What are the best fundamental analysis tools? Did you know that trading isn’t investing? Did you also know that traders look at different metrics than investors when deciding what stocks to buy? Some successful long-term investors lose their money when attempting to day trade, and some day traders can’t pick a good long-term investment if their life depended on it. Day trading or investing, is one better than the other? Truthfully, we should all be long-term investors; it shouldn’t even be a choice.
The reality is, day traders and long-term investors both make money, and both lose money. Both are viable forms of trading, and they need not be mutually exclusive. Whichever path you choose – and I hope it’s both, you’ll need to know the best fundamental analysis tools when investing.
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What Are the Methods of Fundamental Analysis?
Sometimes the most challenging part of investing is trying to decide where to put your money. So I’m a huge fan of finding the diamonds in the rough. And the best fundamental analysis tools help with that.
Also known as value investing, it’s simply finding undervalued companies and buying them at a discount. Of course, there’s nothing better than getting stuff on sale; I know you bargain-basement shoppers can relate.
That said, when “shopping,” there are a few key fundamentals you may want to look at. And remember, a number or ratio, in this case, may “look” sound, but you need to understand why that number looks good or if it looks “too” good to be true.
The hardest part of deciding where to put your money is deciding what criteria you want to look for in a company. Of course, as a value investor, one looks for solid companies on sale at a discounted price (maybe due to bad short-term news).
At this point, you’re probably asking where to find these deals. Well, the trick is to use a stock screener. Most online brokerages have them, as well as Finviz or Yahoo! Finance. What I highlight below are some key fundamentals you may want to look at before putting money into a company.
Remember, just because a number or Ratio may look good doesn’t mean it is. One must understand why that number looks good or if it looks “too” good. Luckily, the best fundamental analysis tools will help you do just that.
Best Fundamental Analysis Tools and Market Capitalization
Market capitalization is one of the best fundamental analysis tools for you. Commonly called a market cap, it’s the total market value of all outstanding shares on the market. Market capitalization is equal to the share price multiplied by the number of shares outstanding. The result is the companies worth.
For small investors, market capitalization might not be that important but it plays a role in the types of companies you’ll see in the screener.
Personally, I prefer to exclude those with a capitalization of less than $300 million. Also known as microcap companies, they’re mostly young start-ups or highly volatile. Because of this, they can skew some of the other measures that I like to screen by hence why I leave them out.
Price/Earnings-To-Growth Ratio (PGE Ratio)
The PEG ratio is a valuation metric for determining if a company is reasonably valued. To calculate, one takes the company’s Price/Earnings ratio and divides it by its earnings growth rate over a period of time (typically the next 1-3 years).
Thus, the PEG ratio adjusts the traditional P/E Ratio by considering the growth rate in earnings per share expected in the future.
A ratio of 1 means that the company is reasonably priced, while a ratio of less than 1 means that the company is undervalued.
Personally, I find value in the P/E Ratio alone because it looks at whether the P/E Ratio is excessively high or reflects the company’s growth prospects.
However, it does have its disadvantages. For starters, this measurement doesn’t work at the extremes (very low-growth or ultra-high growth). Secondly, it relies on estimating a company’s growth rate; this isn’t a definite number. For these two reasons alone, one must use it in conjunction with some of the other best fundamental analysis tools.
Profit Margin TTM
A companies profit margin tells you how much they earn out of every dollar they generate in revenue. To calculate the profit margin one divides profit by gross revenues. And the term “trailing 12 months” refers to the just-completed 12-month period. Likewise, the TTM profit margin is the trailing 12 months of profit over total revenues for a company.
The trailing 12 months’ profit margin allows owners and investors to observe any recent profit trends. It is most useful when the TTM does not coincide with the fiscal year. Without a doubt, it’s an excellent indicator of how the company is performing.
Now one just can’t assume a company is doing well because of good TTM profit margins as each industry has different standards for profit margin. As an investor, you must compare the company’s profit margin to the industry in which it operates.
Let me give you an example to help illustrate. In the tech industry, the margins can be very high. However, they may take a nosedive in industrial production due to input costs.
For these reasons, when you screen for TTM profit margins, look for companies that consistently have above industry average profit margins. However, this alone isn’t enough; you need to know why.
Successful investors know this “why” is key to discovering the company’s competitive advantage in the market. For example, does the company have a cutting-edge type of technology that lowers costs? Do they have special deals in place where they can buy their production goods at a discount rate? By asking the right questions will lead you to answers that will allow you to make a very informed decision about the company. Hence the best fundamental analysis tools.
The next great indicator to look for is the Price to Book Ratio. The P/B ratio compares a company’s market capitalization, or market value, to its book value. And no, I don’t mean the value of books in their library.
When calculating a company’s book value, one subtracts the company’s total tangible assets from its total liabilities. Moreover, if you’ve invested in a company, it gives you an idea of how much you stand to make if the company went bankrupt immediately.
Let me put this in perspective for you. When a company has a P/B ratio of less than one, pay attention. Not only can it signal that a company is undervalued – the value of its assets minus liabilities is currently worth more than the share price, but it could also mean you stand to make money if the company went bankrupt immediately.
Similar to the profit margin TTM, book value varies significantly depending on the industry. Also, a company in distress – similar to people in distress, may have many more liabilities than assets. In a situation like this, the book value is meaningless. Finally, book value fails to consider brands and intellectual property, which some companies use that their main asset – think Nike and Deloitte. In a situation like this, the book value may also be meaningless.
Best Fundamental Analysis Tools and Dividend Yield
Dividend yield equals the annual dividend per share divided by the stock’s price per share. For example, if a company paid out $5 in dividends per share and its shares currently cost $150, its dividend yield would be 3.33%.
It should come as no surprise you should look for companies with positive dividend yields, even if it is minimal. Dividends are fantastic as they can show that the company is financially healthy enough to pay its shareholders.
Thus, it is essential to examine the payout ratio of dividend-paying stocks to ensure that the company can continue paying its dividend. Investing is a long game, and it may take a long time for the company’s value to be realized. But on the bright side, if you invest in companies with a dividend, you are essentially paid to wait. How great it that!
Before purchasing any stock for your portfolio, you need to be thorough. Please do your homework and use the best fundamental analysis tools. To succeed as a long-term investor, you have to become adept in picking stocks likely to gain value over time.
Apart from this, understand your cash will be tied up for a significant period of time. In spite of this, even novice investors can succeed by simply gaining the right help. Why don’t you check out our Bullish Bears blog for tips on picking the right broker for your investing needs?