Fundamental Analysis: How to Analyze and Value Stocks

but one of the most common questions i get from people is how do you actually tell whether or not a stock is cheap or expensive and we're going to cover all of that going through fundamental stock analysis but i want to start with just some of the very basics of this and talk about what is fundamental stock analysis and why should you care as an investor so when it comes to investing in the stock market there are typically two strategies that people follow one is technical analysis and that is used more for short term trading day trading and swing trading and then fundamental stock analysis is used more for investing long-term investing so when people are trading stocks they're looking for stocks that have volatility they're looking to track the price movements look at things like volume and different technical indicators like simple moving averages and if you guys want to learn more about technical stock analysis what i might do is bring out an expert who can teach you about this right here in the group so if you guys want to learn more about that drop me a comment there over on the stock radar membership group and i will definitely do my best to get that to you guys but the reason why people use fundamental stock analysis is a way for them to determine the actual underlying value of an asset so basically this is what i look at fundamental stock analysis is used to determine the financial health of a company is this company in good financial health do they have good coverage of their debt are they generating a lot of free cash flow or is this company in poor financial health where they're burdened with debt they have more debt than they do have assets and maybe they're losing money or they're not making much money at all it's a way to determine the financial health of this company now technical stock analysis on the other hand is used to look at the price history and other data like volume and different numbers to determine the price movements in the short term so fundamental stock analysis is used to determine where is this company heading in the long term are they going to good places or are they going to bad places based on the financial health while technical stock analysis is used to determine in the short term what is that price likely going to do looking at things like support and resistance areas and all kinds of different indicators so traders use technical stock analysis to determine the optimal buy points for stocks and they're looking to do swing trades or day trades and make many small gains over a short period of time where long-term investors are looking to invest in a company hold it for many years and see that appreciate in value so people who are trading use technical analysis to determine when is the best time to get into a position and people who use fundamental stock analysis are looking to invest for the long term and invest in a company with very good financial health fundamental stock analysis tells you the health of the company and then technical stock analysis tells you the personality is this a durable investment that doesn't have much volatility or is this a tech investment or a biotech investment that is very volatile it's kind of like the personality of that investment and people who are looking to trade on small price moves within the week that is what you're using you're using technical stock analysis and people who are looking to invest in the long term are going to rely on fundamental analysis now you could use technical stock analysis to find the optimal entry point by looking at support and resistance areas but you really don't have to do that so but if you do want to be a successful long-term investor you really do need to understand some of the basics of fundamental analysis in order to understand whether or not something is overvalued or undervalued you can do fundamental stock analysis you can look at the things that we do here on stock radar like the pros and cons the moat for this company the barriers to entry and then looking at the actual fundamentals the key financial documents like the balance sheet the income statement and the cash flow statement you look at all these things and you determine the overall health of this company so your goal when performing fundamental stock analysis is to determine the underlying value of the asset a lot of people get confused they look at the price of something and they say okay that price must tell me what the actual value is and in the next section we're going to talk about price versus value and how these are two entirely different things and i'm going to give you an example down below of how the share price has nothing to do with whether or not a stock is expensive or cheap but this is the basic strategy of fundamental stock analysis you take a look at the fundamentals of the company you determine the financial health of this company and some people decide to bet on a strong company they're looking to buy low and then sell at a higher price in the future or some people are actually looking for very poor companies as far as very poor financial health that are burdened with debt and likely to fall in the long term and they're actually going to bet against weak companies by short selling them i'm assuming most of you guys are looking to bet on good companies not betting against bad companies and i don't personally get involved with short selling so that's not really anything i'm going to discuss but that's pretty much what people are doing they determine the financial health and they either bet on good companies or bet against the bad ones but now i want to show you guys how the share price has nothing to do with whether or not a stock is cheap or expensive and it's a very simple example here so let's say company a has a market capitalization of a hundred thousand dollars and the market cap is very simple that is essentially the total value of all of the outstanding shares so now let's say they have a thousand outstanding shares shares available to both the public and the private which means that they have a share price of a hundred dollars per share now let's take a look at company b company b has a one hundred thousand dollar market capitalization as well but instead of having a thousand outstanding shares they only have 100 and as a result this stock is a thousand dollars a share now somebody who doesn't understand how to perform fundamental stock analysis might just take a look at this stock and go okay a hundred dollars a share that's cheap a thousand dollars a share that's expensive and that is why a lot of people fall into the trap of buying into penny stocks or stocks with a very low price per share because they think they're getting more bang for their buck they look at a stock like amazon that's trading around fifteen hundred dollars a share as of making this video and they look at a penny stock that's trading for 15 cents a share and they go wow i can get a lot more shares of this penny stock than i would of amazon and they think they are getting more of a bang for their buck but the truth is guys as you can see here it all depends on how many outstanding shares they have of that company amazon has made the decision not to split up their shares through a stock split and they prefer to have a higher share price and it has nothing to do with the actual piece of ownership you're getting of that company because it depends on how many shares there are out there so the main takeaways from this guy so that fundamental stock analysis is going to show you the health of this company while technical stock analysis shows you the personality most long-term investors are going to focus solely on fundamental analysis and traders and short-term investors are only going to focus on technical stock analysis they don't really care