Fundamental Analysis Overview
Agenda
What is Fundamental Analysis?
Financial Statement Overview
Key Financial Ratios
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Applying Fundamental Analysis
What is Fundamental Analysis?
Utilizing a company’s financial data to:
• Determine financial health
• Discover intrinsic value
• Compare to industry
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• Invest accordingly
Financial Statement Overview
How to find the financial information?
• Public companies are required to publish their financials
• Financial earnings reports
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10-Q
• Reports the company’s performance after each fiscal quarter
• Not required to be audited
10-K
• Reports the company’s performance after each fiscal year
• More detailed than the 10-Q
Financial Statement Overview
The Balance Sheet
• Presents information about a company’s assets, liabilities and equity
at a given point in time
Fundamental Accounting Equation:
Assets = Liabilities + Equity
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Assets
• Resources that a business owns at a given point of time
• Cash, Inventory, Accounts Receivable, P.P.E.
• Provide future probable benefit
Liabilities
• Represents the company’s debt
Equity
• Value that owners have contributed to the business
• Profit reserved (not paid out as a dividend)
represents retained earnings
Financial Statement Overview
The Income Statement
• Presents periodic information about revenues, expenses, and profits
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Revenues
• The money a company brings in; growth is key
Expenses
• Cost of Goods Sold (COGS)
• Cost of purchasing the goods and services sold by the company
• Selling, General and Administrative (SG&A)
• Costs of operating the business
• Includes depreciation and amortization
Net Income
• The “bottom line” or earnings
• Net Income = Revenues - Expenses
Financial Statement Overview
Statement of Cash Flows
• Represents a record of the business’ cash inflows and outflows over a
period
3- Types of Cash Flow
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Operating Cash Flow
• Cash generated from day-to-day business operations
Cash from Investing
• Cash used for sale and purchase of assets
Cash from Financing
• Cash paid or received from the issuing and borrowing of funds
REMEMBER
• Ratios alone have no value
• Need to compare ratios to other companies and industry
averages (benchmarks)
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• Only compare ratios to similar companies (in the same
industry)
• Fundamental analysis is just one tool to investing, it does not
paint the entire picture
Financial Ratios
Key Ratios
• Liquidity Ratios
• Profitability Ratios
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• Solvency Ratios
Financial Ratios
Liquidity Ratios
• Measure ability to pay debts as they come due
1. Current Ratio = Current Assets ÷ Current Liabilities
• measures company’s ability to pay current liabilities with
it’s current assets
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2. Quick Ratio
• doesn’t include inventory (like current ratio using only
highly liquid assets)
3. Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
• the higher the ratio, the faster the company is selling it’s
inventory
Financial Ratios
Profitability Ratios
• Rate of return
1. Gross Margin = Gross Profit ÷ Net Sales Revenue
• how much profit realized per unit sold
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2. Profit Margin Ratio = Net Income ÷ Net Sales Revenue
• percent of sales revenue that becomes net income
3. Return on Assets = Net Income ÷ Average Assets
• how the company uses it’s assets to generate income
4. Return on Equity = Net Income ÷ Average Total Equity
• how the company generates income through stockholder’s
investments
Financial Ratios
Profitability Ratios
5. Earnings per share (EPS) = Net Income ÷ Number of Shares Outstanding
• net income associated with each share of common stock
6. Price per Earnings (P/E) = Price per Share ÷ Earnings per Share
• measures how much investors are willing to pay per dollar of earnings
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7. Price/Earnings to Growth (PEG Ratio) = P/E Ratio ÷ EPS Growth
• Determine a stock’s value while taking the company’s earnings growth
into account
Additional Investment Considerations
Dividends
• Money a company gives it’s shareholders as an additional
incentive to own the stock
• Not all companies provide a dividend
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Share Repurchases
• When a company buys its own shares in the market
• Utilized when a company believes it’s stock is undervalued
Stock Splits
• Essentially a meaningless stunt by company’s to make their
stock seem like a better value for investors
Financial Ratios
Industry Specific Ratios
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• Consumer
Same Store Sales
• Compares the year over year sales of similar stores
• Excludes any new stores built in a given year
• Usually a figure presented by companies, doesn’t need to be calculated
Sales Per Square Foot
Sales Per Sq Ft = sales ÷ total sq ft
• Measures how efficiently locations run their stores
• Important for retail and grocery stores, not important for Amazon
• Have to measure very comparable stores (i.e. Nike and Under Armour)
Things to consider
• Promotions/Discounts
• Price Changes
• Inventory levels
• Traffic (both foot and online)
• Profit margin trends
• Seasonality
Financial Ratios
Industry Specific Ratios
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• Healthcare
Biotechnology
•
Product portfolio and research pipeline
•
Patents to protect products
•
Drug phases 1-3
•
R&D as a percent of sales
•
PEG ratio
Healthcare Providers and Services
•
Hospitals or insurance companies
•
Enrollment numbers
•
Operating margin
•
Sales
•
Net income
Pharmaceuticals
•
Similar to Biotech but typically larger
•
Make drugs from chemicals as opposed to biological
substances
•
Make drugs themselves or license drugs from outside
sources
•
Revenue growth provides insight to market share and
competition
•
R&D as a percent of sales
•
Profit margin shows success of drugs
Medical Equipment
•
Manufacture medical and surgical devices
•
Operating margin
•
Cost of goods sold percentage
•
Inventory turnover (COGS/Avg. Inventory)
Financial Ratios
Industry Specific Ratios
• Industrials
Turnover
Inventory Turnover = Sales ÷ Inventory
• Rate at which a company sells and replaces its inventory
Fixed Asset Turnover = Sales ÷ Property, Plant & Equipment (PP&E)
• A company’s ability to generate sales from fixed assets (PP&E)
• Measure of effectiveness of investments made to increase output
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Average Collection Period
•
Amount of time it takes to receive payment for goods
•
Important for companies selling large/expensive goods like heavy machinery, aircraft, etc.
