When a professional security stock analyst evaluates a stock, he or she usually focuses on a number of considerations, two of which are fundamentals and underlying valuation.
You may wish to take into account these evaluation methods when considering a stock for your portfolio. You can find the information you need from annual or quarterly company earnings reports, from reading the newspapers or by asking your financial advisor (if you have one) for more information.
Fundamental Stock Analysis
Fundamentals include the outlook for the company and for its industry. In looking at a company’s fundamentals, some of the criteria you will want to consider are:
- Earnings growth history and outlook
- Strengths in products or services versus the competition
- Management’s track record
- Industry conditions in general
- The company’s balance sheet (cash and debt levels)
Stock Valuation refers to the market price of the company’s stock in relation to its fundamentals. Even if you locate a company with solid fundamentals and a bright outlook for the future, the stock may not be attractive if it is “too expensive.”
How do you determine whether or not a stock is too expensive? One common measure of valuation is the price/earnings ratio (P/E). This tells you how much investors are willing to pay for each dollar the company earns. The P/E is the price of the stock divided by its earnings per share. If a hypothetical stock’s P/E ratio is 15, it means that for every $1 in earnings, investors are paying $15.
The significance of these ratios is determined by comparing them to those of the stock market in general or of comparable companies. For high-growth stocks, the P/E is often measured against the projected earnings growth rate. In such a case, a company with hypothetical earnings growth potential of 30% per year might have a P/E ratio of 30 times earnings or more. When this ratio falls below that of the market or a peer company, a stock may be attractive for purchase. On the other hand, sometimes there are reasons for a stock’s P/E ratio to be depressed, such as deteriorating company fundamentals.
Fundamentals and stock valuation are just two of a number of considerations (like technical analysis) on which professional stock analysts focus. You can use these two basics to help identify stocks that may be suitable for your portfolio.