The six fundamental  indicators every investor  must use

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The

 

six

 

fundamental

 

indicators

 

every

 

investor

 

must

 

use

Fundamental   analysis   includes   the   study   of:

Definition

Fundamental   analysis  

– the   study   of    a   company’s   capital   value  

(on   the   balance   sheet)   and   profit   or   loss   (on   the   income   statement)   to   determine   its   overall   viability   as   an   investment;   to   identify   financial   trends;   and   to   decide   whether   the   current   price   is   reasonable   based   on   trends   in   revenue   and   profit.

‐ the   balance   sheet,   the   value   of   assets,   liabilities   and   net   worth   as   of   the   end   of   the   quarter   or   year.

‐ the   income   statement,   a   summary   of   revenues,   costs,   expenses   and   profits   during   a   quarter   or   full   year.

‐ other   financial   attributes   including   the   earnings   per   share,   competitive   position   within   the   industry,   and   dividend   history.

The

 

six

 

indicators

An   investor   may   use   any   number   of   fundamental   indicators,   but   six   are   essential   for   everyone.

  These   are:

1.

  growth   in   revenues

2.

  growth   in   earnings

3.

  price/earnings   ratio   (P/E)

4.

  dividend   yield

5.

  dividend   growth

6.

  debt   ratio

1.

  growth   in   revenues

The

 

nature

 

of

 

revenue

 

growth

What   should   you   expect   to   see?

The   trend   and   how   it   changes

The   tendency   for   trends   to   level   out

Revenues   are   tied   to   earnings

Revenue   dollar   values   should   grow

Earnings   percentage   should   be   consistent

Problems

 

with

 

revenue

Revenues   trend   erratically

Revenues   grow   while   earnings   do   not

Revenues   remain   level   or   begin   to   slide

2.

  growth   in   earnings

How

 

earnings

 

grow

Net   return   should   remain   consistent   or   rise

The   net   dollar   value   should   grow   as   well

Seek   consistent   earnings   trends

Problems

 

with

 

earnings

The   net   return   declines   even   if   dollar   amount   grows

Revenues   outpace   the   net   return

Revenues   grow   while   earnings   move   to   negative

Revenue

 

and

 

earnings

 

examples

You   can   only   tell   how   a   trend   is   evolving   by   studying   a   long ‐ term   trend

A   10 ‐ year   trend   is   excellent   because   it   reveals   how   trends   move   through   time

Track   revenues   and   earnings   together   to   get   the   full   picture

General

 

Mills

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

(In   millions)              .

Revenue Earnings

$10,506 $     917

11,070

11,244

11,640

12,442

13,652

1,055

1,240

1,090

1,144

1,295

14,691

14,797

14,880

16,658

1,304

1,531

1,804

1,567

Caterpillar

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

(In   millions)              .

Revenue Earnings

$20,152 $     798

22,763

30,251

36,339

41,517

44,958

1,099

2,035

2,854

3,537

3,541

51,324

32,396

42,588

60,138

3,557

895

2,700

4,928

Wal

Mart

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

(In   millions)              .

Revenue Earnings

$244,524 $     8,039

256,329

285,222

312,427

348,650

378,799

8,861

10,267

11,231

12,178

12,884

405,607

408,214

421,849

446,950

13,254

14,414

15,355

15,766

Sears

 

Holding

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

(In   millions)              .

Revenue Earnings

$30,762 $ ‐ 3,262

17,072

19,701

49,124

53,012

50,703

248

1,106

948

1,490

826

46,770

44,043

43,326

41,567

53

235

150

‐ 3,113

3.

  price/earnings   ratio   (P/E)

How

 

the

 

P/E

 

works

The   price/earnings   ratio   (P/E)   is   a   summary   of   the   relationship   between   the   current   price   per   share,   and   latest   reported   earnings   per   share  

(EPS)

To   compute,   divide   price   per   share   by   earnings   per   share.

Problems

 

with

 

the

 

P/E

The   P/E   compares   a   current   technical   indicator  

(price)   to   an   outdated   fundamental   indicator  

(earnings).

The   P/E   multiplier   is   a   reflection   of   how   many   years'   earnings   are   in   the   current   price.

  The   higher   the   P/E,   the   more   expensive   the   stock

Solutions

 

to

 

the

 

P/E

 

problem

The    P/E   cannot   be   reliably   used   as   a   singular   value   at   the   moment.

However,   volatility   of   the   stock   can   be   judged   by   a   review   of   the   range   of   annual   P/E   and   its   trend.

A   consistent   level   of   P/E   in   a   narrow   range   is   a   positive   indicator.

For   example,   General   Mills   has   reported   a   narrow   P/E   over   many   years.

P/E

 

rules

 

of

 

thumb

Generally,   a   P/E   between   10   and   25   is   a   positive   signal.

  However,   the   trend   is   as   important   as   where   P/E   is   today.

Irregular   and   volatile   P/E   is   a   sign   of   volatility   in   the   stock   and   in   the   fundamentals.

For   example,   Caterpillar   has   reported   very   erratic   P/E   range   over   recent   years.

4.

  dividend   yield

The   meaning   of   dividend   yield

Definition

Dividend   yield  

– the   percentage   yield   based   on   dividend   declared   and   paid   per   share.

To   determine,   divide   dividend   per   share,   by   the   current   price   per   share.

Example:

a   company   currently   pays   $0.44

  (forty ‐ four   cents)   per   share.