about the financial health of the company they just care about the personality of that stock in the short term price movements and to be a successful long-term investor you do need to understand fundamental stock analysis but it is not important to understand technical analysis it's just another tool in your toolbox if you want to use it but you certainly don't have to have that as something that you are relying on and people are going to bet on strong companies and bet against weak companies through performing fundamental analysis and again the share price has absolutely nothing to do with whether a stock is expensive or cheap fundamental investors understand that the price of an actual stock and the value of that piece of ownership are two entirely different things and those who don't understand fundamental stock analysis believe that the price actually determines the value and what you need to begin to understand is that these are entirely different things and they operate in different ways so once you understand that the actual price of something is not always equal to the underlying value that is where you can begin to unearth some opportunities as a fundamental investor so your goal through fundamental stock analysis as we said before is to determine the overall financial health of a company and the reason you are doing this is because you want to get an idea of the underlying value of that piece of ownership of a company remember that when you're investing in stocks this is actually an ownership interest in a real company and you own a piece of that company and you want to understand what is this piece of ownership actually worth relative to the market price so first of all let's go ahead and talk about price price is very simply what you would expect to pay for something so if you went to the store right now and went to buy laundry detergent you would have an idea of what the actual price would be that you would pay for that now if you went to a store and all of a sudden laundry detergent was 50 a jug you would say this price is well above the value of this laundry detergent there's no way i'm going to be buying that on the other side of the coin if you went to the store and you saw that laundry detergent was a dollar a jug you would say wow this is a great value i know what this laundry detergent is actually worth the price is well below the value so i'm going to buy five or 10 jugs and stock up this is exactly what people do when they're investing and when they're looking at a stock and they see that the actual price is well above the value they say that's not something i want to touch that stock is trading on a speculative level and the actual market price is well above the underlying value now on the other hand when they see something that is trading at a price well below the value they say okay this is on sale it's just like having laundry detergent be on sale at the grocery store and they say okay i better stock up on this i better buy some shares of this company that is what you're looking to do with fundamental stock analysis is determine whether or not an asset is overvalued or undervalued now as i'm sure you know when you look at a stock online and you look at the price chart during a trading day the price goes up and down and up and down throughout the day and i want to ask you a question do you think the actual underlying value of that company or of that stock is changing every couple of seconds just like the prices the answer is no the actual value of something changes in the long term while the market price or the price people are willing to pay at a set point in time changes in the short term and once there is a deviation between the market price and the value that is where there is a potential opportunity so let's go ahead and look at these three examples here okay so the green line represents the actual value of something and the red line represents the market price so on the left here this is an example of something that is undervalued the actual value is well above the market price and if this was a stock this could be a buying opportunity because you could buy in for less than the actual assets are worth now on the other hand let's look at something that is actually overvalued and that would happen when the market price is above the underlying value of that asset so if you were a fundamental investor and you were looking at these two examples on the left would be one where you'd be interested in buying because the actual value exceeds the market price now if you're looking to bet against a company and you performed your fundamental analysis and you found a company in poor financial health and you found that the actual market price was trading above the value that might be something where you decide to short or bet against that asset now this on the bottom left here is what most people see they don't think there's any difference between the price of something and the value of something they think that the price determines the value and that is just not the case again these are the same people that look at a stock and determine if it's cheap or expensive by looking at the share price and we already dispelled that myth in the last video so understand this is what most people see they see the price equal to the value but there is deviation between market price and underlying value taking place every single day now why does this happen this happens due to supply and demand supply and demand is going to create price and value deviation so supply is a result of people being fearful they're afraid of holding this particular asset and so they sell it and when the overall sentiment around that asset is fearful it's going to go into a sell-off and that may result in a buying opportunity for investors now on the other hand when people are greedy they're going to be buying assets they're going to be buying shares of that stock left and right and that may result in that stock becoming overvalued that is where a couple of these quotes come from for example buy from the pessimists and sell to the optimists you want to buy when people are fearful and then sell to them when they are greedy or the famous quote from warren buffett be greedy when others are fearful and fearful when others are greedy you are looking to buy stocks when they are undervalued and then sell them when they are overvalued so the main takeaway for this video here is that the market price is going to change in the short term every couple of seconds what people are willing to buy or sell that stock for is going to change based on supply and demand or the market fear or greed but the actual underlying value changes in the long term the value of amazon is not going to change every couple of seconds but the market price of those shares is going to and what you are looking to do is find an opportunity where you see the market price is well below the underlying value that is an investment that is undervalued and that is when you would want to buy but when it comes to fundamental stock analysis you have to look at many different things to get an idea of the overall landscape of that investment and you can't rely on any one indicator a lot of people make the mistake of solely looking at the p e ratio when determining whether or not a stock is expensive or cheap and you just can't do that you just can't rely on one indicator and in the next video we're going to talk about the peg ratio as well as the forward p e and we're going to explain where the p e ratio falls short but let's go ahead and talk about the price to earnings ratio in this video here so the way you calculate the p e ratio is very simple you're going to take the market price per share and divide it by the annual earnings per share and typically they're looking at ttm or the 12 trailing months so the earnings per share over