Fundamental Stock Analysis is
typically more closely tied to buy and hold investors, whereby day traders use
solely technical analysis and most swing traders use both fundamental and
technical stock analysis. Technical analysis is specifically important for
swing traders with a very short time horizon (that is, a couple of days or just
a few weeks).
Stock Fundamental Analysis (Value, Growth, Income, Quality, GARP)
Many people rightly believe that when
you buy a share of stock you are buying a proportional share in a business. As
a consequence, to figure out how much the stock is worth, you should determine
how much the business is worth. Investors generally do this by assessing the
company’s financial’s in terms of per-share values in order to calculate how
much the proportional share of the business is worth. This is known as
“fundamental” analysis by some, and most who use it view it as the only kind of
rational stock analysis.
Value. A cynic, as the saying goes, is
someone who knows the price of everything and the value of nothing. An
investor’s purpose, though, should be to know both the price and the value of a
company’s stock. The goal of the value investor is to purchase companies at a
large discount to their intrinsic value – what the business would be worth if
it were sold tomorrow. In a sense, all investors are “value” investors – they
want to buy a stock that is worth more than what they paid. Typically those who
describe themselves as value investors are focused on the liquidation value of
a company, or what it might be worth if all of its assets were sold tomorrow.
However, value can be a very confusing label as the idea of intrinsic value is
not specifically limited to the notion of liquidation value . These value
investors tend to have very strict, absolute rules governing how they purchase
a company’s stock. These rules are usually based on relationships between the
current market price of the company and certain business fundamentals. A few
examples include:
·
Price/earnings rations (P/E)
·
Dividend yields above a certain absolute limit
·
Book value per share relative to the share price
·
Total sales at a certain level relative to the company’s market
capitalization of market value
Growth. Growth investing is the idea
that you should buy stock in companies whose potential for growth in sales and
earnings is excellent. Growth investors tend to focus more on the company’s
value as an ongoing concern. Many plan to hold these stocks for long periods of
time, although this is not always the case. At a certain point, “growth” as a
label is as dysfunctional as “value,” given that very few people want to buy
companies that are not growing. Growth investors look at the underlying quality
of the business and the rate at which it is growing in order to analyze whether
to buy it. Excited by new companies, new industries, and new markets, growth
investors normally buy companies that they believe are capable of increasing
sales, earnings, and other important business metrics by a minimum amount each
year. Growth is often discussed in opposition to value, but sometimes the lines
between the two approaches become quite fuzzy in practice.
Income. Although today common stocks
are widely purchased by people who expect the shares to increase in value,
there are still many people who buy stocks primarily because of the stream of
dividends they generate. Called income investors, these individuals often
entirely forego companies whose shares have the possibility of capital
appreciation for high-yielding dividend-paying companies in slow-growth
industries. These investors focus on companies that pay high dividends like
utilities and real estate investment trusts (REITs), although many times they
may invest in companies undergoing significant business problems whose share
prices have sunk so low that the dividend yield is consequently very high.
Quality. Most investors today use a
hybrid of value, growth, and GARP approaches. These investors are looking for
high-quality businesses selling for “reasonable” prices. Although they do not
have any shorthand rules for what kind of numerical relationships there should
be between the share price and business fundamentals, they do share a similar
philosophy of looking at the company’s valuation and at the inherent quality of
the company as measured both quantitatively by concepts like Return on Equity
(ROE) and qualitatively by the competence of management. Many of them describe
themselves as value investors, although they concentrate much more on the value
of the company as an ongoing concern rather than on liquidation value.
GARP. Investors combines the value and growth approaches and adds a numerical slant.
Practitioners look for companies with solid growth prospects and current share
prices that do not reflect the intrinsic value of the business, getting a
“double play” as earnings increase and the price/earnings (P/E) ratios at which
those earnings are valued increase as well.One of the most common GARP
approaches is to buy stocks when the P/E ratio is lower than the rate at which earnings
per share can grow in the future. As the company’s earnings per share grow, the
P/E of the company will fall if the share price remains constant. Since
fast-growing companies normally can sustain high P/Es, the GARP investor is
buying a company that will be cheap tomorrow if the growth occurs as expected.
If the growth does not come, however, the GARP investor’s perceived bargain can
disappear very quickly.