  The   price   per   share   is   $20.00.

 

Dividend   yield   is:

0.44

  ÷ 20.00

  =    2.2%

Price   is   changing   constantly,   but   the   dividend   declared   per   share   does   not   change.

  As   a   result,   dividend   yield   changes   every   day.

The   lower   the   price,   the   higher   the   yield.

Examples:

0.44

0.44

0.44

 

 

 

÷ 20.00

÷ 18.00

÷ 16.00

 

 

 

=

=

=

  

  

  

2.2%

2.4%

2.8%

The

 

meaning

 

of

 

dividend

 

yield

To   evaluate   dividend   yield,   remember:

‐ Your dividend   yield   is   always   based   on   the   price   you   paid   per   share.

‐ To   judge   a   company’s   value,   review   dividend   yield   over   many   years,   and   not   just   what   is   paid   today.

The

 

meaning

 

of

 

dividend

 

yield

Year

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Compare   two   companies   to   see   how   dividend   yield   works.

  Both   yielded  

3.43%   as   of   December   11,   2012:

0.96

1.16

1.28

0.80

0.54

0.80

dividend   per   share

Johnson

Pfizer  

0.52

0.60

0.68

0.76

&   Johnson

0.80

0.93

1.10

1.28

1.46

1.62

1.80

1.93

2.11

2.25

The

 

meaning

 

of

 

dividend

 

yield

In   this   comparison,   Pfizer’s   dividend   over   10   years   was   lower   than   Johnson   &   Johnson’s.

More   significantly,   Pfizer   reduced   its   dividend   per   share   over   several   year,   while   JNJ   increased   its   payment   every   year.

5.

  dividend   growth

The   meaning   of   dividend   growth

Definition

Dividend   growth   –

the   percentage   of   increase   each   year   in   dividends   per   share,   over   payments   in   the   previous   year.

Dividend   growth   may   be   more   revealing   than   dividend   yield.

  The   rate   of   growth   is   a   significant   factor    as   a   long ‐ term   trend.

The   change   from   year   to   year   in   the    dividend   per   share   is   a   significant   factor.

 

Although   a   company   may   increase   its   annual   dividend   per   share,   if   growth   is   declining,   that   has   to   be   taken   into   account   as   well.

Evaluating   dividends   should   be   a   combination   of   dividend   yield   and   dividend   growth.

The

 

meaning

 

of

 

dividend

 

growth

Year

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Compare   two   companies   to   see   how   dividend   yield   works.

  Both   yielded   3.43%   as   of   December  

11,   2012: dividend   per   share

Johnson

Pfizer  

0.52

0.60

&   Johnson

0.80

0.93

0.68

0.76

0.96

1.16

1.28

0.80

0.54

0.80

dividend

Pfizer

1.10

1.28

1.46

1.62

15%

13

12

1.80

1.93

2.11

                               ‐ 68  

2.25

48

26

21

10

‐ 38

  growth

Johnson

&   Johnson

16%

18

16

14

11

11

7

9

7

The

 

meaning

 

of

 

dividend

 

growth

These   results   tell   the   story   of   dividend   growth.

Although   Pfizer’s   yield   was   erratic,   the   growth   during   positive   years   was   impressive

In   comparison,   Johnson   &   Johnson   increased   its   dividend   yield   each   year,   but   growth   diminished.

6.

  debt   ratio

Debt

 

Ratio

The   debt   ratio   is   a   test   of   how   well   management   plans   and   controls   its   cash   flow.

 

The   debt   ratio   is   the   percentage   of   total   capitalization   represented   by   long ‐ term   debt.

“Total   capitalization”   is   the   combination   of   long ‐ term   debt   and   stockholders’   equity.

The   meaning   of   debt   ratio

Definition

Debt   ratio–

the   percentage   of   total   capitalization   represented   by   long ‐ term   debt.

Total   Capitalization  

– the   combination   of    long ‐ term   debt   and   stockholders’   equity.

Example: long ‐ term   debt   =   $62.7

  billion stockholders’   equity   =   82.1

  billion total   capitalization   =  

$62.7

  +   $82.1

  =   $144.8

  billion debt   ratio   =

$62.7

  

÷ $144.8

   =    43.3

Debt   ratio   is   the   percentage   of   total   capitalization   represented   by   long ‐ term   debt.

It   is   always   expressed   as   a   number   without   percentage   signs.

  A   debt   ratio   of   43.3

  means   that   long ‐ term   debt   is   43.3%   of   total   capitalization.

When   debt   ratio   is   steady   or   falling,   it   is   positive.

When   debt   ratio   is   rising,   it   is   negative.

The   meaning   of   debt   ratio

For   example,   Eastman   Kodak   was   for   many   years   considered   one   of   the   strongest   and   best   capitalized   blue   chip   companies   in   the   market.

However,   EK   did   not   keep   up   with   changing   markets   and   when   the   digital   camera   boom   arrived,   they   lost   market   share.

In   2007,   EK’s   debt   ratio   was   about   30   – but   by   the   end   of  

2010,   it   was   above   160.

When   debt   ratio   is   over   100,   it   means   debt   has   entirely   absorbed   equity.

  The   company’s   stock   is   worthless.

Conclusion

Fundamental   analysis   is   nothing   more   than   the   study   of   financial   conditions   and   trends.

It   is   imperative   to   analyze   trend   direction   and   strength   over   time.

The   fundamentals   identify   the   value   of   companies   and   levels   of   competitive   strength.

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