Comprehensive Fundamental Analysis Methods

Understanding the true value of a stock requires more than just looking at its price. Fundamental financial ratios are powerful tools that help investors analyse a company’s financial health, profitability, and growth potential. Whether you are a beginner stepping into the world of investing or an experienced trader refining your skills, mastering these key ratios can guide you in making informed and confident investment decisions. In this post, we’ll explore the most important financial ratios every stock investor should know to evaluate companies effectively and build a strong investment portfolio.

Let’s learn some ratios-

1. 📊 Earnings Per Share (EPS)

• Definition: Measures the profitability attributed to each outstanding share.

• Formula:

  EPS = (Net Profit−Preferred Dividends​) / Weighted Average Shares Outstanding

• Purpose: Indicates how profitable a company is on a per-share basis.

• Types:

  • Basic EPS – ignores dilutive securities.

  • Diluted EPS – includes convertible instruments like stock options.

• Investor Insight:

  • Consistently growing EPS = strong profitability.

  • Compare with industry peers for performance benchmarking.

2. 💰 Price-to-Earnings (P/E) Ratio

• Definition: Indicates how much investors are willing to pay per ₹1 of earnings.

• Formula:

  P/E Ratio = (Market Price per Share) / Earnings per Share (EPS)

• ​Two Types:

  • Trailing P/E: Based on last 12 months' earnings.

  • Forward P/E: Based on forecasted earnings.

• Investor Insight:

  • High P/E = high future growth expectations (may be overvalued).

  • Low P/E = potentially undervalued (check for risks).

• Benchmarking: Compare with industry average. E.g., IT sector P/E may be higher than manufacturing.

3. 🧾 Price-to-Book (P/B) Ratio

• Definition: Compares market value to book (net asset) value.

• Formula:

  P/B Ratio = Market Price per Share / Book Value per Share

• Investor Insight:

  • P/B < 1: Company possibly undervalued, or assets overstated.

  • P/B > 1: Market sees higher intangible value (e.g., brand, growth).

• Ideal For: Capital-intensive companies like banks, real estate.

4. ⚖️ Debt-to-Equity (D/E) Ratio

• Definition: Measures the company's financial leverage.

• Formula:

  D/E Ratio = Total Liabilities / Shareholders’ Equity

• Investor Insight:

  • High D/E = risky during downturns (more debt than equity).

  • Low D/E = conservative financing, less risk.

• Benchmarking: Varies by sector:

  • Utilities: High D/E is common.

  • Tech: Generally lower D/E.
    

5. 📈 Return on Equity (ROE)

• Definition: Measures how efficiently the company uses equity to generate profits.

• Formula:

  ROE = (Net Income​ / Shareholders’ Equity) X 100

• Investor Insight:

  • High ROE = effective capital use.

  • ROE > 15% is generally considered strong.

• Tip: Decompose ROE using DuPont Analysis to understand:

  • Net Profit Margin

  • Asset Turnover

  • Equity Multiplier

6. 💼 Current Ratio

• Definition: Measures short-term liquidity — ability to cover obligations within a year.

• Formula:

  Current Ratio = Current Assets​ / Current Liabilities

• Investor Insight:

  • Ratio > 1 = sufficient liquidity.

  • Ratio < 1 = possible cash flow issues.

• Sector Norms:

  • Retail: Typically higher due to inventory.

  • Tech: May operate with leaner balance sheets.

7. 💵 Dividend Yield

• Definition: Shows return from dividends relative to price.

• Formula:

  Dividend Yield = (Annual Dividend per Share / Market Price per Share) X 100​

• Investor Insight:

  • High yield = income potential (but check sustainability).

  • Low or no yield = may reinvest earnings into growth.

• Cross-check: Use Dividend Payout Ratio to assess risk of dividend cuts.

8. 🚰 Free Cash Flow (FCF)

• Definition: Money left after capital expenditures — available for dividends, buybacks, debt reduction.

• Formula:

  FCF = Operating Cash Flow − Capital Expenditures​

• Investor Insight:

  • Positive, growing FCF = good financial health and flexibility.

  • Negative FCF = may signal high reinvestment or cash stress.

9. 📊 PEG Ratio (Price/Earnings to Growth)

• Definition: Price/earnings-to-growth ratio, draws the relationship between a stock’s P/E ratio and projected earnings growth rate over a specific period.

• Formula:

  PEG = P/E Ratio​ / EPS Growth Rate

• Investor Insight:

  • PEG < 1 = undervalued relative to growth.

  • PEG > 1 = potentially overvalued.

10. 🌍 Economic Moat Evaluation (Qualitative)

• Definition: A company's competitive advantage that protects long-term profits.

• Types of Moats:

  • Brand Value (e.g., Apple)

  • Network Effects (e.g., Meta)

  • Cost Advantage (e.g., Walmart)

  • Switching Costs (e.g., Adobe)

• Investor Insight: Companies with wide moats tend to outperform long-term.

✅ Checklist for Fundamental Research

There are several other important ratios that play a key role in fundamental analysis. We’ll explore those in the next part of this series.

Happy trading!