, costs for utilities and equipment to produce a product, direct labor costs, any type of commissions, or fees related to selling its products and many more.

EBIT

EBIT = Earnings Before Interest and Taxes is one of the most important key metrics and indicators of a company’s profitability. It is calculated by deducting all expenses (excl. interests & taxes) from the total revenue of a company and reflects a company’s net income before interest and tax expenses are deducted. EBIT in relation to the total revenue of a company provides you a broader perspective about its profitability. Thus, to me a growth of the EBIT is more important, than a growth of the total revenue.

Net income after taxes (NIAT)

Net income describes a company’s profit after all expenses (incl. interests and taxes) have been deducted from the total revenue and is also an important key figure in terms of profitability. It describes what a company earns after all expenses are considered and is also used to calculate earnings per share. I usually review it in relation to the EBIT, to determine a company’s tax burden. To compare different companies to each other you can use profit margin, which expresses the net income in relation to the total revenue of a company.

Equity ratio

The equity ratio is a great measure to determine how leveraged a company is and how well it manages its debts. It is calculated by dividing its total equity by its total assets. The lower the ratio is, the more debt has been used by the company to acquire assets, which results in a higher financial risk. A high ratio (min. 50-70%) reflects, that a company is effectively funded and only a minimal amount of debt is used to acquire assets. In general, I invest in companies with a minimum equity ratio of 20-30%.

PER

The Price to Earnings Ratio (PER) relates a company’s share price to its earnings per share. Thus, it is a great measure to compare different companies from different market segments with each other, or to review it in the perspective of a company’s historical records. A high PER could mean, that a company’s stock is overvalued, or that a higher growth rate of the company is expected, which led to an increase of its stock price already. A low PER in contrast could mean, that a company’s stock is undervalued, or that a lower or even negative growth rate of the company is expected. There is no general definition for the PER, when to consider a company as over-, under-, or fair valued. A common definition for the PER is:

  • PER < 10: undervalued
  • PER = 10-20: fair valued
  • PER > 20: overvalued

PER always needs to be reviewed historically and in relation to a company’s total revenue and EBIT, but also in relation to the general valuation of a market segment. E.g. tech stocks often are rated with a PER greater than 20 and are still fair valued due to their massive growth rates. On the other hand side, a PER below 10 does not necessarily mean, that a company is undervalued. It could also mean, that a company’s business model is not sustainable anymore long-term. Thus, share prices dropped already, while earnings temporarily were not affected yet.

PBR

The Price to Book Ratio (PBR) is calculated by dividing a company’s stock price per share by its book value per share (BVPS) and thus values a company’s market capitalization (market capitalization = number of shares outstanding x current share price) in relation to its book value (book value = total assets – total liabilities). Thus, it expresses, how much of the book value of a company is acquired by an investor, with every euro or dollar invested. A PBR of 1 means, that the current market capitalization of a company is equal to its book value (fair value). Like the PER, there is no general definition for the PBR, when to consider a company as over-, under- or fair valued. A common definition for the PBR is:

  • PBR < 1: undervalued
  • PBR = 1: fair valued
  • PBR > 1: overvalued

Also, the PBR always needs to be reviewed historically and in relation to a company’s total revenue and EBIT, but also in relation to the general valuation outlook of a market segment.

Dividend rate, dividend yield and dividend payout ratio

The dividend rate is the combined total of all dividend payments from a company during one year and is expressed e.g. in euro or dollar. The dividend yield in contrast, relates the dividend rate to a company’s stock price and is expressed as a percentage. In terms of dividends, it is important to analyse the long-term history of a company. Some companies have been paying and increasing their dividend payments for many decades. I personally like to invest in companies with a reliable dividend history, which pay their dividends regularly and increase them annually. But, it is important to consider a company’s dividend payout ratio. A healthy payout ratio is 50-70%, but I would question a payout ratio close to 100%, as this means that close to 100% of a company’s net income is paid out as dividends. In this case, no funds are left to invest in the company’s further expansion and growth.

Summary

Key stock metrics can help to better understand a valuation of a company and support your investment decisions. It is important to put all key metrics in relation to other companies from the same market segment, to find a company that is currently fair valued or even undervalued. Moreover, key metrics should not be the only basis to decide to invest, or not to invest in a stock. Some companies are valued high, considering their key metrics, but investing in their stocks can still provide high returns, due their high growth rates. In addition to that, some companies are always valued higher than other competitors, due to their constantly good news flow and reputation.

A great website to check out stocks and their company’s key metrics is Yahoo Finance.

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