See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/294089528

Views: Fundamental Analysis For Novice

Chapter · December 2015

CITATIONS READS

0 2,832

1 author:

Md Bokhtiar Hasan
Islamic University (Bangladesh)
19 PUBLICATIONS   19 CITATIONS   

SEE PROFILE

Some of the authors of this publication are also working on these related projects:

Sentiment of investors toward the announcement of cash and stock dividends of firms: Evidence from Bangladesh. View project

All content following this page was uploaded by Md Bokhtiar Hasan on 12 February 2016.

The user has requested enhancement of the downloaded file.

FUNDAMENTAL ANALYSIS FOR NOVICE earnings which denotes the amount of earnings for each
Md. Bokhtiar Hasan outstanding share. We can compute EPS simply using the
Security analysis is all about the examination and valuation following formula:
of various factors affecting the value of a security. The main EPS = Net profit after tax / Number of shares outstanding
goal of security analysis is to understand the company, its In essence, EPS tells you how much money the company is
products and services, its customers and its competitive making for its shareholders, so it is a measure of earning
advantages. The better you understand a company, the power. In Dhaka stock exchange (DSE), we found various
better you will be able to make appropriate investment types of EPSs: annual and quarterly EPS, EPS including and
decision. Therefore, there are multiple of techniques to without extra-ordinary income and, then basic and re-stated
perform security analysis properly. But, security analyses are or diluted EPS. However, all types of EPS are important to
basically split out into two popular methodologies: consider, but we have to give more emphasis on quarterly
fundamental analysis (FA) and technical analysis (TA). EPS with restated figure which is current and more relevant
Fundamental analysis is the process of investigating firms at in this regard. We should not consider EPS including extra-
its fundamental financial level with a view to find out its ordinary income since this extra-ordinary income may not
intrinsic or true value. This type of analysis reveals financial repeat in the coming year. In fundamental analysis, earning
health of a company and gives you an idea of the value of the is not the only consideration, and one cannot decide which
stock of that company. In contrast, technical analysis involves company shares to buy only on the basis of earning.
the examination of past market data such as prices and the 2. Price to Earnings Ratio (P/E):
volume of trading, which leads to an estimate of future price
When taking the current market price into consideration, the
trends and, therefore, an investment decision. The technical
most popular ratio is the Price-to-Earnings (P/E) ratio. As the
analyst believes that the previous trend will repeat in the
name suggests it is the current market price divided by its
future ignoring the future growth or performance of the
earnings per share (EPS). It is an easy way to get a quick
company.
look of a stock's value.
These two methodologies are not against one another, rather
P/E Ratio = Stock Price per share / EPS
they are complimentary. Investors may use one or both
A high P/E ratio indicates that the stock is priced relatively
methods for stock analysis. However, my today’s attempt is
high to its earnings, and companies with higher P/E therefore
toward the new retail investors who have just started or think
seem to be more expensive. However, this measure, as well
starting their investments in the stock market. Hence, I
as other financial ratios, needs to be compared to similar
confine my today’s writing to fundamental analysis since the
companies within the same sector or to its own historical P/E.
technical analysis is comparatively complex as well as risky
This is due to different characteristics in different sectors and
technique. TA will be suited to matured and large investors.
changing markets conditions. As EPS is denominator of P/E
This following topic focuses on the key tools of fundamental
ratio, akin to EPS we also find different types of P/E ratios in
analysis and what they tell you. Even if you don’t plan to do
DSE. Accordingly, we will deem those P/E ratios as we did for
in-depth fundamental analysis yourself, it will help you follow
EPS in the earlier.
stocks more closely if you understand the key ratios and
This ratio does not tell the full story since it does not account
terms.
for growth. Normally, companies with high earnings growth
Diagnosis of Fundamentals of Stocks
are traded at higher P/E values than companies with more
Although there are several tools of fundamental analysis, I moderate growth rate. Accordingly, if the company is growing
have identified ten different tools or ratios of fundamental rapidly and is expected to maintain its growth in the future
analysis. They focus on earnings, growth, and value in the this current market price might not seem so expensive. This
market. is the reasoning for the existence of different investment
1. Earnings per Share (EPS): styles.
The key element that all investors look after is earnings. 3. Projected Earnings Growth (PEG):
Before investing in a company you want to know how much A PEG ratio is calculated by dividing the stock's P/E ratio by
the company is making in profits. Future earnings are a key its expected 12 month growth rate. A common rule of thumb
factor as the future prospects of the company's business and is that the growth rate ought to be roughly equal to the P/E
potential growth opportunities are determinants of the stock ratio and thus the PEG ratio should be around 1. A relatively
price. low PEG ratio indicates an undervalued stock and a PEG
Factors determining earnings of the company are such as ratio much greater than 1 indicates an overvalued stock.
sales, costs, assets and liabilities. A simplified view of the

