Fundamental Analysis of Stock Research Mentor Session One
Joseph York Tuesday, November 04, 2008
What is Fundamental Analysis?
Can be split into two categories: • Quantitative Analyzes key ratios Provides concrete data for analysis • Qualitative Analyzes Intangible Data Management, patents, innovation, etc. Difficult to measure numerically
• The following presentation will give you some understanding into what these quantitative measures are and how to use them • It is important to remember, however, that you must not focus on only one of these values, but rather, use several of them together with other research tools (technical analysis, industry analysis, annual/quarterly reports) to develop a true picture of the company’s health Source:
ROE/ROA Alpha PEG
EPS Quick Ratio Beta
Price to Sales
PE Current Ratio Debt to Equity Net Profit Margin Price to Book
• Money that a company collects from customers for the sale of a product or service. When you subtract out all costs from revenues, you get profits or earnings.
• The total dollar value of all outstanding shares, calculated by multiplying the price of a single share by the total number of shares outstanding.
1. Mega Cap: Market cap of $200 billion and greater 2. Big/Large Cap: $10-$200 billion 3. Mid Cap: $2 billion to $10 billion 4. Small Cap: $300 million to $2 billion 5. Micro Cap: $50 million to $300 million 6. Nano Cap: Under $50 million
Net Profit Margin
• Net income as a percentage of sales. You get this by dividing net income by sales. Since it's a percentage, it tells you how many cents on each dollar of sales is pure profit. • The higher a company‟s profit margin compared to its competitors, the better
Net Profit Margin Example:
• Suppose True Religion made a profit of $20 on the sale of a $200 pair of jeans. Dividing the dollar amount of earnings by the product cost, that firm's profit margin would be 0.1 or 10 percent, meaning that each dollar of sales generated an average of ten cents of profit. • The profit margin is very important as a measure of the competitive success of a business, because it captures the firm's unit costs.
Earnings per Share (EPS)
• A very important fundamental, calculated:
• Basically, this will tell you if and how profitable the company is. • What‟s preferred stock? A class of ownership in a corporation with a stated dividend that must be paid before dividends to common stock holders.
• One of the favorite ratios, it is simply:
• EPS from the last four quarters is called trailing P/E • EPS taken from the estimates of earnings expected in the next four quarters is called forward P/E • P/E is referred to as the "multiple," because it shows how much investors are willing to pay per dollar of earnings. • High P/E means high projected earnings in the future. • ** It's usually only useful to compare the P/E ratios of companies in the same industry, or to the market in general, or against the company's own historical P/E
Price to Sales
• Price to sales is calculated by dividing a stock's current PRICE by its revenue (SALES) per share • A low price to sales ratio (for example, below 1.0) is usually thought to be a better investment since the investor is paying less for each unit of sales. However, sales don't reveal the whole picture, since the company might be unprofitable.
Price to Book
• Price to book is calculated by dividing the current closing price of the stock by the latest quarter's Book Value equals book value. recorded on the balance sheetof the A liability is total all, minus • What is book value you ask? It is taxes, all and can include accounts payable, liabilities, thewages, accrued the company's total value of expenses, and deferred the dividing result assets that shareholders would debts by the revenues. Current liabilities are theoretically receiveyear,company number of payable within one if a while long-term common were liquidated today. liabilities are debts payable over a longer shares outstanding. period. • A low P/B ratio could mean the ~ stock is undervalued, or something is very wrong with the company…
For Those Interested:
Debt to Equity
• A relative measure of how much debt a company has: • Essentially: long-term funds provided by creditors divided by funds provided by shareholders. • A higher debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile (RISK) earnings
• A good measure of liquidity of a company, or how easily it can „cough up‟ cash. • AKA - Indicator of company's ability to pay short-term obligations; calculated by dividing current assets by current liabilities. • The higher the ratio, the more liquid the company! (What types of companies might this ratio be VERY important?)
