Analysis is very important in stock trading because it allows you to determine whether the selected equity is worthy or something to stay away from. There are two main types of analysis that you can use; fundamental analysis and technical analysis when evaluating a stock. In this article, we will look at the fundamental analysis when trading USA 500 stocks.
A closer look at fundamental analysis
Fundamental analysis is the process of analyzing a security to try and forecast the movement of its price in the future. It entails focusing on a number of things, including the domestic conditions, company press releases, competitor analysis, and financial statements, among others. If the overall fundamental analysis shows a negative impact, the effect is likely to get reflected with a downtrend in the price movement of the stock.
Some of the common performance statistics that are used for fundamental analysis are earnings per share (EPS) and Beta. Each of the performance statistics provides specific info that helps with further price evaluation. Keep reading to learn about the main fundamental analysis parameters and how they are applied:
Earnings per share (EPS)
This is the percentage of a company’s profits that is apportioned to every share of its stock. In stock trading, this is considered the bottom line net income on a per-share basis. When EPS is growing, it is considered a good sign because investors’ shares are likely to be worth more.
When trading USA 500 or Tech 100 stock, you can calculate the earnings per share of a firm by dividing the total profit by all the shares. Here is an example. If a company reported a profit of $400 million and there are 400 million shares, then the EPS is $4.00. When following the EPS of a selected company, make sure to go back a few years and compare the changes.
Price to earnings ratio (P/E)
P/E ratio measures the relationship between the price of a stock and per share earnings. This statistic is used to establish whether the selected stock is overvalued or undervalued compared to others in the same sector. Because P/E ratio indicates what the market is currently willing to pay depending on the past or future performance, most investors just compare P/E ratio to those of competitors. They might also factor in the industrial standards.
If the P/E is low, that is considered an indicator that the price of a selected stock is pretty low to the overall earnings. Investors consider this favorable and are likely to start buying.
So, how do you calculate the Price to Earnings Ratio? You need to divide the current price per share of the selected company’s stock by the earning per share. Here is a demonstration. If a company’s stock is currently selling for $100 per share and has earnings per share of $10, the P/E ratio will be $100 divided by $20 which $5.
P/E ratios can be broken further into two; trailing PE ratio and forward-looking ratio. The main difference between the two is the type of earnings applied in the calculations. If the calculation is done using one-year projected earnings, the result will be a forward-looking P/E ratio. However, you will end up with a trailing PE ratio by using historical trailing 12 month-earnings.
The projected earnings growth (PEG)
P/E ratio is an excellent fundamental analysis indicator when trading stocks, but it comes with limitations because it does not factor in future earnings. This is where PEG comes in. The indicator compensates for future earnings by anticipating a company’s one-year earnings growth rate of the equity.
For expert analysts, the future growth rate of a company is estimated by checking the historical rate of growth. This helps to give a better picture of the equity’s evaluation. In order to get PEG, you first calculate P/E ratio and then divide it by the firm’s 12-month growth rate. Note that the percentage in the growth rate is removed.
When dealing with PEG fundamental indicator, results of more than one show that the stock is overvalued while anything below one means undervalued.
Free cash flow (FCF)
Free Cash Flow is a term used to indicate the cash that is left after a firm has paid all the capital expenditure and operating expenses. If a company has high FCF, it means that the additional cash can be directed to fund innovation, improve the value of shareholders, and survive challenges more effectively. A lot of investors love FCF because it shows them if the selected firm still has ample funds to reward shareholders, especially via dividends.
To calculate FCF, you start by calculating the Operating Cash Flow and then subtract the company’s Capital Expenditure. You can also calculate FCF by checking the Income statement to note the Net Operating Profit After Taxes (NOPAT) and then and depreciation. Then, subtract capital expenditure and working capital.
Price to book ration (P/B)
This indicator is also referred to as the price to equity ratio and is used to compare the equity’s value on the book to that on the market. By demonstrating this difference, investors are able to establish if the USA 500 stock is undervalued or overvalued in relation to what is presented in the books. So, how do you calculate P/B?
You need to divide the stock’s latest closing price by the value listed in the company’s annual report. The book value is established as a cost of all the assets and then subtracting liabilities. Simply put – it is the theoretical value of a firm if it were to be liquidated.
Now that you know the main fundamental indicators to apply when trading USA 500 or Tech 500 Stocks, you will need one more thing – a good broker. The broker provides you with the actual access to the stock market so that you can actualize your strategies. One of the top brokers today is capex.com, and you can count on their platform to access multiple trading instruments. Their transaction fees are also low, meaning that you get to keep the bulk of the returns you make. Do not just work with any broker; select the best.
Story by Alex Boatman
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