Fundamental Analysis is a vast topic and a short article is certainly not enough to give it the full attention it deserves. Fundamental analysts, in the simplest of terms, attempt to identify the intrinsic value or fair value of an asset. From the economic theory perspective, fair value of an asset is where supply and demand intersect.
Let’s explore the common stock fundamental analysis technique of Price to Earnings (P/E) Ratio. Benjamin Graham, the man who is known as Warren Buffett’s mentor and is hailed as the “Father of Value Investing”, developed this metric. Today, potential investment companies can be compared by using P/E ratio.
Share Price / Earnings per Share (EPS)
Share price represents market value per share, the price that you need to pay right now to buy one share of a company. The EPS is an accounting metric and it is calculated as (Net Income – Dividends of Preferred Stock)/Average Common Shares.
Let us put it in simpler terms. Share price represents how much the market thinks one share is worth, while EPS represents how much income (that can be distributed to ordinary shareholders) is actually generated by a company. Therefore, P/E ratio shows us how much a trader is paying for $1 or £1 or €1 of a company’s earnings.
“Normal” P/E Ratios
Different industries have different “normal” ranges for P/E ratios. For example, technology companies usually have P/E ratios of 20 or more, while manufacturing companies will have average of 10 and less. This tells us that the market recognizes the greater earnings potential of technology companies. It is also important to analyze the growth potential of a company, so analysts usually compare P/E ratios with peer group. Some analysts additionally use PEG ratio to analyze EPS growth as well.
Fundamental Analysis vs. Technical Analysis
In addition to fundamental market analysis, there is another commonly used method called technical market analysis. What is the difference between the two? Fundamental analysis of stock value looks primarily at the business to determine a number. Technical stock analysis look more at market factors. Depending on who you talk to, they will probably tell you one is better than the other. However, it is all about personal preference. If you really want to figure out which stock analysis technique is the best, considering exploring further.
Explore Stock Analysis Techniques
At Shaw Academy for Trading, they find it useful to explore some stock fundamental analysis techniques, including their benefits and drawbacks. But, it is important to remember that relying on stock fundamental analysis alone is quite risky for the inexperienced traders. To be successful, you have to consider a vast number of variables beyond the analysis of stock fundamentals. Therefore, we prefer to use technical analysis in order to develop your trading techniques.
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