Fundamental Analysis
By Martin Brenner
S
What is Fundamental Analysis?
S A method of evaluating a security that entails attempting to
measure its intrinsic value by examining related economic,
financial, and other qualitative and quantitative factors.
S Major analysis for Value Investing
S Evaluating whether the security is underpriced or overpriced then
trading based on that evaluation.
S The market overreacts to news which can lead to deals that
investors can exploit.
S In the long run, the price will follow the intrinsic value.
S Typically used to value stocks, but can be used to value other
securities like bonds.
Questions to Ask
S Is the company growing?
S Is it making a profit?
S Can it beat out its competitors?
S Can it pay its debts?
S Is the management adequate?
S Is the stock a good investment
Who Uses Fundamental
Analysis?
S Almost everyone.
S Value investors include pretty much anyone who buys a stock
thinking that it is cheap and the price will go up.
S Fundamental Investors
Critics of Fundamental
Analysis
S Technical Analysts
S Believers in the Efficient Market Hypothesis
Financial Statements
S Income Statements
S Balance Sheet
S Statements of Retained Earnings
S Cash Flow Statement
Balance Sheet
S Assets = Liabilities + Shareholders’ Equity
S Shows all available assets and liabilities along with the equity
the company has access to.
S Important figures:
S Cash – liquid asset the company can use to pay liabilities (high)
S Inventory – unsold product the company has available (low)
S Accounts Receivable – outstanding bills (low)
Income Statement
S Revenues
S Expenses
S Cost of good sold
S Selling, general, and administrative expenses – marketing,
bills., R&D…
S Earnings per share
Cash Flow
S Net cash (or cash equivalents) moving into and out of a business.
S Positive cash flow => more money into a business =>
more liquid assets
S Split into three groups
S Operating – money spent or received from day-to-day operations.
S Investing – money spent on investment or obtained from the sale of
an asset.
S Financing – money given out or taken in loans
S Shown on the Statement of Cash Flows
The Fundamentals
S Qualitative – Less tangible factors that have an impact on
the intrinsic value of a company
S 10K Form
S Quantitative – The numbers that are used to determine is a
company is currently profitable or a good investment
S Financial Statements (10K form/Annual Report)
Qualitative Factors
S Business Model
S Vemma Verve
S Competition
S Moat
S Management
S Steve Jobs
S Regulation
S Drug companies/FDA
Qualitative Factors
S Market Share
S Customers
S Industry Growth
Quantitative Factors
S Revenue
S Net Income
S Expenses
S Cash Flow
S Debt Load
S Margin
S Free Cash Flow
S EBITDA (?)
Revenue
S The money a company actually receives.
S “The Top Line” of an income statement.
S Price of Good X # of Good sold.
Net Income
S Net income = Revenue – Expenses – Taxes =
Total Earnings = Profit
S “The Bottom Line”
Profit Margin
S Net Income / Revenue = (Revenue – Costs) / Revenue
S Low profit margins show that a company struggles to keep
costs low
S
Management Quality
Debt Load
S Total debt on the books of a company.
S Debt Load/Total Assets = Debt Ratio
S Lower is usually better.
Book Value
S Total Assets – Intangible Assets – Liabilities
S Liquidation
S Compare to market price
S Value of company if liquidated
Earnings Per Share
S Indicator of profitability
S Portion of profit translated to the common stock
S = (Net Income – Preferred Dividend) / Average # of
outstanding shares
EBITDA
S Earnings Before Interest, Taxes, Depreciation, and
Amortization
S Revenue – Expenses (not including taxes, interest,
depreciation, or amortization
S Net income with I,T,D,A added back onto it
S Evaluates profitability
Price-to-Earnings Ratio (P/E)
S Share Price / Per-Share Earnings (EPS)
S Trailing P/E vs. Forward P/E
S Dollar amount an investor can expect to invest in a company in
order to receive one dollar of that company’s earnings
S Effects of Debt
S Averages:
S Dow P/E: 15.5
S S&P P/E: 21.63
S Low P/E => undervalued company (or low expectations for
growth)
S High P/E => high expectations for growth (or overvalued)
Price-to-Book Ratio (P/B)
S = Stock Price / Total Assets – Intangible Assets
S Market Price / Book Value
S Low P/B (below 1) could mean an undervalued stock or
that something is very wrong fundamentally with the
company
Current Ratio
S Can a company pay off its short term liabilities with its
short term assets?
S =Current Assets / Current Liabilities
S Average of 1.5-3
S Balance Sheet
Quick Ratio
S Similar to Current Ratio, but does not include inventory
S (Current Assets – Inventory) / Current Liabilities
Debt to Equity Ratio
S = Total Liabilities / Shareholders’ Equity
S Measures “quality” of liabilities
S Debt used to finance assets relative to value of its stock
S Higher = Aggressive = Risky
S Increased volatility
Return on Equity
S = Net Income / Shareholders’ Equity
S How much profit company’s make through shareholders’
investments
S How efficiently does a company generate profits.
S 5%-20% average depending on industry
Return on Investment
S Profit from an investment
S Total return – cost of investment = ROI
S Compare ROI’s amongst your portfolio to find out which
are most valuable.
Discounted Cash Flow
S Method of evaluating a company’s intrinsic value using
estimates of its future profits
S If you can accurately estimate how much a company is
going to be worth, you can discount that value to get the
current intrinsic value.
S http://www.investopedia.com/university/dcf/?rp=i
Earnings Power Value (EPV)
S Sustainability of current earnings
S = Adjusted Earnings / Cost of Capital
S You determine adjusted earnings by taking operating earnings and
normalizing for taxation, non-recurring charges, economic
depreciation, cash/debt, etc.
S Compare EPV to Reproduction Cost to determine whether
management creates value and the company has a competitive
advantage
S Reproduction Cost – cost another company would have to pay to
have identical fundamentals.
S http://www.stockopedia.com/content/how-does-the-earnings-
power-valuation-technique-epv-work-60553/
Examples: