Moneywise24 Personal Finance

I know, most of you would have expected me to dig into the financials of a company first. However, I have explicitly chosen to write the first article on fundamental stock analysis about the P/E ratio. The P/E ratio stands for Price-to-Earnings Ratio, and might is also referred to as PER.

The P/E ratio measures the price paid per share relative to the earnings on that share, or the Earnings Per Share. The P/E ratio is expressed in years. As such, having a P/E ratio of 8 means that if I would buy 1 share, it would take me 8 years to earn back my investments on that share; A P/E ratio of 30 means that if I would buy 1 share, it would take me 30 years to earn back my investments on that share. Thus, the formula is:

P/E ratio = Price per Share / Annual Earnings per Share

The P/E Ratio can also be expressed in percent:

• A P/E ratio of 8 resembles an annual return 12.5% (becuase 8 times 12.5% is 100%),
• A P/E ratio of 30 resembles an annual return of 3.33%.

From the above examples, it is easy to conclude that a lower P/E ratio means higher annual returns. However, since the Earnings Per Share is related to the actual income of a company, it also makes a statement as to whether the share is relatively inexpensive or expensive considering the company’s current economical situation. Generally said:

• Share with a P/E ratio below 10 is considered as inexpensive,
• Sahre with a P/E ratio above 20 is considered as expensive.

P/E ratios should never be considered alone, but always in the context of the performance of the company. One reason the P/E ratio of a company is low might be simply due to the fact that the company has been somewhat ‘forgotten’, although the company is performing well. However, another reason might be, because the company’s performance is very poor and investors have been selling the shares massively.

Some internet platforms offer the possibility to select shares according their P/E ratio, such as Yahoo! Finance; this allows you to select the more inexpensive shares, and work from there. But you will definitely want to conduct further research as to the company’s future.

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Many books and websites write about analyzing stock performance, fundamental analysis and financials. However, many forget to include where to find all this information. I thought it would be logical to first write about the various resources available, before digging into the details of fundamental analysis.

Official annual / quarterly reports

If you want to know more about a company, the first place you might think of are official publications of that particular company. This usually includes the annual and quarterly reports. The main benefit of such reports is that they are extensive, complete, they come directly from the source, and that they include a lot of background information. Annual reports usually include an extensive background of the company, its divisions, products, and markets. Additionally you will find all the financial figures you need for your analysis, and the report might provide extensive information about the direction the company wants to head, and possible problems they might encounter in the next years.

The downside of such reports is that it is very time consuming, and you will need to know the company you want to invest in, in order to visit their website and download their reports.

Your bank

Banks usually have their own business unit for investors. A bank will usually be able to provide you with some consolidated information, such as the latest company results, the latest news pertaining to certain stocks, as well as their rating of particular stocks. Banks might recommend to buy, hold, or sell stocks, based on their analysis.

However, banks are still somewhat limited in the information they provide. Many banks are limited to only certain markets or stock exchanges, and the analyses they provide is a mere summary of facts from one of the analysts. Additionally, the analyst’s recommendation is quite subject, as he/she will need to interpret his findings in order to make a recommendation, and interpretations may vary from person to person.

Newpapers

Newspapers are a good source for recent micro- and macro economic developments, Mergers & Acquisitions, crises, etc. Additionally, newspapers offer an overview of stock prices.

Of course, printed media are never as up-to-date as online media, the stock prices are from the previous day, and the news is not the latest. If you are relying on broadcastings (radio, television), you are usually restricted to pre-set times of when news will come available, as well as what they choose to broadcast. Personally, I hardly use any print media anymore in order to conduct my fundamental analysis.

Finance portals

Finance portals, such as Yahoo! Finance or Reuters are platforms, which consolidate certain information. For example, Reuters offers the latest news of a particular company, it offers financial figures and ratios over the last 4 years or 4 quarters, and it offers analyst research and findings. Some portals (e.g. Yahoo! Finance) offer a filter, allowing you to filter down available stocks according to a number of criteria. In other words, you will find everything in one place.

The downside of such financial portals is that information is supplied by other sources, and therefore certain information might either be not up-to-date or not available.

My personal experience has demonstrated, that using a few resources simultaneously works best for me. Usually, I would first visit a finance portal, narrow down my search for available stocks, and I would take a glance at the financials, the available ratios, and the latest news about that company. If I have a good feeling about this particular company, I would download their annual report for further reading. This would allow me to make a personal recommendation of whether I would buy, hold, or sell the stock. Last, I would visit the website of my own bank and view the recommendations of its analysts; this is to assure that there is an overlap of my findings and their findings.

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I consider long-term investing in stocks/shares as a crucial element of building wealth; in fact, you will most probably find this confirmed by most personal finance blogs on the internet. This also brings a number of interesting questions, such as how we can pick the best investment opportunities, and on what do we base our investment decisions. In the next few weeks, I intend writing a number of articles, focussed on how to analyze company stocks and investment pportunities.

Currently, there are two main methodologies for analyzing and possibly predicting the future value of a stock or share. These are:

• technical analysis
• fundamental analysis

Technical Analysis

The basic principle of the technical analysis, also called chart analysis or market analysis, is to identify potential buying or selling signals, and generally predict the future development of a stock price by its historical price and volume data. While doing this, the actual company data (e.g. annual reports, strategies, developments) as well as other economic factors are are not being involved in the technical analysis. Technical analysis is based on the fact, that particular price and volume patterns in the past have frequently been followed by a particular price and volume movement. Technical analysts attempt to identify these patterns, via the calculation of many different indicators, aiming at identifying buying and selling signals.

Technical analyses can be conducted using different time frames; long-term, mid-term, or short-term.  Additionally, technical analysis is largely based on the fact, that a stock’s price is largely determined by supply and demand of investors, irrelevant to what the actual company is worth. However, many technical analysts combine their technical findings with current macro and micro economic trends, in order to find whether these are in line with each other or not.

The topic of using technical analysis as a stock analysis method is quite controversial, as it does not attempt to involve the actual company’s performance. Many analysts swear by the technical analysis, others prefer using fundamental analysis methods.

Fundamental Analysis

The fundamental analysis is based on researching the fundamentals of the economy and the company. The fundamental analysis includes analyzing the annual reports of companies, specific ratios, the strengths and weaknesses of a company, potential development opportunities or threats, as well as macro economic developements. Fundamental analysts assume that generally the stock price reflects a company’s real performance, keeping in mind that sudden micro or macro economic news, market fluctuations, or sudden panic might let the stock deviate from its course. The fundamental analyst therefore attempts to identify which stocks are undervalued, overvalued, yearly earnings, and future potential.

Fundamental analysis is adopted by many large financial institutions, who publish their mid- and long-term view on a particular stock’s development. Also Warren Buffett used the fundamental analysis to select his stocks, or why do you think that the book “Warren Buffett and the Interpretation of Financial Statements” is about a company’s financials rather than technical analysis?

Each person will have his or her own preferences. Myself, since I aim to invest with a long-term vision and also share the idea that generally a stock will move in the direction of a company’s performance or potential, tend to adopt the fundamental analysis as my main investment strategy.

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