You cannot build a strong building on a weak foundation
When you are looking for any kind of investment in a company as a partner or a shareholder, you should calculate the strength of the financial foundations of the company. The financial aspects are to be scrutinized at basic levels. This type of pore over is well-known in the name of Fundamental analysis. By taking various dynamic aspects like sales, revenue, net worth, capacity levels of the company and bank rates at which company is being funded etc., fundamental analysis travels. Ratios are mainly considered for this purpose. In order to evaluate the real worth of the shares or stocks of a company, this kind of analysis always lend a hand and make the investment decision bit simple. One should keep in mind that the market rate of a share depends upon the basic principle of demand and supply; hence there may be chances of misguiding the market with some fictitious demands, though the government and the SEBI are keeping some controls, we must be cautious. For this purpose, the fundamental analysis can be shored up.
Brawny base is fundamental
If basics are strong, then the market fluctuations have minimal impact, and though there is a downfall, it will be temporary in nature and financial fruits will ripen in the long run. Thus, a keen analysis of financial basics is required.
Fundamental analysis is not a simple task. It composes of the business climate analysis, market analysis, sentiment analysis etc. So, a good professional approach is required, gathering professional knowledge might not be possible for all, hence some simple tools are elaborated in this article such that even financial illiterate is going to have some idea on the fundamental analysis of the company in which the investments will be made by him.
Tools to tackle
A common word on which we can depend for analysis is profit which is also termed as earnings. Every company has some earnings, either positive (Profits) or negative (Losses). The financial health of the company can be determined on the basis of this earnings comparability with different factors. And few are mentioned below.
- Earnings per Share (EPS):
- Return on Equity (ROE)
- Dividend Payout Ratio
- Dividend Yield
- Price to Earnings Ratio (P/E):
Earnings per Share (EPS): EPS is a financial ratio, which divides the net earnings available to common shareholders by the average outstanding shares over a certain period of time. The EPS formula indicates a company’s ability to produce net profits for common shareholders.
To keep simple
EPS = (Net Income – Preferred Dividends) / Weighted Average number Equity shares
Return on Equity (ROE) ROE gives an easy insight of returns on the equity. The skillfulness of the company’s finance management can be traced out with the ROE figures. If the ROE is in increasing mode, the share holder’s value will also increase. The formula to evaluate ROE is as follows
ROE = Net Income / Share Holder’s Equity
Dividend payout Ratio. The total profits of the company are not distributed among the owners or equity shareholders as something to be retained for the future growth purpose. DPR is nothing but the percentage of distributed part of the net income in the form of dividends. We can analyze DPR with a simple formula
DPR = Total dividends/ Net income
Dividend Yield Ratio: Dividend yield is the financial ratio that measures the quantum of cash dividends paid out to shareholders relative to the market value per share. It narrates the investment’s productivity.
Dividend Yield = Annual Dividend / Current Stock Price
P/E Ratio: This is another vital ratio which is used by investors and analysts to determine the relative value of a company’s share against the market value of the same. It can also be used to compare a company against its own historical record or to compare aggregate markets against one another or over time. It gives a pilot’s view on the over or undervaluation of shares
To put as a formula
P/E Ratio = Market Value per Share /Earning per Share
Conclusion
Honestly, the ratios cannot be perceived as crusaders, they just flash a light in the wild investment forest. They support in gaining a general understanding of the results, financial position of a business. Especially investors, who need to create a picture of the financial results and position of a business just from its financial statements. Just KYC (Know your company) before entering into its business through equity.
Dr. CMA V.V.V. Phani Kumar
Manager (F&A) – Rashtriya Ispat Nigam Limited (RINL)
