Fundamental Analysis

Tuesday, June 06, 2006

Fundamental Analysis

Fundamental analysis is the nuts and bolts of good stock trading. It is also something that is neglected by many day traders. The basic meaning of the term is that the business upon which the stocks are based is fundamental to the value of the stock. If you look, there are tons of high flying stocks that are for companies that have never made a profit, and maybe never will. These stocks have bad fundamentals. Stocks of companies that have been in business for a long time, and made money every year have good fundamentals.Without looking at the fundamentals you might as well be throwing darts at the stock pages. I know its an old cliché, but its true.

My favorite fundamental indicator is the P/E ratio, but its sometimes hard to get accurately on the web. In my experience yahoo finance is usually right up to a point, but usually has only (ttm) trailing twelve months (last years numbers). If you can get good P/E numbers, the lower the number is the better. Any P/E of under one will definitely get my attention, and under 5 is usually good. Most big companies don’t have what I consider good P/E’s unless they just had a major sell off, but this is one way to look at real world value of the company vs. market value of the stock.

Watch out for earnings inflated by the company selling off it’s assets, usually listed in quarterly reports as income from discontinued operations. This can make the P/E look outstanding right at the moment the company has the least real world money making potential. If you have the per share numbers you can figure the P/E yourself by dividing the stock price by the earnings per share (EPS), but look at those quarterly reports first!Annual and Quarterly reports are the best way to get a picture of the company over time, and an idea of what to expect for the future.

Might as well say it again, because it is hugely important, if basing analysis on P/E’s, look out for those discontinued operations entries. Look for consistent money makers with a price that is below that stock's 52 wk average. There are tons of other fundamental things to look at. Return on equity is similar to a P/E and is a percent, at least 15% is good, below 15% is bad, and over 30% is excellent. Dividends also fall in the area of fundamentals. And usually show a strong company with ethical management. CEO salaries can tell you a lot about management and ethics. If the EPS is minus or non-existent, and the CEO made 1.5 million in salary last year, it’s probably not a company that cares much about rewarding shareholders.

Fundamentals are everything about the real world business numbers. You can get totally anal retentive about it and have ratios it takes ten years to understand, but when it all comes down to it, it is a simple question of is this a good business in real world terms? Not in terms of hype, hope, or speculation, but the BOTTOM LINE. One way to find good opportunities with good fundamentals is to look at the losers and gainers section of a lot of financial web sites. On the losers list, you’ll find stocks that just made a big price drop. Some of these losers are fundamental winners that won’t stay losers for long. Happy Trading.

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