Company analysis

Fundamental analysis is very popular among stock traders who gather all available information about a company to decide whether an investment is wise.

Just like with all types of fundamental analysis, here too, the company is examined based on as much available data as possible to determine whether its stock is undervalued or overpriced.

Company analysis is divided into two main areas: evaluating the company itself and assessing the broader factors that influence it.

1. Company earnings

The simplest way to form an opinion about a company is to examine its financial data, which it publishes in earnings reports for investors. Every publicly listed company is required to regularly disclose its earnings – typically once per quarter, with a more detailed report released annually.

Earnings season

Many large public companies release their earnings in the same period every quarter – this time is known as earnings season. Earnings season can have a significant impact on the overall performance of the stock market. If many companies "miss" expected earnings and revenue, major stock indices may experience a decline.

There are several areas you should pay attention to when reviewing earnings:

Income statement

The income statement is a document where a company reports its revenues, expenses, and net income, as well as various profit calculations – for a three-month period in the quarterly report or 12 months in the annual report.

Income statements cover a variety of different metrics, but most will include the following:

• Revenue: All the money the company earns during the period, without subtracting any expenses.

• Expenses: Capital spent to generate revenue, including the cost of goods sold (COGS).

• Net Income: Total revenue minus total expenses. Also known as profit or earnings.

• Earnings Per Share (EPS): Total profit divided by the number of shares outstanding. This is used to measure the company's profitability.

• Gross Margin: The degree to which the company effectively realizes sales, calculated as net income divided by revenue.

• Interest Payments: Payments the company makes based on its short-term and long-term interest obligations.

• Gains and Losses: Any income or loss not derived from sales or expenses, such as income from selling unused equipment.

Other important metrics

These numbers appear in almost every income statement. However, in different sectors, there may be specific metrics that are also very important. For example, for investors in technology companies, user growth may be more significant than actual revenues.

2.Balance sheet

A company's balance sheet provides an overview of everything the company owns and owes at a specific point in time. To determine when the balance sheet was created, look at the date at the top of the report.

The balance sheet will include:

• Assets: Everything the company owns, including goods, property, and other valuable items.

• Liabilities: Debts or other obligations the company has to other parties, whether they are financial liabilities or legal claims.

• Equity: The claims of the owners or shareholders on the company’s assets after liabilities are deducted.

Assets vs. Liabilities

The balance sheet gets its name because assets and liabilities should balance each other. This means that the total amount of liabilities and equity must equal the value of the assets. In this way, the balance sheet shows how the company finances everything it owns—i.e., how it pays for its assets.

Cash Flow

The cash flow statement provides an overview of how a company generates the money it needs to cover its operating expenses, debts, and investments. This statement allows you to assess whether the company has healthy financial management and shows how the company handles its finances.

The cash flow statement is divided into three main sections:

• Operating Activities: Shows the sources or uses of cash from the company's daily operations.

• Investing Activities: Displays the money spent on long-term investments that secure the company’s future.

• Financing Activities: Shows cash obtained from investors or banks, and the money paid to shareholders.

3. Financial ratios

Fundamental analysts often use data from earnings reports to calculate various ratios that provide a quick analysis of performance. Some of the most important include:

• Price to earnings (P/E) ratio

The P/E ratio compares the current stock price of a company to its earnings per share and shows how much you are paying for each dollar (or other currency) of profit. This ratio is used to determine whether a stock is overvalued or undervalued relative to its profitability.

Price to Earnings = Stock Price / EPS

Different sectors can have varying P/E ratios, so it’s important to conduct your own research to determine what a realistic P/E value is for a given sector. If a company has not yet made a profit, the P/E ratio will not provide meaningful insights.

• Price to Book (P/B) Ratio

The P/B ratio compares a company’s stock price to its book value per share. The book value per share is calculated by subtracting liabilities from total assets on the balance sheet and dividing the result by the number of outstanding shares.

Price to Book = Stock Price / BPS

A higher ratio means that the market values the company more than its tangible assets, indicating that investors are also valuing intangible assets such as brands, patents, or customer relationships.

• Return on Assets (ROA) and Return on Equity (ROE)

These ratios assess the company’s performance, but instead of comparing it to the stock price, they focus on how effectively the company utilizes its assets or equity.

• ROA (Return on Assets) shows how efficiently a company generates profit from its assets.
  
  

• ROE (Return on Equity) shows the return the company achieves from its equity (assets minus liabilities).

Both ratios are expressed as percentages and provide insight into how well the company’s management converts assets or equity into profits.

4. Other factors to consider

In addition to analyzing individual earnings reports, it is also important to consider other factors when evaluating stocks. These may include:

• Copyrights or patents: For companies in software or biotechnology, copyrights and patents can be very valuable.

• Performance over time: Looking at just one year or one quarter may provide an incomplete picture. A better overview is achieved by considering multiple reports in various economic and operational conditions.

• Cost growth vs. gross profit: If costs are growing faster than profits, the company may struggle with controlling expenses.

Broader factors

Earnings reports can provide valuable insights into a business, but they are not the complete picture. Before deciding to buy or sell stocks, it’s important to examine other factors and data.
There are many areas you can explore, but many investors simplify this process by using a "top-down" approach.

Start with the broader economy

A growing economy is a big benefit for businesses, so most investors focus on countries that show strong economic performance, avoiding those that are in recession.

Look at specific sectors

The next step is to analyze the performance of specific sectors in the coming months and years. Could central banks or new regulations negatively affect this sector? Or do you expect consumer demand to grow, which could positively impact the industry?

Compare the company with its peers

After analyzing the broader sector, you will be able to identify which companies are leaders and which have the potential to outperform the average. Ratios such as P/E and P/B can be especially useful at this stage, as they allow you to see how each company compares to its competitors.