What are the best and most common ratios used in fundamental analysis to help analyze a particular business or company?

Fundamental analysis basically stock centered in that it concentrates on all financial data and management processes that come from the running of individual companies. In particular this relates to the financial statements, the earnings from sales revenue and all other accounting variables. Because they impact upon all businesses, other variables such as market share, management changes, structure of debt and equity, asset usage, sales and marketing are included in fundamental analysis.

Most investors will use some if not all parts of fundamental analysis before making stock market trades.

The price to earnings ratio is a key element of fundamental analysis. Calculating P/E ratio is simply the face value of a single share of stock divided by the company’s allocation of earnings per share.

Fundamental analysis demands comparison of the current P/E ratio with the historical P/E ratios. If it is consistently lower than 1, warning bells should ring over a business that isn’t growing. Alternatively it may indicate a business where the share price is a bargain currently. It may also imply that the stock is reasonably priced now.

A fundamental analysis of the company’s balance sheet will help to see the liquidity position, a key concept when considering buying any stock. It can show how leveraged the company is and reveal specific asset types and quantities.

The debt-asset ratio is another key concept in a fundamental analysis. It can reveal how much of the company’s assets are not yet in full ownership but rather are bought with debt. It is calculated by dividing the total liabilities by total assets. When this ratio is less than 1 then the majority of company assets are paid for by owners’ money, or equity. Greater than 1 and the debt could be an issue.

The so-called ‘current ratio’ is the converse of the debt-asset ratio. To calculate it is to divide the total assts by the total liabilities. A number greater than 1 is a positive indicator because the company can cover short-term repayments of debt from its current assets. A current ratio less than 1 could indicate a possible cash flow problem. While a number very much higher than 1 could be telling you that assets are somewhat inaccessible and perhaps not being properly utilized.

A fundamental analysis is a very far-reaching audit of company performance and includes other rations such as the ‘acid test’, the ‘shareholder equity’, the ‘working capital’, the ‘turnover’ and the ‘leverage’ ratios.

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Lesson. 16 – Technical Analysis Continued

What are the different principles or methods of technical analysis?

Technical stock market analysis is the quantitative or statistical approach to tracking and predicting stock price movements. It is based on the conviction that past performance is the only accurate way to predict future direction. Technical analysis is the opposite view to the qualitative approach that assesses things like management pedigree or the vision and values of the company leadership.

Technical analysts would admit that markets as a whole and individual stocks are subject to pressure from psychological forces but the indices and individual stock prices react in a predictable correlated way. Thus if you analyze the numbers and ratios you can buy low (sell high) in the confident expectation of a price appreciation (depreciation).

Here are the five commonest technical analysis principles used to predict share price movement.

1. Resistance level; this is the upper price beyond which a stock will not go. When a stock price reaches this resistance price according to the technical analyst it time to sell because the only way is down.
2. Support level; this is the lower price beyond which a stock price will not fall. When a stock price wave bounces to this bottom price, according to the technical analyst it is time to buy because the only way is up.
3. Breakout; this is when according to technical analysts the stock price goes significantly beyond either the resistance or the support levels.
4. Advance-Decline Line; the sum of all of the advancing issues -batches of stocks- take away the sum of all declining issues, added to a cumulative total. This is a technical analysis of the market as a whole.
5. Moving average; this is a measure of trends in any particular stock or market sector price. It involves noting the price at a given number of moments in time say 10 times and then calculating the mean or average price. Plot these averages on a graph to give a moving average and visible trend. Clearly the aim would be to isolate the low turning point in a trend and make a successful buy. Depending upon the time interval of the prices the technical analyst can derive a daily, weekly monthly or even an annual trend.

Of course the flaw in all technical analysis is its basic assumption that past performance predicts the future performance. All the metric in the World can only measure what has gone past and there is no technical analysis of the future. It is all just probabilities and chance.