the last 12 months of the quarterly earnings reports and that's going to give you an idea of the earnings per share so apple stock as of making this had a market price of 177.66 and in the trailing 12 months they have had nine dollars and 70 cents of earnings so you take that 177.66 divided by 970 and this comes out to a p e ratio of 18.3 now for those of you that do not want to be sitting down and doing math on paper or on your computer the good news is this is calculated for you but it's very important to understand where these numbers are coming from when you're doing fundamental analysis it's important to understand the actual theory behind this and where you calculate the p e ratio now what's also important to note is that you can use the p e ratio as a comparison tool but you can't compare companies from one industry or sector to another because every single sector or industry out there has a different level of normality or what is normal so just for an example of this let's take a look at this here the construction materials industry has an average p e of 22 and that's a 2018 estimate while the semiconductors industry has a price to earnings ratio of 80 and that's again a 2018 estimate so you could not compare a construction material stock to a semiconductor stock because the levels of normality are almost four times the difference here it's almost four times more expensive for a semiconductor stock and that is primarily due to the fact that the projected growth for the semiconductors industry is significantly higher than the projected growth for the construction materials industry but let's take a step back and talk about what this p e ratio actually means so we said apple has a p e of 18.3 but what does that actually mean that means that apple stock is trading at an earnings multiple of 18.3 or as an investor you would expect to pay 18 dollars and 32 cents for exposure to one dollar of company earnings so if a stock had a p e of 80 for example the semiconductors industry you're paying eighty dollars today for one dollar of company earnings per year so that shows you how stocks become overvalued or undervalued looking at the price to earnings ratio and certain industries become priced in at a higher price today due to the fact that there is greater potential growth expected now we're going to talk about that more in the next video when we go into the peg ratio but just understand that when there's more anticipated growth for an industry or a particular stock you're going to see that p e ratio climb so when you're looking at stocks out there you're going to typically see a higher p e ratio with growth stocks because they're going to grow more in the future and income stocks are going to have a lower p e ratio because there is less anticipated growth expected so now that we know what the p e ratio actually is how do we use this tool for comparison so number one you can compare the p e ratio of a company to the industry average and i recommend using the fidelity sectors and industries tool it's very helpful for getting industry data and average p e ratios as well as industry growth statistics so you can compare it to the industry average or compare it to the competition so for example here we have jp morgan stock has a p e ratio of 18.4 while bank of america stock has a p e ratio of 17.7 so looking at those figures right there based on the price to earnings ratio jpmorgan stock is a little bit more expensive than bank of america stock now the other way you can use the p e ratio is to compare the price of this stock to the overall market average so we know that apple's p e ratio is 18.3 but the average p e ratio of the s p 500 is a 25.7 so in relation to the overall market we can see that apple stock is significantly cheaper so that is basically how you use the p e ratio it is a comparison tool between the market as a whole and that stock or stocks within the same industry or comparing this stock to that industry or sector average we're going to talk about two ratios that i find to be more useful in the p e ratio and those are the p e g ratio as well as the forward pe so we already talked about how the p e ratio is a useful comparison tool when comparing stocks within the same industry or if you're looking at the price of that stock compared to the overall market but now i'm going to point out the major flaw of the price to earnings ratio and the main reason why you cannot rely solely on this financial ratio that is the fact that the p e ratio does not calculate any anticipated growth into that number so let me go ahead and show you guys an example of this let's say tech company a has a p e ratio of 25 but they have an anticipated growth rate of 5 percent per year while tech company b has a p e ratio of 75 but they have an anticipated growth rate of 20 percent so if you're looking at just the p e ratio we would say okay tech company b is a lot more expensive than tech company a but when you actually consider the fact that tech company b is going to grow a lot faster than tech company a you have to ask yourself how would i even compare these figures that is where the peg ratio comes in and this is a much more useful tool in my opinion than the p e ratio alone so the way you calculate this is very simple you take the p e ratio which we learned how to calculate in the last video and you divide it by the anticipated five year growth of earnings of that company and that's going to give you an idea of the price to earnings ratio with the growth factored in and whether or not that stock is overpriced fairly valued or undervalued based on that anticipated growth so what are you looking for as far as the peg goes first of all a peg of under one is going to tell you that that stock is probably undervalued and a peg of one means that that stock is fairly valued while a peg over one means that that stock is overvalued now i'm just going to warn you guys right now especially during a bull market you're never going to find a stock with a peg of under one otherwise there has to be something very wrong with that stock it's going to be very hard to find low peg stocks during a bull market because lots of stocks are overvalued and the market in general does become overvalued this is a more useful tool during a bear market because you can unearth potential opportunities and look at peg ratios and find low peg stocks so i want to give you guys two examples of this okay first of all we have qualcomm qualcomm has a peg ratio of 1.22 so looking at this here because it has a peg of over one the stock is considered to be overvalued but if you compare it to the peg ratio of nvidia which is 4.06 you can see that the peg ratio is much higher for nvidia so if you were to compare the price to earnings ratio with growth factored in of nvidia and qualcomm you can see here that nvidia is significantly more overvalued than qualcomm so this is how you would use this tool you would pick two stocks that are in similar areas of operations and you would compare the peg ratio of these stocks and determine how much of that growth is actually priced in today and that is how stocks begin to trade on a speculative basis is when all that growth or all that future anticipated growth begins to be priced in today and that is where a stock begins to be priced for perfection where everything that is expected to happen to that stock gets priced in today and if they have one hiccup during that operation then the stock may fall significantly because all of that future growth or anticipated growth was priced into today's number so what you're trying to figure out when looking at the peg ratio is how much of that anticipated growth is priced in today and again guys i just want to remind you you do not have to calculate the p e ratio or the peg ratio yourself or the forward p e which we're going to cover next