Investors in the stock market use many different tools to evaluate companies as investment candidates. Many of these tools look at fundamental information as a guide to the financial health of the company.
Fundamental analysis is the process of looking at financial ratios and other financial markers for information. It is important to note that no single number, ratio or marker tells the whole picture and sum are even misleading if you do not look at the whole picture.
Two of the tools investors use include equity-based and sales-based evaluations. Both have value, but also draw backs when it comes to evaluations.
Equity is usually defined as tangible and intangible assets held by a company that can be converted to cash, although some assets (such as real estate) often take time to sell. Intangible assets may include the brand name and reputation and the existing goodwill with customers and suppliers.
A parallel comparison is how you compute the equity in your home is the difference between what the house is worth (what it will sell for) and how much you owe on your mortgage. The fair market value of your home includes tangible as well as intangible assets. The tangible assets include the house itself and the property it sits on, plus any additional assets such as landscaping, fences, and so on. The intangible assets might include the neighborhood, curb appeal of the house, and proximity to shopping and schools.
A company's assets follow the same general pattern with real estate, equipment, and inventory, which make up the tangible assets.
An intangible asset might include the brand name that the consumer knows the company by. This type of intangible asset can be worth a lot.
What would you pay to rename your computer company IBM? It probably wouldn't take long for people to figure out you weren't the IBM they were familiar with, but the point is virtually everyone even remotely connected to computers-and a lot who aren't-would recognize this respected name.
One of the ways to evaluate a company involves relating equity to stock price. The balance sheet is where you find the company's equity, which is was the assets of the company minus the liabilities? This is also known as book value. The calculation is a bit more complicated than that, but fortunately all that is figured out for you and available on almost any site reporting stock prices.
To calculate the book value per share, you take book value and divide it by the outstanding number of shares. Next, take the current stock price and divide it by the book value per share. This gives you a price-to-book ratio. A price/book ratio of 1 would indicate that for $1 in share price you were buying $1 in book value.
Sometimes you need a way to evaluate a company that isn't making money for one reason or another. Price earnings ratio doesn't work in this case because there are no earnings.
The fact that a company is not currently earning a profit doesn't mean it is not a good investment candidate. There may be some good, short-term reason for the losses that will be corrected in the near future.
However, the company may be very young and in a very hot industry, such as the Internet stocks. Many of these companies are quite active and have huge market capitalization despite the fact they have never made money.
What many of them do have is sales, and we can use sales as a way to evaluate a company when there are no earnings. The sales-price ratio gives us a look at what those sales might be worth relative to the stock's price.
The sales-price ratio is calculated by taking the stock's market capitalization plus any long-term debt and dividing that number by sales for the last 12 months. The closer this number is to 1, the better. The sales-price ratio is also very helpful in comparing the company with others in the industry, some who are making money and some who aren't.
Fundamental analysis is the process of looking at financial ratios and other financial markers for information. It is important to note that no single number, ratio or marker tells the whole picture and sum are even misleading if you do not look at the whole picture.
Two of the tools investors use include equity-based and sales-based evaluations. Both have value, but also draw backs when it comes to evaluations.
Equity-Based Evaluations
Equity is usually defined as tangible and intangible assets held by a company that can be converted to cash, although some assets (such as real estate) often take time to sell. Intangible assets may include the brand name and reputation and the existing goodwill with customers and suppliers.
A parallel comparison is how you compute the equity in your home is the difference between what the house is worth (what it will sell for) and how much you owe on your mortgage. The fair market value of your home includes tangible as well as intangible assets. The tangible assets include the house itself and the property it sits on, plus any additional assets such as landscaping, fences, and so on. The intangible assets might include the neighborhood, curb appeal of the house, and proximity to shopping and schools.
A company's assets follow the same general pattern with real estate, equipment, and inventory, which make up the tangible assets.
An intangible asset might include the brand name that the consumer knows the company by. This type of intangible asset can be worth a lot.
What would you pay to rename your computer company IBM? It probably wouldn't take long for people to figure out you weren't the IBM they were familiar with, but the point is virtually everyone even remotely connected to computers-and a lot who aren't-would recognize this respected name.
One of the ways to evaluate a company involves relating equity to stock price. The balance sheet is where you find the company's equity, which is was the assets of the company minus the liabilities? This is also known as book value. The calculation is a bit more complicated than that, but fortunately all that is figured out for you and available on almost any site reporting stock prices.
To calculate the book value per share, you take book value and divide it by the outstanding number of shares. Next, take the current stock price and divide it by the book value per share. This gives you a price-to-book ratio. A price/book ratio of 1 would indicate that for $1 in share price you were buying $1 in book value.
Sales-Based Evaluation
Sometimes you need a way to evaluate a company that isn't making money for one reason or another. Price earnings ratio doesn't work in this case because there are no earnings.
The fact that a company is not currently earning a profit doesn't mean it is not a good investment candidate. There may be some good, short-term reason for the losses that will be corrected in the near future.
However, the company may be very young and in a very hot industry, such as the Internet stocks. Many of these companies are quite active and have huge market capitalization despite the fact they have never made money.
What many of them do have is sales, and we can use sales as a way to evaluate a company when there are no earnings. The sales-price ratio gives us a look at what those sales might be worth relative to the stock's price.
The sales-price ratio is calculated by taking the stock's market capitalization plus any long-term debt and dividing that number by sales for the last 12 months. The closer this number is to 1, the better. The sales-price ratio is also very helpful in comparing the company with others in the industry, some who are making money and some who aren't.
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