Valuation Ratios
Price to Tangible Book Value (P/TBV) = Share Price ÷ Tangible Book Value per Share
• Ratio of share price to the value of the tangible assets each share represents
• Important metric in an asset-heavy sector such as industrials
Other Factors
Relevant Commodity Prices
•
Fluctuating commodity prices affect net profit margins. Many industrial companies are reliant on raw and
refined materials.
Backlog/Contracts
•
Measure of committed future demand for products
Financial Ratios
Industry Specific Ratios
• Tech, Media, Telecommunications
Technology Sector (Valuation Ratios):
• EV/Sales = (Market Cap + Debt – Cash)/Annual Sales
- Gives investors an idea of how much it costs to buy the company’s sales
- Will be used if you’re investing in growth companies
- Lower is better
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• EV/EBITDA = (Market Cap + Debt – Cash)/EBITDA
- Enterprise Value/Earnings Before Interest, Tax, Depreciation & Amortization
- Measures the price an investor pays for the benefit of the company’s cash flow
- Will be used if you’re investing in large tech
- Lower is better
Telecommunications Sector (Key Metrics):
• Average Return per User (ARPU)
- Illustrates the company’s operational performance (ability to maximize profits and minimize costs)
• Churn Rate
- Measures the number of subscribers who leave (low churn rate is ideal)
• Subscriber Growth
- Measures the company’s future revenue growth and its ability to grow its customer base and add
new subscribers
Financial Ratios
Industry Specific Ratios
• Energy
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Price/CF
• Oil industry generally carries larger levels of debt so it allows for increased
certainty in meeting debt obligations
• The higher the ratio, the risker the stock
Production/Reserves
• Production/Reserves shows how long reserves will last at current production rate
with no additions to reserves
• 1/Production to Reserves Ratio finds the Reserve Life Index in years
• Reserve-Replacement Ratio (%) = (Increase in Reserves + Production)/Production
is to see if a company is increasing or depleting reserves
Things to consider
• Price of oil, natural gas, and other resources
• Sensitivity to regulation and political events
• Reserve rules creating additional costs
• Wide variety of ratios are used depending on type of business segments
Financial Ratios
Industry Specific Ratios
• Financial Institutions Group (FIG)
Key Profitability Ratios:
Net Interest Margin (NIM) = Net Interest Income ÷ Avg. Earning Assets
•
Determines how effectively the bank is using assets to generate income (higher is better)
Return on Average Common Equity (ROAE) = Net Income ÷ Avg. Common Equity
•
Determines a bank's ability to generate returns to investors in its common stock (higher is better)
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Capital Adequacy Ratio
Tangible Common Equity Ratio (TCE) = (Total Equity - Intangible Assets) ÷ Tangible Assets
•
Determines how much loss an institution can take before shareholders' equity is zero
Valuation Ratios
Price to Tangible Book Value (P/TBV) = Share Price ÷ Tangible Book Value Per Share*
•
*Tangible Book Value Per Share = Tangible Assets ÷ # of Shares Outstanding
•
A representation of how many income-producing assets an institution has
Dividend Discount Model (DDM) = Dividends Per Share ÷ (Discount Rate - Dividend Growth Rate)
•
A procedure for valuing the price of a stock by using predicted dividends and discounting them back to
present value
•
If the value obtained from the DDM is higher than what the shares are currently trading at, then the stock
is undervalued
*P/E Ratio is also heavily used but it's not industry specific*
*Insurance
companies also use Embedded Value
• (EV = Present Value of Future Profits + Adjusted Net Asset Value)
*Asset Managers are able to used EV/EBITDA