all these numbers are calculated for you i always use yahoo finance so you don't have to sit down and do the numbers yourself but it's very important to understand where these numbers are actually coming from so moving on now let's talk about the forward pe which is also a useful tool for comparison the forward pe takes the current market price per share and divides it by the predicted earnings per share from analyst expectations now the one thing we have to point out here is all of this here the peg and the forward pe is based on expectations and as we know oftentimes expectations are not a reality so you have to always consider the fact that this is not a guarantee these are wall street estimates at the end of the day it's an analyst's best guess as far as where earnings per share will come in and how fast that company will grow so always understand that the earnings expectations are not always going to be a reality so these are all based on predicted numbers and again the way you use the forward p e ratio is to determine how much of that future growth is priced in today or if a stock appears to be overvalued today with a sky-high p e ratio it might be because the forward p e ratio is expected to be much lower now we're going to use amazon as an example and their p e ratio is 247 while their forward p e ratio based on predicted earnings per share is at 99. both of these are very high as we know amazon is a stock that is probably overvalued but they are a stock that is executing with perfection on all fronts so a lot of people have high hopes for amazon and a lot of that has been priced into the share price today but amazon is a stock that is absolutely dominating so it makes sense for them to have this high of a valuation now many investors would not be comfortable investing in a stock with a p e ratio of 247 and a forward p e of 99 remember from our earlier discussion that means that currently you pay 247 dollars for exposure to one dollar of earnings from amazon and in the future you would expect to pay 99 for one dollar of amazon's earnings so you use this as a comparison tool between different sectors and industries to compare the peg and the forward pe of competitors to determine whether or not a stock is overvalued fairly valued or undervalued but by far one of my favorite tools for analysis is looking at this peg ratio and it's very helpful to tell whether or not all that anticipated growth is priced into today's number in this video we're going to be talking about the dividend now i want to start out by pointing out the typical growth rate of a company and it looks very similar to this curve here so when a company starts out and when they're a new company they're going to grow at a much faster rate than they're going to grow in the future and as a result you're going to see that growth begin to taper off going forward so this is what companies do when they're in this zone here when they're growing at a much slower rate or they're just consistent with their operations what they do is they pay dividends as a way to reward shareholders and keep them around now dividends are quarterly cash payments and they're sharing their earnings with the shareholders so if they're earning a lot of money they have a lot of earnings per share they might make the decision to pay shareholders a quarterly dividend now we talk about the dividend quite a bit here in stock radar we talk about uh the dividend history how long this company has been paying that dividend the dividend growth streak so how many years has that dividend been growing and we also talk about the dividend yield or how much they are paying to shareholders so just understand that when a company is in income mode when a lot of the growth has already happened and they're growing at a much slower rate or they just have consistent or flat growth they're going to become an income investment because they are likely going to reward shareholders with dividends but a company that is in growth mode if they're trying to grow as fast as possible they're not going to pay dividends they're going to be reinvesting those earnings into the growth of the company so we used att as an example of an income investment they pay dividends to shareholders because they are not growing very fast and amazon is a growth stock because they are reinvesting all the earnings to grow the company as fast as possible and as a result they don't pay a dividend so amazon is still down here on this curve where they're growing very rapidly while at t is further along in this curve where they're pretty much flat with very little growth going on and as a result at t is paying dividends to reward shareholders and give them a reason to stick around because if you guys saw that video here on stock radar the stock has had very lackluster performance and there's not much they're being offered other than that very high dividend so how do you actually calculate the dividend the company pays what you do is you take the annual dividends paid out divided by the market price and that's going to give you the dividend yield and again all you have to do is do a search for a stock on google and is going to show you the dividend yield right on that chart but that's how you go about calculating it so let's calculate the dividend yield for a t over the last four quarters they've paid a 49 dividend so we take 49 cents times four and divide it by the market price of 37.16 and that gives us a dividend yield of 5.3 percent so what kind of dividend yield should you be looking for as an investor if you're looking for an income investment well the s p 500 average dividend is around 2.2 percent but if you're looking for an income investment and you're not focused on growth a good number to look for is between three to six uh so 18t falls in there they have a 5.3 a very good dividend but they have no growth potential pretty much i mean the growth has been non-existent over the last five years so that's the issue that you have there you have to weigh the pros and cons are you looking for a high dividend with low growth or no dividend with higher growth that's what you have to decide as an investor is what you are looking for now another very important thing to consider is whether or not a company can afford to pay a dividend because high dividends are great but understand that dividends are not guaranteed and they can cut or discontinue a dividend at any time a perfect example of this is general electric they had to slash that dividend because they simply could not afford to pay that dividend and they still can't afford to pay the dividend even now so the future for them is uncertain they may have to cut the dividend again but anyways the way you calculate that is by looking at the dividend coverage ratio and this is very simple to figure out and this might be something you have to calculate on your own because i have yet to find a resource that does this for you but all you do is you take the annual earnings per share and divide it by the annual dividend per share and that gives you an idea of how much of the earnings they are passing along to shareholders and how much of the earnings they are keeping for themselves so basically let's go ahead and calculate this for at t looking at the fiscal 2017 year numbers so for fiscal year 2017 at t had earnings of 4.76 and they paid out 1.97 of dividends giving them a dividend coverage ratio of 2.4 so what exactly does that mean here's what it means if the dividend coverage ratio is below one that means they are paying out more in dividends than they are earning that was the case with general electric and as a result that is very bad that means they are likely going to have to restructure or cut that dividend now if the dividend coverage ratio is between a one to a 1.5 they don't have great coverage of that dividend and they will