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Technical Analysis for beginners

In our previous lesson we discussed fundamental analysis, wherein you determine company strength and future profitability based upon actual financial information about a particular company. This lesson will move on to another major method used in analyzing a company and its stock price, technical analysis. Technical analysis employs the use of charts, to spot things such as trends or patterns. Unlike fundamental analysis, this method relies upon analyzing volume in trading in the markets and the individual investment, along with prices.

Although technical analysis has been referred to as pseudoscience, users hold that even if technical analysis cannot predict the future, it helps to identify trading opportunities.[6]

Most large brokerage firms use both methods in analyzing a company.

Let me give you an example. I may know a particular firm is well managed, not over loaded with debt, they have cash in the bank, they’ve had consistent sales, and the overall company is a good one. At the same time I’ve watched the stock price over the last year, and know that stock was at around $50 just a month before, but now it has dropped into the low $40’s. I would think, heck, the price is right and poised to rebound, this is a great buying opportunity. Now, the above was grossly oversimplified, but its point should be clear to you, it is necessary in many cases, especially when dabbling in foreign currency trading, to use methods such as charting to get a clearer picture.

Here is yet another way to look at this. Take the oil industry for example, recently there was an enormous bubble in the market that popped, oil at its peak was selling for around $150 a barrel, but now it is back down to around $40 a barrel. You could see that its price has leveled off, barring a complete economic collapse, it probably won’t go much further down. Having said that, you could also take a leap and say if history repeats itself, the price of oil won’t stay this way too long, I’m buying in now. That’s the 10,000 foot view of technical anaylsis, in reality it is much more complicated, we will discuss this in greater detail in further lessons.

The big 3 bailout makes no cents, why not give each employee $40,000?

In my previous article, I wrote why helping these failing companies is a recipe for disaster and how giving them money hurts everyone more than simply allowing them to fail. However, if the determination by congress is made to help the Big three auto companies with a bailout, for the sake of keeping the jobs, tell me why it wouldn’t make more sense to just give that money to the employees rather than the company?

Let’s break this down: Between the big 3 automakers there are an estimated 628,699 employees working at these companies. The request is to give these guys 25 billion dollars (25,000,000,000) in aid. This equates to roughly $39,675 per employee, right at the average annual income for all Full time workers between the age of 25-64 in the US per the census bureau.

With money to hold them over for at least year, they could surely find equal paying jobs in other, more efficient and effective industries.

Fundamental Analysis, a closer look

In the previous lesson, I mentioned that there were two different methods that are currently being used to analyze stocks and such, fundamental and technical analysis. This lesson will focus a greater effort on taking a closer look at fundamental analysis.

Let’s say a distant friend of yours told you about XYZ company, and said you have to invest in these guys, they’ve been around for a while now – and their stock is about to explode- it’s the next Wal-Mart. Now, would your just take their word for it that company is a good buy? I surely wouldn’t. So, how would I go about determing if that stock is worth what it is being sold for, in terms of the current price and how it relates to their future ability to make me money?

As mentioned in the previous lesson, you have (if the company is already publicly traded) the ability to look at a companies’ financial position through looking at their financial statements. These financial statements, in general, consist of three major statements, the P&L or profit and loss statement (or income statement), the balance sheet, and the statement of cash flows. This sounds more complicated than it really is; The P&L has multiple names, but don’t let them confuse you. Here, you are only concerned with the revenue a company generates, and the money it costs the company to generate that revenue. Next, the Balance sheet, this is where you can analyze the companies’ assets and liabilities, or the money, investments and properties a company owns along with what money is still owed to other comapnies (as it will not show in expenses until it is paid). Lastly, the cash flow statement shows you how the company finances or pays for their daily operations. If a company has limited cash flows, they may have a difficult time paying their bills.

You can gauge their financial statements by using different ratios to determine if the company is valued correctly. We will discuss in further lessons the different types of financial ratios you can use to compare similar companies within an industry and or the company you are soley interested in.

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So, you’re ready to pick stocks on your own?

What do you need to know if you want to pick stocks on your own? How can you analyze the thousands of investment options available to you? There are a couple of different methods used to evaluate stocks, they are fundamental analysis and technical analysis.

