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How to Do A Fundamental Analysis of Stocks


What are the key things to look for while buying a stock? It’s easy to make mistakes in the stock market, and it’s not just the first-time investor but even traders with some reasonable experience are prone to miscalculate. Some of the most common investment slipups include putting money in a stock while being clueless about how the company in question is generating or planning to generate profits.
Looking for short-term gains rather than viewing stocks as a long-term play is a common failing of a lot of investors. Some end up tying all of their hard-earned savings to the same industry or company instead of spreading out one’s options, which is certainly a less risky option. The more one gets emotional, the less rational one gets. So it’s advisable not to let strong feelings (e.g., fear, greed) and gut instincts take control of key investment decisions.
In any kind of investment, there is a scope for poor decision-making but a fundamental analysis of stocks can certainly help keep the margin of error to a bare minimum. Here are some useful indicators of a company’s performance and its financials. Based on these, an investor can decide whether investing in the stocks of the company will give her/him a good and realistic return on investment:
Earnings per share (EPS)
EPS is the portion of a company's profit that is allocated to each individual outstanding share (in the open market) for a given period. A consistently rising EPS over a period of 5-10 years indicates that the company is creating value for shareholders and paying them dividends.
Cash earnings per share (CEPS)
CEPS takes into account the cash generated by a business, on a per share basis, from its regular operations for a specific time period. Cash earnings are critical to the financial performance of any business. For example, a consistently growing EPS over a period of 5-10 years is a good sign but doesn’t indicate that the business is in the pink of health. To arrive at that conclusion, there should be a corresponding rise in CEPS as well. Else, there is a strong possibility that the business is not generating enough cash. And add to that, the income statement might be overstating profits!
Net profit margin ratio
Another metric of the fundamental analysis of stocks is net profit margin ratio, which clearly shows what percentage of profit is available to the investor as dividend for every rupee of sales revenue. For instance, if the net profit or “bottom line” (i.e., gross profit minus expenses like operating expenses, interest, and taxes) of a business is INR 10 lacs and sales revenue is INR 50 lacs, the net profit margin ratio is 0.25 or 25 percent. Businesses with a higher net profit margin ratio leave more profits per rupee of sale in the hands of investors.   
Debt/equity ratio
The financial assets of a given business typically comprises equity (shareholder’s contribution) and debt (borrowings from banks and other lenders in the form of loans, bond, and other short-term debt instruments). Companies with a low debt or zero debt are any day safer investment destinations than those with a higher debt-to-equity ratio (“leveraged companies”) because the latter may not be able to generate enough profits to repay debts and may even go into bankruptcy.
Return on capital employed (ROCE)
If a business posts net operating profits (before interest and tax) of INR 15 on a capital of INR 100, its ROCE is 15% (i.e., 15/100). It is a measure to assess whether or not a company is using the capital at its disposal efficiently. In any case, ROCE should be higher than the combined expected rate of return payable to equity holders and interest rates charged by creditors.
Dividend per share
This ratio indicates how much dividend a business is distributing against each share in the open market. A growing dividend per share suggests the company is good to stay invested in.
Apart from the financial indicators mentioned above, companies come out with annual reports that provide investors with valuable information on their financial performance, so a reading of relevant sections of this report should also be a part of the fundamental analysis of company stocks. Also, do keep in mind that the above methods of determining the essential value of a stock are not comprehensive. And most importantly be careful with your money.

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