likely be cutting it or restructuring it in the future the optimal zone to be in is between a two and a three and as we can see a t and t came in at a 2.4 so they're right where they need to be so when you're looking for a dividend coverage ratio i always look for a dividend coverage ratio between two and three but on the other side of the coin if the dividend coverage ratio is above three that means the company is retaining most of those earnings and they may be being greedy so what i look for is a dividend coverage ratio between two and three if it's below a 1.5 i don't think that is investment worthy and if it's above three then you want to make sure that company is reinvesting earnings and not just retaining them for themselves we just wrapped up talking about the dividend and i want to show you guys one of the most common mistakes that i see people make when it comes to investing in dividend stocks a lot of people start their search out by searching for high dividend yield stocks and if you do so you can find a nice list of stocks that pay very hefty dividends but you have to calculate the dividend coverage ratio to determine whether or not a company can actually afford to pay that high dividend so i'm going to show you guys an example of this here a high dividend trap a company called spark energy inc and they trade under the symbol spke so on the surface here we can see that spark energy has a p e ratio of 11.8 that's a pretty low pe and they have a dividend yield of 7.6 percent that's a very high dividend as we said the market average is around two point two percent and a good dividend is between three and six percent so a seven point six percent must be a fantastic dividend right the answer is absolutely not and i'm going to show you guys why that is so now because you know how to perform fundamental analysis of the dividend and calculate the coverage ratio we can take a look under the hood so the coverage ratio again we're going to calculate here by looking at the 2017 earnings per share divided by the 2017 dividends per share so in 2017 spark energy inc had earnings of 27 cents per share and they paid 72.5 cents per share in dividends so that coverage ratio comes out to a 0.37 but what does that actually mean what that actually means is that in 2017 spark energy inc had earnings of 3.5 million dollars and they paid 9.5 million dollars in dividends so they had a deficit in 2017 of six million dollars just from that dividend let me ask you guys a question does that make financial sense to you if you were making 25 cents and you paid someone 75 cents you're gonna have a deficit that is what is happening here with spark energy inc and i can guarantee you that they're going to cut this dividend they have no choice but to cut that dividend because they cannot afford to pay it this is what you have to do anytime you're investing in a high dividend stock take a look under the hood calculate the dividend coverage ratio and make sure the company can actually afford to pay that dividend because spark energy can very clearly not afford to pay this this is the high dividend trap that people fall into all the time i've never done it myself because i understood this very simple concept of the coverage ratio and now you guys do as well and i hope you never fall into the trap of buying into a stock with a very high dividend always take a look at the coverage ratio we are now going to start talking about the key financial documents which are the income statement the cash flow statement and then the balance sheet now this is the part of fundamental stock analysis where a lot of people go oh my gosh i don't understand any of this and i'm never going to understand it because if you go online and you start looking at a balance sheet or an income statement or a cash flow statement and you've never looked at these things before you're going to be overwhelmed by the massive amount of information available to you and it's very easy to just say oh my gosh i'm not going to ever understand this i'm going to give up and i want to encourage you guys not to do this i'm going to try to make it as simple as possible and show you guys what things i'm looking for but understand this is something you build upon with time you learn a little bit each week and over time you learn how to interpret these financial documents it certainly does not come overnight it took me months to really understand how to interpret these documents but this should provide a basic understanding for you and hopefully as i go through these during stock radar and i'm doing actual analysis of these financial documents you'll start to grasp what it is that you are looking for but first of all let's start off by talking about the income statement the income statement basically explains this formula which is net income is equal to revenue minus expenses so the actual income statement is just explaining to you what is the company's net income what is their revenue and what kind of expenses do they have as well and they are also explaining to you how the revenue is turning into net income for this company so really all it's doing for you is outlining the net income the revenue and the expenses and these are the main things that i look for on this document i look at the total revenue the gross profit the cost of revenue the net income and the operating expenses and i'm going to go ahead and explain what each one of these things are now so first of all total revenue is very simple it is the total sales of a business or all of the revenue generated from the sales of their goods and services and then your cost of revenue is the cost incurred to obtain those sales so let's go ahead and use a lemonade stand as an example if you were selling lemonade then your actual sales of lemonade everything you were selling would turn into your total revenue and your cost of revenue would be your actual supplies your cups and maybe if you had some advertising and then your actual lemonade stand itself so you take the total revenue and then you subtract out that cost of revenue and that's going to give you an idea of what your gross profit is and like i explained there guys gross profit is simply when you take your total revenue and subtract your cost of revenue so for our lemonade stand example it's all of your sales of lemonade minus all of your expenses incurred to have those sales is going to tell you what your gross profit is now there are other expenses we have to talk about and these fall under operating expenses and operating expenses are simply the expenses incurred that are unrelated to the sales of the goods and services and these are broken down into three categories you have research and development sales general and administrative and then non-recurring expense items and these are things you'll be able to see looking at the income statement so let's say you had your lemonade stand and you were researching a proprietary mixture of water lemons and sugar then those expenses for research and development would fall under your operating expenses they're not going to fall under your cost of revenue and then all this factors in to tell you the net income which is the total earnings or profit of a business so again if this was your lemonade stand it's going to be what is your actual profit on that stand after accounting for your expense items and again this is both your cost of revenue expenses and then your operating expenses that are unrelated to the sales of that lemonade so those are the key metrics that i look at on the income statement and here is what i'm actually looking for number one is total revenue increasing if you're investing in a growth stock you want to make sure the actual revenue or the sales of the goods and services is increasing over time and typically if i'm looking at a growth stock i want to see a double-digit