Fundamental VS Technical Analysis Part 1

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Markets have been and will probably continue to be extra crazy these coming weeks. Investors are looking to cling to any kind of domestic good news possible to give them reason to jump back in to these turbulent financial waters. There's still a ton of volatility in European markets as Greece and other nations tackle debt, inflation, and unemployment. Even Hungary seems to be doing their part rattling the cages of the IMF with their default threats. How are you, the average investor, approaching your next investment decisions? How do you approach them at all? If you follow the news, read the Financial Times or the Journal, and tune in to your favorite pundit on Twitter odds are you won't be finding any real opportunity gems or arbitrage. By the time you are getting that information, assuming markets are pretty efficient, the markets have already incorporated it into the values of whatever financial instruments they are talking about. If you're looking for any kind of edge or to add balance to your holdings you should be doing a little digging on your own. I believe Warren Buffett said it best, that you should be giving a few hours consideration/research to every one position you have. So here today we are going to explore the first of two common approaches to finding the right investment for you.

Someday we'll have these in our back yards. Today we are going to start with Fundamental Analysis. This topic is really the meat of a college finance course and in the interest of keeping you reading we are going to cover it in concept for the most part. Fundamental Analysis is the process of understanding the financial health of a company. The goal is to identify a companies value using various calculations and information gathered from financial statements. If the company meets (or beats) the thresholds of your investment strategy then it could be a good fit, especially when you happen across an equity that is undervalued by the market - it's like shopping for sales, great products at discounted prices. You get the information from a company's balance sheet, income statement, and statement of cash flow. What you are looking for are trends in the company's growth, profitability, its position amongst its competitors and how the management runs the company. 5 key ratios to keep in mind with one side note - nothing should be calculated in a vaccum, when you are taking ratios like this into consideration make sure you're comparing them to other companies and the industry standards to get a feel for how a company measures up:

1. Current Ratio - Current Assets/Current Liabilities - can give insight into a companies ability to cover its debt. The product of the ratio is a dollar amount available to cover every dollar of debt.
2. Debt to Equity - Long Term Debt/Stockholder's Equity - can give insight to a companies possible default and is a measure of leverage. The product is a level of debt (in dollars) per every dollar of equity. If the ratio yielded $.25 it means that $.25 of every dollar in the capital structure is financed by debt.
3. Return on Assets - Net Profits After Tax/Total Assets - can give insight into the management's ability to generate return on the available assets of the firm. 
4. Earnings per Share - Net Profit After Tax less Preferred Dividends/Number of Common Shares Outstanding - can give insight into a company's profitability. The EPS shows the earnings the company receives for every share outstanding.  The idea here is to compare the Earnings per Share's of other companies to yours in question. If another company can yield the same EPS but with less shares outstanding then odds are it is a more efficient firm - they needed less capital raised to do the same job as the company you are investigating.
5. P/E Ratio - Market Price of Common Stock/EPS - can also give insight into a companies profitability. The product tells us how much we need to invest or how much people are willing to pay to generate one dollar in profit. P/E's can be very speculative as it has to do with guessing at what the company is worth today and what people would be willing to pay for that dollar in earnings - but an easy way to see it is the lower the P/E the less dollars to invest per one dollar of profit and probably the less volatile the security.
6. *BONUS RATIO* Return on Equity - Net Profit After Tax/Stockholder's Equity - can give insight into the management's ability to successfully maneuver the firms capital structure, operations, and assets. It's about what they are doing with the money they raises in the sale of equity.

That list could really keep going and if you are looking for more ways to figure out a firms value or worthiness of investment check out Investopedia. It's a site that's a little ad-heavy but full of great inforamtion and tutorials. It's kind of the Wikipedia of all things investment related. Or you can check out these digs (including one I reviewed here at Financially Digital): The Neatest Little Guide to Stock Market Investing by Jason Kelly, Stock Investing For Dummies (which was surprisingly good) and Why Are We So Clueless about the Stock Market? (already reviewed in a previous post by Financially Digital).

Stay tuned for tomorrows post where we will talk about the other side of this comparison - Technical Analysis. Should be fun!! Oh, and the winner, chosen by random number generator, of the way of the Book Giveaway was Tanya Vital. Congrats!! You should have received an email by now and the book will be on it's way as soon as we get a sending address all squared away.

Comments

[J.C.]

This is good info. Thanks.