Do it yourself fundamental stock analysis

Because of the Internet and online investment accounts, more and more people are investing in the stock market and doing it without the help of a stockbroker. Using the Internet to purchase stocks allows the investor to execute trades faster and save money on full service brokerage fees. The only drawback to this type of investing is that the investor usually does not have access to the financial analysis and research of the full service firms. Simply put, they have to make decisions on their own.

Well, this doesn’t have to be a problem. By learning a few key concepts and financial ratios, investors will be able to analyze stocks on their own. Let’s take a look at where investors can find this information.

The financial statements of a company are the most useful tools in analyzing the potential of a stock. Companies publish numerous financial statements, and they can vary from company to company depending on the sector. The most important ones to look at, however, are the income statement, balance sheet, and the cash flow statement.

The income statement is important because it shows whether or not a business earned a profit (also called net income). A net income is earned if the company’s revenues exceed its expenses. At net loss is incurred if the expenses exceed the revenues. Income statements also list the types and amounts of the revenues and expenses.

The purpose of the balance sheet is to provide information that helps investors understand the financial status of the business. In fact, the balance sheet is often called the statement of financial position. The balance sheet lists the types and amounts of assets, liabilities, and equity of the business.

The cash flow statement is a financial statement that reports the cash inflows and outflows for an accounting period. It separates these cash flows into three activities. They are either classified as operating cash flows, investment cash flows, or financing cash flows. Operating cash flows come from day to day sales. Investment cash flows come from dividends and profits earned from the purchase and sale of securities. Money obtained from loans or the sale of bonds is listed in the financial cash flow column.

Now that you know where to find the information you need to analyze a stock, let’s take a look at how you can use this information. There are several equations and ratios that are very important and commonly used in the analysis of stocks and the companies that issue them. They are current ratio, profit margin, total asset turnover, return on equity, price earning ratio, and dividend yield.

The current ratio is the relationship between a company’s current asset and its current liabilities. To calculate the current ratio of a company simply divide total assets by total liabilities. For example, if a company had current assets of $20,000 and current liabilities of $10,000, its current ratio would be 2.0. The company’s current ratio is two times its current liabilities. A high current ratio generally indicates a stronger position, because a higher ratio means a company is more capable of meeting its current obligations. On the other hand, a company might have a current ratio that is too high. This means that a company is invested too much in current assets compared to its needs. A company with a 2 to 1 ratio is generally thought to be a good risk.

The operating efficiency of a company can be expressed in terms of profit margin. Profit margin describes the company’s ability to earn a net income from sales. This number is calculated by dividing the net income by net sales. For example, a company that had a net income of $33,000 and net sales of $960,000 would have a profit margin of 3.4%. To evaluate the profit margin of a company, consider the nature of the industry. A publishing company might have a 10 to 20% profit margin, while a supermarket might have a 2% profit margin.

Total asset turnover describes the ability of a company to use its assets to generate sales. To calculate total asset turnover, divide net sales by the average total assets. If net sales were $800,000 and the average total assets were $400,000, then the total asset turnover rate would be $2.0. In general, the higher the total assets turnover the more efficiently the company is using its assets. This usually makes for a good investment.

The most important reason to operate a business is to provide a profit for the owners. The return on equity equation measures the success of a business in reaching this goal. When doing this equation you should use the average of the beginning-of-year and end-of-year amounts of stockholders’ equity in calculating the return. A sample calculation is below.

Net income after taxes $33,000

Average equity [(311,800 + 315,800)/2] $313,800

Return on Equity $10.5%

If preferred stock is outstanding, subtract the dividend requirements for this stock from the net income to arrive at the common shareholders’ share of income to be used.

An equation that is commonly used to compare stock investment opportunities is the price earnings ratio. To calculate this ratio, divide market price per share by earnings per share of a stock. If ABC Toy Company’s common stock sold at $15 per share at the end of the year and they earned $1.32 a share for that year, the end-of-year PE ratio would be 11.4.

Different industries usually have different PE ratio averages. Please keep this in mind when doing your analysis. Slower growth companies usually have low PE ratios. A ratio of 8 to 10 might be normal for them. A high growth company may have a ratio of 20 or more. Local and national trade associations gather data and publish standard and average ratios for their trade or industry. This data is usually available for free and can be a good guideline for individual investors.

Dividend yield is used to compare the dividend paying performance of different investment alternatives. To calculate the dividend yield of a stock, divide the amount of dividend paid annually by the market price per share. If a company paid out $1.00 per share in dividends and the share price is $10, the dividend yield would be 10%. The higher the yield the better.

Some high growth companies and new companies may not pay dividends. This is not necessarily a bad sign. If this is the case, make sure that they are reinvesting profits back into the company to continue growth.

There are numerous other pieces of information that investors can use to make informed decisions when purchasing stocks. They include press releases issued by companies and letters sent out my management. Some companies are even hosting “chat” rooms on the Internet. They allow investors to talk to management and ask vital questions.

So, as you can see, analyzing investments is not as difficult as it seems. If you take advantage of the tools presented in this article, the process is painless and even fun. What are you waiting for? Get out there and invest wisely!

Written by Rodney Byrd