year-over-year return over the last couple of years now do remember when you're looking at total revenue many businesses have seasonality where they're going to sell a lot more of their products during a certain period of time we were looking at amazon and amazon does most of their revenue in the fourth quarter because of holiday sales so you always want to think about whether or not a business is affected by any kind of seasonality whether it be back to school shopping or holiday spending and things like that and that will be indicated looking at the quarterly data on the income statement as far as how much revenue is coming in for each quarter so assuming total revenue is growing the second thing i look at is the cost of revenue or the cost incurred to obtain those sales of the goods and services because if total revenue is growing but the cost of revenue is growing faster then you're not going to be seeing much growth of net income because they're spending more money to actually obtain those sales so you always want to make sure that if the total revenue is growing and if you're looking at a good investment a growth investment it should be you want to make sure the cost of revenue is not growing at a faster rate or the rate is steady or consistent over a long period of time you don't want to see cost of revenue going through the roof and seeing total revenue not growing at the same rate that would mean they are spending a lot more money obtaining those sales and as a result you're not going to see that represented in the net income because they're spending more money now and one of the easiest ways you can look at this is just by looking at the gross profit the gross profit like we said is your total revenue minus your cost of revenue so if your cost of revenue is reasonable then you should be seeing your gross profit increasing so you really all you have to do is look at the total revenue and the gross profit and they should be growing at a very similar rate if you're seeing total revenue growing at 20 percent and then your gross profits only growing at 10 percent that might tell you that your actual cost of revenue is growing faster than your total revenue the fourth thing i look at is i take a glance over at the operating expenses or as we said those are the expenses unrelated to the sales of the goods or services and all i'm looking for here is any significant jump in expenses was there a big jump in research and development or sg a or are there any non-recurring expense items and if so i might do a little bit more investigation on what those expense items actually were or why there was such an increase in the expenses and then fifth and finally i take a look at the net income and i say is the net income increasing is it flat or is it decreasing and again if you're looking at a growth investment i like to see double-digit growth of net income double-digit growth of gross profit and double digit growth of the total revenue and ideally you want to see the actual cost of revenue growing at a similar rate or a slower rate but that is basically what i'm looking for with the income statement i'm looking at the net income the revenue and expenses i want to make sure the expenses are not growing faster than the revenue and i want to make sure the cost of revenue is reasonable in this video we're going to talk about the second key financial document which is the balance sheet and the balance sheet is simply a comparison of the assets to the liabilities so for those of you that watched my bonus video where i talked about my net worth that is basically what i did here my net worth is equal to my assets minus my liabilities so in my bonus video example i talked about how i have cash i have stock market investments i have a car and those are all assets and as far as the liabilities go i talked about my car loan as well as the small amount of credit card debt that i have that i'm using to build credit over time and you guys can check out that video if you want more details on my actual net worth and how that works but the best way to visualize a company balance sheet is to think about what if this was my balance sheet what if these were my assets in my liabilities would i be in good financial health or in poor financial health and that's what i want you guys to keep in the back of your mind when you're looking at the balance sheet of a company would this be a good balance sheet for you if you were this company so first of all let's go ahead and define what an asset is an asset is an economic resource maybe it's a building maybe it's just cash but it's something that is an economic resource now some assets depreciate with time and there are assets that depreciate for example my car is technically an asset but it's not going to increase in value with time it's going to decrease so my vehicle is a depreciating asset and then a liability is a financial debt or an obligation so for my example my car loan is a financial debt and it falls under a liability so it's basically assets versus the company's debt now as far as assets go we have current assets and long-term assets and current assets are cash or assets that are readily convertible into cash within the next year and then as far as liabilities go you have current liabilities and long-term debt current liabilities are any liabilities or debt that is expected to be repaid within one year and long-term debt is being paid back over one year so for me my current liabilities would be my credit card debt that i'm paying back every single month it's just two thousand dollars that i get interest-free and as far as my long-term debt goes i'm paying back my car loan over the course of five years and so maybe the first year is considered to be current liabilities but the rest of that is all considered to be long-term debt so if i wanted to i could actually split that up between my current liabilities and my long-term debt and look at my car payments for the next 12 months would be under current liabilities because i'm paying that back within one year and then the cash and cash equivalents is any liquid assets the company has so for me my actual cash savings would fall under the cash and equivalent section of the balance sheet and then finally we have to talk about stockholders equity which is the equity stake a shareholder has in the company or the equity applicable to shareholders which would be you if you're an investor in this company so once you understand what this is you look at the assets versus the liabilities what exactly are you looking for with the balance sheet the first thing i look at is very simple do total assets exceed total liabilities if i was in a position where i had fifty thousand dollars of assets and a hundred thousand dollars of liabilities am i in good financial health or poor financial health and if you're looking at a company where the liabilities exceed the assets the total liabilities versus total assets that's not a very good position to be in the second thing i look at is the short-term debt coverage and the long-term debt coverage now you can do this in two different ways you could start by looking at the current assets and comparing it to current liabilities or the long-term debt or as an even stricter test you can look at the cash and cash equivalents and compare that to the current liabilities and long-term debt and later on in this series we're going to talk about a couple of ratios that actually calculate this for you so again you don't have to actually sit down and do this on paper but what you're looking to do is see whether the company has the ability to pay back their short-term debt and their long-term debt so one of the very simple things that i do looking at the current assets and current liabilities is i make sure that the current assets exceed current liabilities because if your