123
PEG = P/E / Projected growth in earnings
earnings is earnings per share (EPS). This is a figure of the
Views

For example, a stock with a P/E of 30 and projected earnings high price for the stock as it denotes what would be the
growth next year of 15% would have a PEG of 2 (30 / 15 = 2). residual value if the company went bankrupt today.
What does the “2” mean? Like all ratios, it simply shows you A P/B ratio higher than 1 denotes that the share price is
a relationship. In this case, the lower the number the less you higher than what the company's asset would be sold for
pay for each unit of future earnings growth. So, even a stock today. The difference indicates what investors think about the
with a high P/E, but high projected earnings growth may be a future growth potential of the company.
good value. Looking at the opposite situation; a low P/E stock 6. Dividend Per Share (DPS):
with low or no projected earnings growth, you see that what This is the amount that the company chooses to pay out of
looks like a value may not work out that way. For example, a net profit to its shareholders, expressed as a number of cents
stock with a P/E of 8 and flat earnings growth equals a PEG per share. The company has the choice of paying out all of
of 8. This could prove to be an expensive investment. the net profit as a dividend, part of, or none of the net profit.
4. Net Asset Value (NAV) per share: It depends on whether or not the company needs the money
There are several ways to define a company’s worth or value. to fund growth or repay debt. However, it is usually expected
One of the ways you define value is market capitalization or that a good company regularly pay a consistent dividend to
how much money would you need to buy every single share the investors.
of stock at the current price. Another way to determine a DPS = Total dividend paid / Number of shares
company’s value is to go to the balance statement and look outstanding
at the net asset value. 7. Dividend Payout Ratio (DPR):
The net asset value is simply the company’s assets minus its A thorough analyst does not merely observe consistent
liabilities. NAV per share is the value of a share in a company, dividend payment over many years and then determine the
calculated by subtracting a company’s total debt from its total investment to be 'safe' and the company a 'Blue chip'. It is
assets and dividing the result by the number of shares essential to check if the dividends were paid from the current
outstanding. year's earnings or from retained earnings.
NAV per share = (Total Assets – Total Liabilities)/Number To do that you can check the payout ratio or
of shares outstanding dividends/earnings which show what percentage of earnings
It is to be noted that the intangible assets and revaluation was paid out as dividend.
reserve are excluded from the net asset value. DPR = Dividends per Share / EPS
Nonetheless, NAV per share can be a good analytical tool to For example, if a company paid out $1 per share in annual
investors. If the NAV is bigger than the market value, many dividends and had $3 in EPS, the DPR would be 33%. ($1 /
investors will believe that a particular company may be $3 = 33%)
undervalued. Usually, it is expected that the share price of a The question is whether 33% is good or bad and that is
company should move closer to its NAV. A company which is subject to interpretation. Growing companies will typically
expected to perform well would have a share price higher retain more profits to fund growth and pay lower or no
than its NAV per share. A struggling firm will trade at a dividends whereas, the company with flat growth or the
discount to NAV; implying that shareholders are pessimistic company having no profitable project at hand may distribute
about the future of the company and have started to sell all or most of its profits as dividend to the shareholders.
them. But, in case of mutual funds and investment funds, the
8. Dividend Yield:
funds’ price must move with its NAV. Investors can normally
The dividend yield is the yield that a company pays out to its
find the net asset value in the balance sheet. You can also
shareholders in the form of dividends. It is a financial ratio
find it in DSE website or its publications.
that shows how much a company pays out in dividends each
5. Price-to-Book (P/B):
year relative to its share price. In the absence of capital
A price-to-book (P/B) ratio is used to compare a stock's gains, the dividend yield is the return on investment for a
market value to its book value. It can be calculated as the stock.
current share price divided by the book value per share. In a
Dividend Yield = Dividend per share / Share price
broader sense, it can also be calculated as the total market
For example, if a company’s annual dividend is $1.50 per
capitalization of the company divided by all the shareholders
share and the stock trades at $25, the Dividend Yield is 6%.
equity.
($1.50 / $25 = 0.06)
P/B Ratio = The current share price / The book value per
Dividend yield is a way to measure how much cash flow you
share
are getting for each dollar invested in an equity position.
This ratio gives certain idea of whether you are paying too
Investors who require a minimum stream of cash flow from

