Stock Picking Based on Fundamental Analysis

When doing fundamental analysis, we are actually analyzing about the company itself, its fundamental or intrinsic values. When doing stock selection using fundamental analysis, it is like you are choosing which company you want to own with your hard earned money…So you need to choose a company that will give you the maximum amount of profit return for your money invested…

Looks simple isn’t it? But how do we know if the company is worth your investment? You can do it from so many different ways… And it is so subjective that everyone tells you a different pick with their own solid reasons… However, there are some more simple and concrete methods or financial ratios that you can try to use as reference… You can use Price Earning Ratio (P/E), Net Tangible Assets (NTA), Dividend Yield (DY), Debt Equity Ratio (D/E), Return on Equity (ROE) and Earnings Per Share Growth Rate (EPSGR).

I will try my best to explain what are they based on my understanding… But try to use them as reference or basic understanding only… Most of these information can be obtained from the company’s financial statement, or you can derive them using basic calculations…

Earnings per share (EPS) can be obtained from the financial statement of the company. The higher the EPS, that means the more money the company is making… They normally would give the basic EPS or diluted EPS or both… It would be best to use the diluted one if it is available…

A few ratios can be obtained from this EPS, one of it is the Price Earning Ratio (P/E), can be obtained by dividing the current price a share to the EPS. For example, if company A’s share has the price of RM1 and the EPS is RM0.20, the EPS would be 1/0.2 = 5. If looking strictly at the P/E ratio point of view, the higher the P/E ratio, the more overvalue the company is. Thus, the more risky it is to buy the share… However, it is important that you compare the P/E ratio of the company with the companies within the same sector…

Another indicator is the Earnings Per Share Growth Rate (EPSGR) which is calculated by calculating the percentage of increase or decrease of EPS… Which means, to calculate how much earnings the company is making more or less compared to last year… It is recommended that a company has the EPSGR of at least 15% consistently for at least five years…

Return on Equity (ROE) is calculated by (Net profits – Dividends) divided by total shareholder’s fund and converted into percentage… Some financial statements state their ROE readily while some you need to calculate yourself… Recommendation of Warren Buffett is at least 15%.. Which means the higher the better…

Take note: Since EPSGR and ROE are derived from EPS, it is better to have a good and consistent record than to have a sudden surge in them…

Debt Equity Ratio (D/E) can be calculated by taking the total debt of the company divided by their shareholder’s fund… The lower the ratio, the safer it is to invest in the company…

Net Tangible Assets (NTA) measures the net worth of the company… NTA can normally be obtained from their financial reports… So you can use the price to NTA ratio.. Which means you take the market price of the company divided by NTA. The higher the ratio, the more risky the investment is…

Dividend yield is the dividend per share divided by the market price, converted to percent… The higher the percentage, the better it is…

Other than these methods, you can also decide on the worthiness of the company by using SWOT analysis… This however is too subjective and as I say, almost everyone have their own picks…

There are two very important point to take note when using the indicators I mentioned above when choosing stocks:
1) Compare the indicators among those companies within the same sector.
2) Consistency over the years are far more important than one or two years surge, especially when it involves earnings.

Good luck in your stock hunting!!