current assets your cash or things that are readily convertible to cash in one year do not cover your debts expected to be paid in one year there might be a deficit there and that is not something you would like to see on a balance sheet for a company or on your own personal balance sheet so third of all the next thing i look at is whether or not assets are growing or shrinking and obviously if you're investing in a growing company a growth stock you want to see consistent growth of assets and if it's a growth stock i like to see double digit growth of assets year over year but more importantly as well we have to look at whether or not the liabilities are growing and if liabilities are growing faster than assets that might not be a good sign for this company so ideally the liability growth rate is going to be equal to or less than the asset growth rate but this is oftentimes not the case you just want to make sure that it's not completely out of control where you're seeing 10 percent growth of assets with 50 growth of liabilities that is not something you would want to see you want to see similar growth there or if you saw no growth of assets and growth of liabilities that means that that company is increasing their debt without increasing their assets if you were in a position where you had the same amount of assets the same amount of cash and it was not growing and you decided to go out there and buy a motorcycle and a camper and increase your liabilities in your short-term and long-term debt would that be a very wise financial decision that's the question you have to ask yourself and if a company has no growth of assets but they have growth of liabilities it's the same exact thing as that the fifth thing i look at is the type of debt this company has is most of their debt short-term debt that has to be paid back within one year or is most of this company's debt long term and again you want to make sure looking at the coverage ratio whether or not the company has the ability to pay back both the short-term and the long-term debt number six you're going to look at the actual cash and cash equivalents to determine whether or not this company is a cash cow is this company sitting on a lot of cash maybe they're planning on some kind of acquisition or expansion or is this company burdened with debt and they have very little cash and again think about this in terms of you what if you were in a position where you had nothing but assets you didn't have any cash and you had a lot of liabilities if all you had was investments in the stock market and maybe you had your car and some other assets and you had no cash and you had both short-term and long-term debt you know you have to free up some of those assets and that might not be a great position to be in it's always good to see a company having a comfortable cash cushion and i always like investing in companies that are cash cows because that means they have the ability to pay back their debts and maybe they're a company that has enough cash to pay back their short-term and long-term debt that would be fantastic but on the other hand you do want to make sure the company is not being inefficient and not borrowing in the right ways because you do want to see a healthy amount of debt with a company and so you kind of have to find the in between there as far as having too much debt versus too little debt because if they have too little debt they might be operating inefficiently and not taking advantage of the ability to borrow money to grow at a faster rate and then finally i look at stockholders equity i want to see double-digit growth with stockholders equity year over year if this is a growth stock because that is the equity that is applicable to you that is your equity stake in this company and you're going to want to make sure you're seeing consistent growth of stockholders equity if this company has a healthy balance sheet gonna wrap up and talk about the final key financial document which is the cash flow statement in the last two videos we talked about the balance sheet and the income statement and now we're going to talk about the cash flow statement the cash flow statement very simply shows you the movement of cash within a company through three different avenues and those are through operations through investing and through financing essentially what you're looking to determine when looking at the cash flow statement is cash flowing into this company or is cash flowing out of this company and you're looking at both the inflows and the outflows now inflows are going to be cash coming in or receipts for example if this was your small business and then outflows would be any payments that you are making so first of all let's talk about the three avenues of the cash flow statement operations is the most important part and it's mostly what i focus on when i'm looking at the cash flow statement and that is the cash generated from the sales of the goods and services the investing side of the cash flow statement shows any gains or losses from their investments and then the financing side shows any inflows or outflows from financing activities so one example of an outflow would be a dividend payment to shareholders and an example of a financing inflow would be if they issued bonds to raise capital so i really don't pay much of any attention to the investing and financing side of the cash flow statement what i'm most concerned with is the actual cash flow from operations now if you guys want to take this a step further and really go in depth and look at the investing and financing side of the cash flow statement i would encourage you to do so but personally i focus on the operation side of the cash flow statement as that is the actual sales of the goods and services that is what i am most concerned with when i am looking at a company's cash flow statement and interpreting the fundamentals so the only thing that i really look at with the cash flow statement is the free cash flow from operations and i basically want to see is the free cash flow from operations increasing are they generating more cash from the ongoing sales of their goods and services and again like i said guys i really don't pay much attention to the investing and financing side because this is a much smaller piece of this company and that requires a little bit more skill as far as interpreting those numbers because they typically fluctuate all over the place so i like to keep it simple and i'd stick to the cash flow from operations that is the number that makes sense to me in this video we're going to talk about some key financial ratios that you may decide to add to your fundamental analysis strategy now we're going to talk about seven different ratios here and the thing is guys there are so many different things you can look at with fundamental stock analysis you can really drive yourself crazy and we've covered a lot of things and we've talked about the best case scenarios of what it is that you are looking for and i just want to let you guys know you're never going to find an investment that meets all of your criteria if you go through this and you write down all the things i'm looking for on a fundamental level for a stock and you go through and you analyze stocks you can analyze stocks until the cows come home and you probably will never find a company that meets all of these specific requirements so instead what you're doing is you're looking through these and trying to find the best possible option and maybe you're willing to have some leeway on certain things and you don't have to use all these ratios i just want to explain to you what these tools are and what they allow you to do and a lot of these things actually calculate some of the stuff we've talked about earlier on for you so it's an easier way to compare these things but we're going to talk