Let’s explore key tools used in fundamental analysis to assess a company’s financial health and guide investment decisions.

What is Fundamental Analysis?

Fundamental analysis looks at a company’s financial health to see if its stock price is fair. It uses key numbers to check if the stock is too high or too low and tries to predict future growth. This helps investors find out what a company is really worth.

Types of Fundamental Analysis Tools

1. Earnings Per Share (EPS)

EPS (Earnings Per Share) shows how much profit is earned for each share of a company. It’s calculated as:

• A higher EPS means better returns for investors.
• EPS reflects the company’s financial health.

There are two types:

1. Basic EPS – uses only current outstanding shares.
   
2. Diluted EPS – includes all possible shares, like those that may be issued in the future.

EPS is also categorized as:

• Trailing EPS – based on last year’s earnings.
  
• Current EPS – based on this year’s projected earnings.
  
• Forward EPS – based on next year’s forecast.

EPS helps compare companies in the same industry. A company with higher profits can still have lower EPS if it has more shares. For example, a company earning ₹5 lakh with 10,000 shares has an EPS of 50, while another earning ₹10 lakh with 1,00,000 shares has an EPS of 10. So, the first may offer better returns per share.

2. Price-to-Earnings (P/E) Ratio

The P/E ratio (Price-to-Earnings ratio) is a key tool in stock analysis. It shows how much you’re paying for a company’s earnings.

For example, if a stock costs ₹50 and the EPS is ₹5, the P/E ratio is 10.

• Low P/E ratio: May mean the stock is undervalued and has growth potential.
• High P/E ratio: May suggest the stock is overvalued.

There are two types:

1. Trailing P/E – based on past 12 months’ earnings.
   
2. Forward P/E – based on expected earnings for the next 12 months.

• If forward P/E is higher than trailing, earnings might drop.
• If forward P/E is lower, earnings may rise.

The importance of the P/E ratio depends on the investor—some may be willing to pay more for future growth than others.

3. Return on Equity

Return on Equity (RoE) shows how well a company generates profits from its shareholders investment. It’s calculated as:

For example, if a company earns ₹50 lakh with ₹5 lakh in equity, the RoE is:

RoE = 5000000 / 500000 = 10%

• A higher RoE means the company is more efficient at generating profit without needing extra capital.
• However, a company with fewer assets can still have a high RoE, so it’s important to compare RoE within the same industry.

An RoE of 13-15% is typically considered good.

4. Price-to-Book /(P/B) Ratio

The Price-to-Book (P/B) Ratio compares a stock’s market value to its book value (the value of assets minus depreciation). It’s calculated by dividing the stock’s closing price by the book value per share from the last quarter.

• A P/B ratio under 1 means the stock is undervalued.
  
• A P/B ratio over 1 means the stock is overvalued.

The P/B ratio helps determine if the market price reflects the company’s actual asset value. It’s more useful for companies with liquid assets (like banks and insurance) but less relevant for companies with lots of fixed assets or R&D spending.

5. Dividend Payout Ratio

The Dividend Payout Ratio shows how much of a company’s profit is paid to shareholders as dividends. It’s calculated as:

• A higher ratio means more profit is being given to shareholders.
• A lower ratio means the company is keeping more earnings for growth, debt repayment, or reserves.

Companies with limited growth opportunities often pay higher dividends.

Conclusion

Analysts use fundamental analysis to estimate what a company’s stock might be worth in the future. If they believe the stock’s value will go higher than its current price, they may recommend buying it. But if they think the stock is worth less than its current price, it could be overvalued, and they may suggest selling it.

Not all investors can do deep analysis, but having a basic understanding of these tools can help you track stocks more effectively and make better investment decisions.

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