Wednesday, May 5, 2010

How to Analyze the Company Before Investing

How to analyze the company before investing

What is Fundamental analysis?
Fundamental analysis is basically done for long term and mid term investment which is also called as delivery based investment or trading.
The main important aim behind is to study and understand the company in which you are planning to invest your hard earned money and get excellent returns.
Generally hard core fundamental analysis is very and is out of the scope of this website, but if you are interested to learn then please contact us and we will provide you appropriate resources to study the same.

How to analyze the fundamentals of the company?
Basically one should be able to judge at least how the company has done in past years, its debit status, its current valuation, its future growth prospects, its earning capacity etc
So that based on these terms he can at least decide whether to invest in this company or not.

What you should look for in a company to invest?

1. About Company -
What the company is doing and what are its businesses?
How is the current demand for their products and how the demand will be in future like in next 3 to 5 years and so? (It is difficult to analyze the future demand yourself so you can visit financial websites or contact us)

2. Earnings -
This is very important parameter. Broadly look into its last 5 or 10 years earnings whether the company has posted profits or losses.
It’s all about earnings. The bottom line is investors want to know how much money the company is making and how much it is going to make in the future.
To find the earning status ratios used are EPS - Earning per share

3. Current valuation -
This is another very important factor which most of the investor forgets while doing their investments.
Generally most of the investors invest at higher valuations of shares and when share prices start coming down then they keep worrying, so this should not happen.
Before investing one should check the current valuation of the share price and invest only when the share price is at right price and not at over priced share.
This is what happened in January 2008. Most of the people invested at very high valuations and later on the share prices started to correct (falling down).
To find the current valuation of the stock the ratios used are
PE ratio - Price to earning ratio
Book value
PB ratio - Price to book value ratio

4. Future earnings growth -
It is very important to analyze how the company is going to do in future. How will be its returns or its profits etc?
Basically most of the investors invest in shares taking into consideration Company’s future growth prospects.
To find the future growth of the stock the ratios used are
PEG ratio - Price to earning growth ratio
Current EPS and Forward EPS
Price to sales ratio

5. Debit status -
For any company to perform well in the future it is very important to be debt free or less debit because if company is having large debits like borrowings, loans then it becomes difficult for it to plan for any acquisitions, expansion plans take over plans, dividend payout and very important its most of the net profit goes in paying the interest and loans and other debits.
So in other words if the company is having fewer debits or no debit then they are having lots of cash in hand and they are free to take any decision in coming future.
To find the debit status of the company the ratios used are
Debit ratio

So to accomplish above parameters fundamental analyst follow certain ratios which are mentioned below

Earnings

Earning Per Share - EPS
EPS plays major role in investment decision.
EPS is calculated by taking the net earnings of the company and dividing it by the outstanding shares.

EPS = Net Earnings / Outstanding Shares
(Nowadays you will get this ready made, no need for you to do calculation.)

For example -
If Company A had earnings of RS 1000 crores and 100 shares outstanding, then its EPS becomes 10 (RS 1000 / 100 = 10).
Second example -
If Company B had earnings of RS 1000 crores and 500 shares outstanding, then its EPS becomes 2 (RS 1000 / 500 = 50).

So what is that you have to look in EPS of the company?
Answer - You should look for high EPS stocks and the higher the better is the stock.

Note - You should compare the EPS from one company to another, which are in the same industry/sector and not from one company from Auto sector and another company from IT sector.

Before we move on, you should note that there are three types of EPS numbers:

Trailing EPS - Trailing EPS means last year’s EPS which is considered as actual and for ongoing current year.
Current EPS - Current EPS means which is still under projections and going to come on financial year end.
Forward EPS - Forward EPS which is again under projections and going to come on next financial year end

But the EPS alone doesn’t tell you the whole story of the company so for this information, we need to look at some more ratios as following.
It’s not advisable to make your investment decisions based on only single ratio analysis.
EPS is the base for calculating PE ratio.

Importance of Earnings -
Earnings are profits. Quarterly or yearly company’s increasing earnings generally makes its stock price move up and in some cases some companies pay out a regular dividend. This is Bullish sign and indicates that the company’s is in growth.

When the company declares low earnings then the market may see bearishness in the stock price and hence its share price starts deceasing and corrects further if the company doesn’t provide any sufficient justification for low earnings.

Every quarter, companies report its earnings. There are 4 quarters.

Quarter 1 - (April to June and earnings will be declared in July)
Quarter 2 - (July to Sept and earnings will be declared in Oct)
Quarter 3 - (Oct to Dec and earnings will be declared in Jan)
Quarter 4/final - Also called as financial year end - (Jan to Mar and earnings will be declared in April)

Now by this time you would have understood how earnings are important for a stock price to move up or down. But depending only on earnings one should not make investment or trading decision. To make decision more risk free you should look into more tools as mentioned below so that your investment decision becomes more solid and you should get excellent returns in future.

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