about the financial ratios first of all the liquidity ratios which is the current ratio the quick ratio and the cash ratio all these ratios show you the ability this company has to pay back debt and then we have the margin ratios the uh gross margin the operating margin and the profit margin and then the after tax roe or return on equity so first of all let's go ahead and talk about the current ratio the current ratio shows you the coverage current assets have on current liabilities this is something that i usually calculate myself but if you want to you can just go over to the financial ratios and take a look at the current ratio so if you had a current ratio of 100 percent that means that the current assets have complete coverage of current liabilities so the cash and assets that are readily convertible into cash in one year have complete coverage of any short-term debt that is being paid back within that year so what i always like to see is a current ratio of above 100 percent that means they have coverage of their short-term liabilities now the quick ratio is going to show you how the convertible assets have coverage of current liabilities and honestly guys i don't really rely on the quick ratio at all i pretty much look at just the current ratio and the cash ratio and as i'm sure you guys can imagine the cash ratio shows you how much coverage cash and cash equivalents have on current liabilities or short-term debt so ideally you'd find a company with 100 cash ratio which means they have enough cash and equivalents to pay back all their short-term debt but again that's in a perfect world and you're probably not going to find that with an investment now moving on let's talk about the margin ratios so the gross margin is a comparison between the gross profit a company has to the sales revenue and this is the money a company has before paying any operating expenses and financing costs now the operating margin is a comparison between the operating income and the sales revenue and this is essentially how much a company makes before paying interest and taxes on each dollar of sales and the profit margin i think is the most important one it shows you how much the company is earning on each dollar of sales and then the after tax roe shows you the post tax profit a company generates with the money invested from shareholders so what am i looking for when i'm analyzing these numbers number one i want to see a current ratio between 120 to 200 percent this means the company has good coverage of their short-term debt and current assets have greater coverage than current liabilities and if they had 200 coverage that means that the current assets are double what the current liabilities are as far as the quick ratio goes you're looking for about a 75 to 100 percent and then as far as the cash ratio goes 50 to 100 percent is reasonable but you don't want to see the cash ratio climbing too high because that means that that company might not be taking on enough liabilities they might be being too conservative and that may be hindering their growth you want to see a company utilizing financing avenues and taking on a healthy amount of debt but a cash ratio of 100 percent would mean that their cash and cash equivalents have complete coverage of their current liabilities or short-term debt now as far as the margins go gross margin you typically want to see about 25 or more uh operating margin again about 25 plus the profit margin of 20 plus is great and a return on equity of 15 is fantastic as well but i just want to remind you guys that all of these figures here four through eight as far as the margin and return on equity goes it's very sector and industry dependent you're going to find that each sector and industry just like with the p e ratio has different levels of normality or what you should expect as a return on equity or as far as profit margins and gross margin and margin in general goes the best way to do this is to take a look at the industry average overall and look at some of the other companies and compare the return on equity and the margins of one company to another company to determine whether or not this company has better margins and return on equity but generally speaking these would be good numbers to look for but again it's going to be very hard to find an investment that meets all this criteria here we have reached our final video in this series here and what we are going to do is go through my final checklist of all the items i'm looking for in a perfect world and again guys remember you will likely never find an investment that's going to be all 12 of these things here but this is what i'm looking for in an ideal world and what we do is we look for the best possible investment looking at the fundamentals but this is what i'm looking for number one we talked about the p e ratio the peg and the forward p e and i'm looking for a reasonable ratio across all these figures here to make sure that this stock is not likely overvalued or all of that future growth is priced into today's number number two i look at the dividend coverage ratio if this is a dividend stock i make sure the company can actually afford to pay this dividend and i also make sure the company is not being greedy and retaining too much of the earnings for themselves number three i look at the revenue growth i want to see that revenue is growing faster than the cost of revenue or at the very least they are keeping up with each other and revenue growth is equal to the growth of the cost of revenue number four i want to see gross profit is increasing especially if this is a growth stock i want to see a double-digit growth of the gross profit year over year number five i want to look at the short-term and the long-term coverage of debt on the balance sheet looking at assets and liabilities number six i look at the growth rate of total assets and total liabilities i want to see if assets are growing faster than liabilities and i also look at the current assets versus the current liabilities to see if the short-term liabilities or short-term debt are growing faster than the current assets number seven i look at the cash flow from operations and i also look at the cash and cash equivalence growth rate on the balance sheet to determine whether or not this company is deemed a cash cow number eight i look at stockholders equity i want to see a consistent growth rate of stockholders equity and 10 percent or double-digit growth is fantastic number nine i look at the cash flow from operations growth rate to see if they have more cash flow from operations coming in and again that will be indicated looking at the balance sheet looking at the cash and cash equivalents number 10 i want to see a current ratio of above 120 percent that means they have good short-term debt coverage their current liabilities do not exceed their current assets number 11 i want to see margins in general above 20 for a growth investment and i also pay attention to the trend i look at the last couple of years and i see our margins consistent our margins growing or our margins declining and number 12 i want to see a return on equity above 15 percent and once again what is the trend with this is return on equity growing consistent or shrinking

Channel: Ryan Scribner

Views: 62,490

Keywords: stock market, investing for beginners, stock valuation, stocks, stock market for beginners, how to value stocks, how to value a stock, fundamental stock analysis, stock market valuation, pe ratio, pe ratio explained, pe ratio in stock market, price to earnings ratio, supply and demand, stock analysis, stock market analysis, value stocks, how to value a stock price, how to value a company, how to value an investment, income statement, balance sheet, cash flow statement

Id: _ZElGSm0pwE

Length: 52min 53sec (3173 seconds)

Published: Fri Jul 29 2022