• Like current ratio, this gives a measure of a company‟s financial strength: • It is a measure of how quickly a company's assets can be turned in cash • You subtract inventories so you can check and see if a company has sufficient liquid assets to meet shortterm operating needs. (NOTE THAT CURRENT RATIO DID NOT SUBTRACT INVENTORIES)
Return on Assets (ROA)
• Also sometimes called “Return on Investment” or ROI, this is a measure what earnings were generated from capital investment back into the company • Always given as a percentage • Think of it as “How much money (income) was generated from a company’s investment into itself (capital investment or company assets)”
Return on Equity
• It is a measure of how much in earnings a company generates in four quarters compared to its shareholders' equity and is a good measure of profitability • It is also measured as a percentage. • For instance, if XYZ Corp. made $1 million in the past year and has shareholders' equity of $10 million, then the ROE is 10%. Some use ROE as a screen to find companies that can generate large profits with little shareholder investment in the company.
• A measure of a security's or portfolio's volatility, or systematic risk, in comparison to the market as a whole. (usually calculated with S&P 500 Index) • Think of beta as the tendency of a security's returns to respond to swings in the market. A beta of 1 indicates that the security's price will move EXACTLY with the market. A beta less than 1 means that the security will be LESS volatile than the market. A beta greater than 1 indicates that the security's price will be MORE volatile than the market.
Price/Earnings to Growth (PEG)
• It is: • Can give you an idea of a stock potential growth, since it divides be Earnings Per Share (EPS) annual growth rate – but is based on analysts ESTIMATES! • If a company has a P/E of 20 and analysts expect its earnings will grow 15% annually over the next few years, you'd say it has a PEG of 1.33. Anything above 1 is suspect since that means the company is trading at a premium to its growth rate.
• There are many other ratios out there to help you get an idea of what the financial health of a company is • What do you do if you don‟t know what they mean? Panic and run around the room? No, use…
Many of the formulas and definitions from this presentation were ‘borrowed’ from Investopedia without their consent; please don’t turn me in.
Our Example Company
• SFBC International Inc. (SFCC) • A drug development services company, Provides clinical drug development services to branded pharmaceutical, biotechnology, generic drug, and medical device companies. SFBC specializes primarily in the areas of Phase I and early Phase II clinical trials and bio-analytical laboratory services. The company also provides late stage clinical development services that focus on Phase II through Phase IV clinical trials.
Analyzing SFCC Fundamentally
• Valuation: Price/Earnings, Price/Sales, Price/Book • Growth Rates: • Debt and Liquidity: Debt to Equity, Quick Ratio • Returns: ROA, ROE
• PE – Always compare to industry and sector!
– 16.55 vs. and industry of 40.54 and sector of 30.89 – Is this due to low price or high earnings?
• PS – Due to higher sales growth, PS is much lower than industry or sector!
• For a small market cap (457.09M), it is imperative that the company is growing its earnings while backing up these earnings with increasing SALES. • Important to look at both quarterly and annual growth rates.
Growth Rates (%)
Sales (MRQ) vs. Qtr. 1 Yr. Ago
Sales (TTM) vs. TTM 1 Yr. Ago
Sales - 5 Yr. Growth Rate
EPS (MRQ) vs. Qtr. 1 Yr. Ago
EPS (TTM) vs. TTM 1 Yr. Ago
EPS - 5 Yr. Growth Rate
Debt and Liquidity
Financial Strength Company Industry Sector S&P 500
Quick Ratio (MRQ)
Current Ratio (MRQ)
LT Debt to Equity (MRQ)
Total Debt to Equity (MRQ)
Management Effectiveness (%) Return On Assets (TTM) Return On Assets - 5 Yr. Avg. Company 6.1 7.36 Industry 3.22 -0.79 Sector 7.18 7.74 S&P 500 7.96 6.19
Return On Investment (TTM)
Return On Investment - 5 Yr. Avg.
Return On Equity (TTM)
Return On Equity - 5 Yr. Avg.