When investing in stocks, choosing wisely can be just as important as it is with purchasing real estate. Knowing when a stock is under priced or over priced for that matter can be a very powerful skill that can make or save an investor a ton of money.
There are certain tools that will be explained in this section that can be used in what is considered “fundamental analysis”. Fundamental analysis doesn’t focus on the economy as much as it does the financial condition of a company and its’ stock price.
The following set of ratios are used in fundamental analysis, to examine the condition of a company and its’ stock price to help an investor make a wise investment decision.
Earnings Per Share (EPS)
The Earnings per share of a company is closely watched by Wall Street and is used to determine if a company met its’ earnings goal and Wall Street expectations. A company’s earnings per share (EPS) is calculated by subtracting money paid out for preferred dividends from the net income, and then divided by the number of shares outstanding (owned by the public).
For easy math sake, let’s say that Nike had a quarterly profit of $10,500, and paid out $500 in preferred dividends. That would then leave $10,000 to be divided by the number of shares that are outstanding. Let’s say that Nike only had 1,000 shares outstanding. That would then give them an earnings per share of $1.00 ($10,000/1,000 =$1.00)
Often when a company’s earnings are released on a quarterly basis, the first thing that is calculated is the company’s earnings per share. Generally if a company missed its goal, or came short of Wall Street’s expectations, the stock price will fall. On the other hand, if a company’s earnings come back stronger than expected, the stock price will generally increase. When earnings are equal to goals and expectations, the stock price usually isn’t affected as stocks constantly adjust based on what is expected of company’s earnings in the future.
Price to Earnings Ratio
The price to earnings ratio of a company is also very heavily watched by Wall Street, but can’t be calculated until after a company’s earnings per share ratio has been calculated. A company’s price to earnings (P/E) ratio is often used to measure if a company is trading for more than it is worth based on earnings.
A company’s price to earnings ratio is calculated by dividing the current market price of a stock by its’ earnings per share. For example, let’s say that Nike was currently trading at $30 and had earnings per share of $1.00 (based on example above for EPS). To find the company’s price to earnings ratio (P/E) you would divide the $30 share price by the $1.00 earnings per share and come up with a price to earnings ratio of 30 ($30/$1.00 = 30).
It has been said that a price to earnings ratio under 32 is very good, and generally represents an under priced (value) stock. This is not always the case as sometimes you do get what you pay for, so it is wise to get to know any company you decide to invest in on a personal level.
In some cases a company’s stock price might be low due to talks of bankruptcy or a possible government investigation on some of the company’s practices. So just because a company has a high earnings per share, and a low price to earnings ratio, it doesn’t mean that you should just automatically invest in that company. That would be quite stupid actually and an unwise business decision.
There are many other ratios out there, including some that would be better discussed in an accounting book. I do feel that some are more important than others, and even further that some are practically non important at all for the individual investor. A lot of these ratios are used by corporate executives to see if they are getting all that they can out of certain investments, e.t.c.
There are certain tools that will be explained in this section that can be used in what is considered “fundamental analysis”. Fundamental analysis doesn’t focus on the economy as much as it does the financial condition of a company and its’ stock price.
The following set of ratios are used in fundamental analysis, to examine the condition of a company and its’ stock price to help an investor make a wise investment decision.
Earnings Per Share (EPS)
The Earnings per share of a company is closely watched by Wall Street and is used to determine if a company met its’ earnings goal and Wall Street expectations. A company’s earnings per share (EPS) is calculated by subtracting money paid out for preferred dividends from the net income, and then divided by the number of shares outstanding (owned by the public).
For easy math sake, let’s say that Nike had a quarterly profit of $10,500, and paid out $500 in preferred dividends. That would then leave $10,000 to be divided by the number of shares that are outstanding. Let’s say that Nike only had 1,000 shares outstanding. That would then give them an earnings per share of $1.00 ($10,000/1,000 =$1.00)
Often when a company’s earnings are released on a quarterly basis, the first thing that is calculated is the company’s earnings per share. Generally if a company missed its goal, or came short of Wall Street’s expectations, the stock price will fall. On the other hand, if a company’s earnings come back stronger than expected, the stock price will generally increase. When earnings are equal to goals and expectations, the stock price usually isn’t affected as stocks constantly adjust based on what is expected of company’s earnings in the future.
Price to Earnings Ratio
The price to earnings ratio of a company is also very heavily watched by Wall Street, but can’t be calculated until after a company’s earnings per share ratio has been calculated. A company’s price to earnings (P/E) ratio is often used to measure if a company is trading for more than it is worth based on earnings.
A company’s price to earnings ratio is calculated by dividing the current market price of a stock by its’ earnings per share. For example, let’s say that Nike was currently trading at $30 and had earnings per share of $1.00 (based on example above for EPS). To find the company’s price to earnings ratio (P/E) you would divide the $30 share price by the $1.00 earnings per share and come up with a price to earnings ratio of 30 ($30/$1.00 = 30).
It has been said that a price to earnings ratio under 32 is very good, and generally represents an under priced (value) stock. This is not always the case as sometimes you do get what you pay for, so it is wise to get to know any company you decide to invest in on a personal level.
In some cases a company’s stock price might be low due to talks of bankruptcy or a possible government investigation on some of the company’s practices. So just because a company has a high earnings per share, and a low price to earnings ratio, it doesn’t mean that you should just automatically invest in that company. That would be quite stupid actually and an unwise business decision.
There are many other ratios out there, including some that would be better discussed in an accounting book. I do feel that some are more important than others, and even further that some are practically non important at all for the individual investor. A lot of these ratios are used by corporate executives to see if they are getting all that they can out of certain investments, e.t.c.
