Fundamental analysis is a way to analyze a company’s intrinsic value by examining qualitative and quantitative factors. Common qualitative factors used in fundamental analysis are a company’s business model, its competitive advantage, its management, and its corporate governance. These items can be found by reading a company’s 10-K (annual report), 10-Q (quarterly report), and news from trusted sources such as Yahoo Finance, Bloomberg, and CNBC. The focus of this article will be the quantitative factors, which are the numbers that showcase the financial performance of a company, allowing you to determine how a company has performed compared to its historic factors and peers. Quantitative factors also allow you to determine future values for a company and help you to better understand if a company is currently undervalued or overvalued. The quantitative factors can be broken down into 4 key fundamental indicators, which are earnings per share, price-to-earnings ratio, price-to-book ratio, and return on equity.
Disclaimer: I am not a financial advisor. I do not know your financial situation. I am purely sharing the information I have learned for educational purposes.
1. Earnings Per Share (EPS)
EPS is a company’s net income divided by the outstanding shares of its common stock. On Yahoo Finance, it is visible under Financials → Income Statement of a company’s page. EPS is an indicator of a company’s profitability, meaning the higher a company’s EPS is, the more profitable the company is considered. In the calculation of EPS, it is common to use the weighted average number of common shares instead of the actual number of common shares due to the number of common shares changing over time. For example, if Company A has a net income of $20,000,000 and the weighted average of common shares is 2,000,000, it has an EPS of $10. If Company B has a net income of $40,000,000 and the weighted average of common shares is 5,000,000, it has an EPS of $8. Strictly focusing on EPS, Company A is considered more profitable than Company B. This example showcases Basic EPS.
There are other forms of EPS that allow for a more granular view of how profitable a company is. There is Diluted EPS which assumes all shares of a company that could be outstanding have been issued. This means that if a company has preferred stock and convertible securities, those are considered a part of the outstanding shares of common stock. There is also Adjusted EPS, which excludes extraordinary items such as one-off purchases or sales by a company. An example is a company that owns factories to produce hammers selling a factory, which produces income for them. The income made from selling this factory would not be considered in the net income of a company for Adjusted EPS since this is a one-off sale.
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