Investing in stocks can be overwhelming, with so many companies and stocks to choose from. Instead of relying on others, it's important to analyse the fundamentals of stocks ourselves to determine whether a stock is worth investing in or not.
In this blog, we will explore the concept of stock fundamentals and focus on five key metrics: Year-on-Year (YoY) growth, profit margin, earnings per share (EPS), price-to-earnings (PE) ratio, and profit after tax (PAT). By understanding these fundamentals, we can determine whether a stock is worth investing in or not.
What are Stock Fundamentals?
Stock fundamentals are key numbers and facts that help us decide whether a company's stock is a wise investment or not. These numbers tell us about the company's profits, growth, and how well it's doing in the market.
Fundamental analysis is like doing a check-up on a company. It involves studying its financial statements and understanding its business model to know if the company is growing, making profits, and is a good investment opportunity.
What are the 5 Fundamental Indicators for Stock Analysis?
Year-on-Year (YoY) Growth
Year-on-year growth is a method of comparing a company's financial results with the same period from the previous year. Investors use this metric to determine whether a company's financials are improving or deteriorating.
If a company's revenue and earnings are increasing on a year-on-year basis, it indicates that the company is growing. On the other hand, if these numbers are declining, it suggests the company is shrinking.
Let's consider an example to better understand this concept.
Suppose a company had a revenue of ₹1000 crore in 2021 and it increased to ₹1100 crore in 2022. This means the revenue has grown by ₹100 crore compared to the previous year, resulting in a 10% YoY revenue growth for the company. It's a simple way to gauge a company's performance.
Profit Margin
Profit margin is a simple profitability metric that allows you to analyse a company's financials. It measures the percentage of profit a company earns from its revenues. The higher the profit margin, the better the company's financials.
To calculate the profit margin, you divide the company's income by its revenues. For example, if a company has a total income of ₹10 crore and revenue of ₹100 crore, its profit margin would be 10%.
Earnings per Share (EPS)
Earnings per share (EPS) is a financial metric that helps us determine a company's profitability. It is calculated by dividing the company's net income (profits or earnings) by the number of available shares. As the EPS value increases, the company's profitability also increases.
When a company has a higher EPS, it is considered profitable, and investors are willing to pay more for its shares.
Price-to-Earnings (PE) Ratio
The price-to-earnings (PE) ratio plays a crucial role in determining the valuation of shares. It is calculated by dividing the company's share price by its earnings per share. A high PE ratio indicates that the company's share price is overvalued, while a low PE ratio suggests that the share price is undervalued.
You can use this ratio to compare a company's performance with its historical records or with other companies in the market. You should know your PE ratio, whether you are an investor or an analyst.
Profit After Tax (PAT)
Profit After Tax (PAT) is the actual profit amount a company earns after paying expenses, liabilities, and taxes. It also includes dividends distributed to shareholders.
For example, if a company has a total revenue of ₹1 Lakh, expenses of ₹60,000, and taxes of ₹20,000, its PAT would be ₹20,000.
Key Takeaways
- Analysing stock fundamentals is crucial before making investment decisions.
- Stock fundamentals are key numbers and facts that help determine the worthiness of a company's stock as an investment.
- The five key metrics of stock fundamentals are year-on-year (YoY) growth, profit margin, earnings per share (EPS), price-to-earnings (PE) ratio, and profit after tax (PAT).
- YoY growth compares a company's financial results from the current year with the previous year, indicating whether the company is growing or shrinking.
- Profit margin measures the percentage of profit a company earns from its revenues, with a higher margin indicating better financials.
- EPS reflects a company's profitability by dividing its net income by the number of available shares.
- PE ratio helps evaluate a stock's valuation by dividing its share price by its earnings per share.
- PAT represents the actual profit a company earns after deducting expenses, liabilities, and taxes.
How can I calculate earnings-per-share (EPS)?
Let's say your automobile company reported a net profit of ₹50 crore in the last financial year. The company has issued 5 crore shares in the market. To calculate EPS, you divide the net profit by the number of shares. In this case, the EPS would be ₹10 per share (₹50 crore / 5 crore shares).
How can I determine if a company is profitable using stock fundamentals?
Suppose ABC Ltd. is a software company. By looking at its profit after tax (PAT), you can assess its profitability. For instance, if ABC Ltd. has a positive PAT of ₹50 crore, it indicates that the company is making a profit after deducting all expenses and taxes.