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As technology becomes easier with every passing day, the number of people investing in stocks has increased dramatically. However, it is vital to keep in mind that while investing can be rewarding, you should research a stock carefully before putting your money into it.
There are two main ways to analyse stocks. First is technical analysis, which looks at past price movements and trading volumes to predict future trends. Second is fundamental analysis. It focuses on finding a share’s true value by studying a company’s performance, industry conditions, and economic factors.
This is where fundamental analysis tools play a crucial role, helping investors make smarter and more informed decisions.
Key Takeaways
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Fundamental analysis helps investors find a stock’s true value before investing.
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It studies a company’s profits, finances, management, and growth potential.
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Tools like EPS, P/E ratio, and ROE make comparison easier.
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Fundamental analysis tools support smarter, long-term investment decisions.
What is Fundamental Analysis?
Fundamental analysis is a method used by investors to understand a company’s true value by studying its overall financial health and future potential. Since markets are unpredictable, skilled investors rely on data, logical reasoning, and careful judgment to spot trends and make informed decisions.
This approach looks beyond daily price movements and focuses on key business factors such as earnings, revenue, management quality, industry position, and economic conditions.
By examining important financial ratios, fundamental analysis helps determine whether a stock is undervalued or overvalued. It also gives insight into a company’s long-term growth prospects, making it essential for smart, confident investing.
What are the Types of Fundamental Analysis Tools?
Some of the widely used fundamental analysis tools are:
Earnings Per Share or EPS
EPS is the amount of profit that is assigned to each stock of the company. It is calculated by dividing the total revenues or gains of the company by the total number of outstanding shares. As EPS is a symbol of the health of the company, a higher EPS means higher returns for the investor.
To put it in a formula: EPS = Net income of the company after tax / total outstanding shares
EPS can be basic and diluted. Basic EPS takes into account total outstanding shares, while diluted EPS includes shares the company holds and those that can be issued to investors in the future. Apart from this, EPS can be subdivided into trailing, current and forward EPS. A trailing EPS is the actual EPS of the recently completed fiscal year. A current EPS is the project EPS of the current fiscal year.
The forward EPS is a projection of the EPS for the upcoming fiscal year. The EPS of one company can be compared to another in the same industry to know in which company to invest in. However, a higher EPS may also lead to reduced earnings or increased stock prices to get back to normal. A company’s EPS may be lower despite earning a good profit.
For example, if a company makes 5 lakh and has 10000 outstanding shares, its EPS would be 500000/ 10000 = 50. Another company which earns ₹10 lakh and has total outstanding shares of 1,00,000, will have an EPS of 10. Therefore, even though the second company makes more profit, the first company with a higher EPS is likely to give more profit to investors.
Price-to-Earnings (P/E) Ratio
P/E is one of the essential tools of fundamental stock analysis. It reflects the company’s payouts as compared to its stock price. With this, you can know if the share of stock pays well for the price you pay. P/E ratio can be calculated by dividing the share price by the EPS. If a company’s share price is ₹50 and the EPS is 5, then the P/E ratio is 10.
A lower P/E ratio signifies the possibility of higher earnings compared to the stock price. A meagre P/E ratio may mean a lower price per share compared to earnings. This signifies the stock is undervalued and shows potential to rise in future. The opposite is the case for a higher P/E ratio.
P/E ratio can be categorised as:
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Trailing P/E ratio, which means the P/E ratio of the past 12 months
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Forward P/E ratio, which is the P/E ratio of the next 12 months
If the forward P/E ratio is higher than the trailing one, then there may be a decrease in earnings. If the forward P/E ratio is lower than the trailing P/E ratio, then there could be an increase in the profits of the company. The significance of the P/E ratio differs from one investor to another. The P/E ratio shows how much you want to pay for the company’s earnings. Your willingness can be different from another investor.
Return on Equity
Return on Equity or RoE shows the efficiency of a company to generate profits on its shareholder’s investment. It is calculated by dividing net earnings after tax by shareholders’ equity. If the company has made ₹50,000 this year with shareholders’ equity at 5 lakh, then the ROE is 50000/ 500000 = 10%. ROE is expressed in percentage terms. A higher ROE signifies a more efficient company. It means the company can increase its profitability without any additional capital.
However, a company without many assets can also have a higher ROE. Therefore, not all companies with higher ROE are suitable for investment. It is best to compare ROE of companies within the same industry. An ROE of 13–15% is generally considered healthy, depending on the industry.
Read More: Shareholder Equity
Price-to-Book (P/B) Ratio
Also known as “stockholders equity”, the price-to-book ratio is the comparison of a stock’s book value to its market value. Book value is the cost of each asset minus its cumulative depreciation. The P/B ratio can be calculated by dividing the last closing price by the previous quarter’s book value per share.
It tells us what the company will be left with if it repays all its liabilities and liquidates its assets. If the P/B ratio is less than one, then the stock is undervalued. If the rate is more than one, then the stock is overvalued. The P/B ratio is essential as it tells you if the company’s assets are comparable to the stock’s market value.