Fundamental analysis takes a more simplified, straight-forward approach in analyzing companies and their stocks. Every public company is required to publish quarterly and annual reports with regards to their financial position. What does this mean to you and me? You have the ability to look at their books, and determine for yourself if their stock is undervalued, right on, or overvalued. By looking at their financial statements you can analyze their profits and losses along with their assets and liabilities. This approach focuses on the long term health and financial postions of companies. We will discuss the tools to help you analyze these statements in later lessons, for now we will stick to the basics.

As for Technical Analysis, this method relies more on market data and relies heavier on investors feelings about particluar stocks and knowing the right time to buy and or sell. This method relies on tools and ratios to determine whether or not a stock is a good buy or sell at any particluar time. This method is probably better suited for the more advanced investor and is more suited for short term investing, rather than the long haul.

In my estimation, use of both methods will probably result in providing you the best idea of how well a company is doing and whether to buy, sell, or hold a particular stock.

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Making sense of your mutual fund choices, loads and no-loads

My Dear investor,

By now you are asking me to make some sense of all the different mutual fund choices available to you, so I will try. Let’s recap them from our previous lesson; We have Money Market funds, Bond funds, and Stock Funds to choose from. Within each Major fund type, we have in some cases extremely different choices, however, the majority of your decision making will take place in selecting your stock funds. So, let us move our efforts to a discussion around the multiple stock fund choices (growth, value, blend, index, international, sector, and other). Keep in mind, your company has picked the major funds you can invest in, you more or less decide percentages.

While I went into depth in the previous lesson about your stock fund choices, I didn’t discuss how to choose or select the best ones. Your mix of choices should depend on your risk tolerance. For example, as an agressive investor my portfolio (90% of my 401k is in stock funds) is heavily weighted towards growth, small cap, international and index funds.

No matter what you end up selecting, as a general rule pick at least 10 different funds and keep your percentage in each fund around 10% for optimal diversification. In addition, choose only funds with no-loads (unless a loaded fund is outperforming no load funds, which is highly unlikely). No-load funds (such as Index funds) have consistently outperformed loaded funds year after year for many reasons. Loaded funds are actively managed funds (meaning the company pays investment managers to monitor, and in some cases change what stocks they are investing in for the fund), and and no load funds refers to funds that are setup and left alone. Why don’t you want someone else managing the fund your invested in? Because they have proven to do no better than funds that are left alone, in most cases, you will lose money having your funds actively managed rather than left alone. In a nutshell, choose funds with low management expenses, it will mean more money to be invested versus in some investment managers’ pocket.

Use common sense when selecting from the funds available to you that are suited around your risk tolerance. You can request a prospectus (basically information provided about the funds past performance and future expectations) from Investment providers like Vanguard or Fidelity or whomever you are working with. Look and compare fees within the different funds. Compare their past performance with how long you will be investing to see if it fits your risk tolerance. Make sure the fund is what it says, look at the companies it invests in. Take the time to do research for a couple of hours, it will pay off big time in the long run.

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Mutual fund details

401k piggy bank invest wiselyIn our previous lesson, we discussed the three major fund types (stocks, bonds, money markets) and what they consisted of, now we will drill down and talk about them in greater detail (as this lingo will be prevalent when you go to choose your plan).

Money markets (funds) are often used when you sell off your investments and the investment firm deposits your proceeds in an interest bearing account (versus sending you a check and you lose out on the interest, while you decide what to do with your money).

The major types of Bond funds include:

U.S. Government Bond Funds are U.S. treasury or government securities.

Municipal Bond Funds are tax-exempt bonds issued by state and local governments.

Corporate Bond Funds are the debt obligations of U.S. corporations.

Mortgage-Backed Securities Funds are securities representing residential mortgages. (from government lenders like Fannie Mae and Freddie Mac).