Monthly Review DEcEmBER 2015

their investment portfolio can secure this by investing in those confidence in the business and may get positive results. But
stocks having relatively higher yields. High dividends are this does not always hold true. Investors should consider the
attractive but they are a representation of past payouts. company’s shareholding pattern with great importance as it
There is not a guarantee that this payout will repeat in future. signifies that the company having very good prospect is
In addition, the dividend yield figure may also be affected by unwilling to issue more shares to the public. We should keep
fluctuating share prices. However, matured, well-established in mind that shareholding pattern in isolation is not sufficient
companies that have already grown significantly, tend to enough to take any investment decision. You must have to
have higher dividend yield, while the young, growth-oriented consider other factors along with shareholding pattern.
companies tend to have lower ones, and most small and How would you proceed with fundamental analysis?
growing companies don’t pay out dividends. Now the Now the time for analysis: first you have to collect data for the
question is why would shareholders accept low or zero yield. above mentioned factors for all companies. You will find most
Perhaps, the shareholders are more concerned with capital of those data in ready form from DSE website, DSE
gains rather than the dividend they will receive. publications or company annual reports. If it is troublesome to
9. Cash Flows: collect data for all companies you may condense your list by
cash flow is a measure of a company's financial strength. It eliminating those companies having higher P/E ratios (e.g.
is calculated as operating cash flow minus dividends from eliminate those having P/E ratio more than 25). comparison
preferred stock, divided by the number of common should be made within same sector or industry. You cannot
outstanding shares. Net cash flow per share helps compare stocks between financial and manufacturing
determining a company's ability to service debt, pay for sectors. After collecting data, you have to rank companies on
goods and services they use, pay dividends and perform the basis of the aforementioned fundamental factors. Pick
other transactions. A high cash earnings per share coupled those companies for portfolio that rank top in most of the
with a low share price indicates that the company likely has factors. However, your portfolio should cover each vibrant
strong earnings and that the share price will soon rise. sector with top ranked companies with a view to minimize
Some analysts prefer to look at cash flow per share rather than risk. As I mentioned earlier that high growth and potential
Earnings per Share, because cash flow per share is more likely company may have higher P/E ratio with low DPS and pay
to be accurate, as earnings data can be manipulated more out. Whenever you pick stocks for your portfolio, you should
easily than cash flow can. If a company announces BDT 5 cash consider this think very cautiously. But I would suggest that
dividend per share while its cash flow is just BDT 3 per share, as a new investor you should not pick those stocks having
the company will not be able to make the payment of dividend very high P/E ratio or pay very low dividend. Another
without borrowing from banks or other sources which is not important suggestion is that as a new investor you should not
expectable. And this practice does not indicate good sign pick a ‘Z’ category company and even the ‘B’ category one.
regarding the company. In DSE, many companies’ cash flows In the long run the stock price should reflect its fundamental true
fall short of covering their announced cash dividends. Hence, value. However in the short run a stock might have great
investors should be cautious in this regard. fundamentals but still be moving in wrong direction. This can be
10. Share Holding Pattern: due to other factors, such as news releases and changes in future
Purchasing a stock is nothing but to become a partial owner outlook, trends in the market and investors emotions which
of the business. As a partial owner you need to consider the influence current market price deviating from its true value.
other investors on that business. Shareholding pattern tells One thing is very important to consider is price. If you pay too
us the detailed ownership of that business. most importantly high price for even the best stock in the world, you will never
many a times, shareholding pattern indicates future stock make a good return on your investment. Therefore, a great
price movement. investment does not likely have a high price. To the end,
Broadly shareholding pattern is divided into two groups – when determining whether a company's stock is a good
Sponsored shareholders group- those who incorporated investment, fundamental analysis is a great toolbox to reach
the company and Public shareholders group- Share a conclusion.
holders other than promoters; i.e. BFI, banks, money In essence, in order to be a successful stock trader, you must
managers, mutual funds, insurance companies, individuals, continually practice, research and learn. Successful stock
etc. trading is a learned skill, with a noticeable learning curve.
Promoters are the founders (or initial investors) of the ---------------------------------------------------------------------------
company. Generally, promoter’s movements are followed to The author of this note is currently serving as an Assistant Professor in the
predict the future outcome of the company. If a promoter department of Finance and Banking, Islamic University, Kushtia. He has

125
extensively published on capital market issues in international journals.
raises his stake, it is comprehended that he has high

View publication stats