The ratio is more significant for companies with higher liquid assets such as insurance, banking, investment and finance companies. Companies with more fixed assets and expenditure of R&D do not get any help from the P/B ratio.
Beta
The Beta is the correlation of the stock price with its industry. You can calculate the Beta by comparing the stock to the benchmark index. The Beta mostly oscillates between -1 and 1. However, it can have a value above or below this mark.
Any beta value above 0 signifies the stock correlates with the benchmark index. Beta values below 0 mean shares are inversely correlated. A higher beta means higher volatility signifying greater risk of assets. The lower the Beta, lesser is the volatility.
Price-to-Sales (P/S) ratio
The price-to-sales ratio compares a company’s stock price with its revenue. You can calculate the P/S ratio by dividing market capitalisation by income or using the formula: P/S ratio = Per share stock price/Per share revenue A lower P/S ratio indicates undervaluation, while anything above average suggests overvaluation.
A lower P/S ratio is preferable as it means investors are ready to pay less for each unit of sale. The limitation of this indicator is that it does not take into account the expenses and debt of the company. As such, a company with a higher P/S ratio can also be unprofitable.
Dividend Payout Ratio
A dividend payout ratio tells us how much the company has earned and what portion of it is being given out as a dividend. It can be calculated by dividing the total amount of dividend by the net income of the company. A company can choose to distribute its profit as a dividend because there may be little room for growth. Dividend payout ratio accounts for the amount of income that a company retains for future growth, debt payoff and cash reserve.
Dividend Yield Ratio
The dividend yield ratio is the dividend per share divided by the share price. Expressed in percentage terms, the dividend yield ratio can be calculated by dividing the annual dividend of a stock by the current share price. The dividend yield ratio is important for investors looking to earn dividends from a company.
This measure for fundamental analysis is not available for all companies as not every company uses its profit to pay dividends. Some companies retain the profit to use for future growth.
Projected earnings growth (PEG) ratio
Projected earnings growth indicates how much you have to pay for each unit of future growth of earnings of the company. It is calculated by dividing the P/E ratio by projected growth in revenues. A lower projected earnings growth indicates a lesser amount to be paid for each unit of future earnings growth. A stock with a smaller PEG ratio is fundamentally stronger as it has higher projected growth in earnings. A stock with a higher PEG ratio is generally avoided by investors.
What are the Tools Used in the Quantitative Fundamental Analysis?
The following are the tools used for quantitative fundamental analysis.
Financial Reports
Financial reports are one of the most important tools in quantitative analysis. They show the true financial position of a company and help investors judge its stability and growth.
1. The Balance Sheet - The balance sheet shows what a company owns and what it owes. Assets include machinery, buildings, and cash. Liabilities include loans and other obligations. A strong company usually has growing assets and controlled liabilities. This indicates long-term stability.
2. Profit and Loss Statement - This statement shows how much a company earns and spends. It lists revenues and expenses for a given period. When revenues are higher than expenses, the company makes a profit. Investors prefer companies with steady and core-source income.
3. Cash Flow Statements - Cash flow statements track real money coming in and going out. They show how a company manages its operations, investments, and financing. Strong cash flow means better control and lower risk.
Earnings
Earnings show how much profit a company actually makes. They are a key driver of stock prices and investor confidence.
1. Quarterly Earnings - Companies release earnings every three months. These reports show the company’s current financial health. Rising quarterly profits usually signal strong performance.
2. Projected Earnings - Projected earnings estimate future profits. They are based on expected income and expenses. Though not always accurate, they help investors understand growth potential.
These tools are essential for the fundamental analysis of stocks. They help investors measure value, risk, and future growth with clarity.
Importance of Financial Analysis Tools
Financial analysis tools play a vital role in helping investors make informed decisions. They allow you to understand the true value of a stock and assess a company’s overall financial strength. By studying key numbers, the business model, and management quality, you can judge whether a company is stable, growing, or risky. This makes investing more thoughtful and less based on guesswork.
How to Find Fundamental Analysis Tools?
Most fundamental analysis tools can be found directly on a company’s official website, usually under the investor relations or financials section. These pages provide access to balance sheets, income statements, cash flow reports, and earnings updates. You can also use trusted stock market platforms and brokerage portals to compare multiple companies at once. These platforms offer filters, forecasts, and detailed financial data, making it easier to analyse stocks based on your chosen criteria and investment goals.
Conclusion
Analysts use fundamental analysis tools to determine an estimated future value of a company’s stock price. If analysts expect a higher future value than the current market price, then the chances of buying a stock are higher. If analysts find the stock’s intrinsic value lesser than the current market price, there may be sell recommendations for the stock since it’s overvalued. Not all investors can conduct a thorough fundamental analysis of a stock. However, understanding the fundamental analysis tools will help in closely and accurately monitoring stocks.
