Down to the Basics - How to Apply Fundamental Analysis to Your Stocks Picking Process. Page:   1     2

Quantitative Evaluation
This involves some number-crunching, but I hope that doesn't scare you. As stated, this you can outsource or support with a software. Hopefully, we'll do a review of some of such software, sometime soon.

You need the company's financials - principally the income statement (profit and Loss account), balance sheet, cash flow statement - for this analysis. Company reports also contain a lot of other valuable information on what the company is doing or plans to do. The external Auditor's report, for instance, can highlight important information (example: account qualification) that an investor, or intending one, should take note of. You also need to be able to interprete the financial statements and this includes reading between the lines for masked indicators. The analysis requires being able to spread the figures and compute important financial ratios (we will examine them in details subsequently) that highlight operational strengths and weaknesses. You will also need to trend the performance over time (some years at least) in key operating indices to see the outlook and make meaningful projections. That would require too that you are able to carry out share valuation, using any or a combination of the available valuation models. Because you are aiming to buy into a business and its earnings potential, projected future earnings and cash flow will be important indices. Discounting the future cash flow stream to present value is a strong index of intrinsic value. There are many important measures analysts focus on relating to earnings, liquidity, gearing, asset quality, etc: Earnings per Share - EPS, Price to Earnings Ratio - P/E ratio, Projected Earning Growth - PEG, Dividend Payout Ratio, Dividend Yield, Price to Sales - P/S, Price to Book - P/B, Book Value, Return on Equity, Current Ratio, Debt to Shareholder's Equity, etc.

If your figures are further subjected to some sensitivity analysis (meaning that certain worst-case scenarios are considered) you may come up with a confident judgment on the real value of a particular company. And, for completeness, you adjust for a margin of safety (making a percentage provision for inaccuracies), you should have a strong position as to whether you have a bargain opportunity or not. Any significant under-valuation determined with this will provide a hot target.

Qualitative Factors
The figures you derive from quantitative analysis need to be re-inforced with qualitative factors, pricipally:

• The business model is critical: what does the company do and how does it generate revenue. Does that look solid?


• The quality of management is fundamental to success as the team is the driver of vision and performance. Do they measure up in key areas: education, training, experience, vision, track record, character, etc?


• Competitiveness should be a priority factor: does the company have leading edge in terms of market positioning, driven by either product advantage, resource base or competitive advantage?


• Industry sector prospects: is the sector growing, driven by strong fundamentals?


• Any other factor that can impact on the future prospects of the business.

With the combined results from your quantitative and qualitative evaluations, you will, hopefully, be in a position to make strong decisions on a company's value that can stand the test of time. Will it be precisely accurate? You may never know. However, given that you want to take decisions on whether to invest money (or even pull out of current investment), you are the judge as to how well you've done in arriving at figures to base such important decision on. While it is difficult for every investor to become an accountant or financial analyst, some level of understanding of financial information should be cultivated. Only practice will help with this. A starting point is to pay attention to the financial reports that companies distribute to shareholders and which even non-shareholders can access. You should begin to probe into what the figures are saying. Gradually, begin to see the important relationships that are pointers to company health and performance and how these trend over time. Naturally, if you take investing as an important project, you will continue to search for how to 'perfect' your performance, which simply means more enquiry and learning.

If it all sounds tasking, making spectacular returns should demand some work, isn't it? Otherwise, you will rely on chance, applying off-the-cuff, rule-of-thumb judgement. Problem is, you may underperform. Using professionals investment advisers and fund managers can take the heat off you as you get them to deploy their experience and skills to work for you. Or, you get into the trench yourself. While it is possible to earn returns by just following the market, outstanding performance will best come through dedicated, focused and painstaking tracking of companies and the market. Good luck as you take steps to build a strong investment portfolio and amass wealth!

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