Stock funds are by far the most complicated of your fund options (in my case they make up 90% of my 401k portfolio). The investment firms have a number of ways they label their different stock funds, which are supposed to help you categorize the different strategies you can follow depending upon your risk tolerance. They are as follows:

Value Funds – The key here is the investment firm considers these stocks to be undervalued. Think of this fund like a real estate investor does when he finds a home that is way under priced, with a little polish, these suckers could make a ton of money. These funds invest in mid to larger sized companies. Stocks in this fund usually pay dividends (some companies pay cash back to their shareholders on an annual (or a variation of) basis in the form of cash and or additional shares based upon the money that they make (so, instead of the price of the stock going up, they opt to pay the shareholders now). These are considered typically safe investment (as there won’t be too much swing in prices).

Growth Funds – These funds invest in stocks that are thought to be the quickest growing companies in the market. Growth funds hardly ever provide dividend income because they are focused on expanding their businesses. These are considered risky investments with an investment horizon of 5-10 years (meaning you better plan to stick with these guys for that time to get the most out of the stocks).

Blend Funds – These funds are a mix or blend of both growth and value stocks. Below are the different types of blend funds by size:

Large-Cap Funds – These funds invest in companies whose value is greater than $5 billion dollars. These are usually companies that have been around for a long time and have a proven track record.

Mid-Cap Funds – These funds invest in companies whose value is greater than $1 billion, but less than $5 billion.

Small-Cap Funds – These funds invest in companies whose value is less than $1 billion. These companies, like the growth fund companies, reinvest profits to expand, versus raising additional money through other methods.

Index Funds – These funds are representative of different stock markets indexes, like Dow Jones, Standard and Poors, etc. Instead of hand picking stocks from different markets (there are thousands); the investment managers of this fund select portfolios built around the entire market. These are very cost efficient funds with this hands off approach to investing, however, they maybe risky too.

International Funds having been doing quite well as the dollar has plummeted.

Global Funds – invest in stocks around the world.

Foreign Funds – invest in stocks outside of the U.S.

Country Specific Funds – invest in one country or physical region of the world.

Emerging Markets Funds – invest in smaller, developing countries and are considered very risky, however very rewarding in some cases.

Sector Funds invest in different industries or segments of the market. Such as utilities or technologies or healthcare.

Now, keep in mind the above is the extreme basics, and there are multiple types of funds out there that could take me hours to discuss. The point here is, now you have an idea of what you are looking at, when you start to analyze your different 401k plan options.

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Mutual funds, the 401k investors main course

401k investment mutual fund imageFirst, let us define a Mutual fund; In a nutshell, a mutual fund is a collection of multiple stocks and bonds and other investments. Basically, an investment firm starts a fund by going out to the stock market and buying a bunch of different shares of companies and various different bonds. They then sell shares of their funds to you through your company (and out on the stock market).

So, you start your job and your company tells you to join their 401k plan. For example, my company uses Vanguard (an investment firm), however, their are many more large investment firms used accross the country like Fidelity. Now, Vanguard has gone out and built a bunch of different funds that invest in very different things. For example, one fund might invest heavily in technology stocks (like google, or yahoo), while another fund may be invested in international food markets, while another fund is invested in utility companies.

So, you decide it’s a great idea to join the company plan as you will defer a portion of your taxes and make free money.

You are then given a list you are supposed to choose from, of different funds. This is where it get’s tricky. What are the major types of funds? What funds should you buy? How to decide what funds are best? Should you choose the growth, value, index, bond, some other fund, or a combination thereof? Don’t worry, we’ll make some sense of this now.

The different major types of funds offered are Stocks, Bonds, and Money Market funds (Cash). Looks familiar huh? We talked about these in lesson 6.

Stock funds are wide and varied based upon economic sectors and geography.

Bond funds consist of various types of government, municipal, and corporate debt obligations (meaning they are additional ways for organizations to raise money for one reason or other.

Money Market funds invest in things mentioned in previous lessons, like CD’s offered by banks along with savings accounts. These are easily converted back to cash, however, they have a hard time keeping up with inflation (meaning the interest you are given for investing in them may be less than the dollars devaluation).

In the nest lessons, we will discuss in greater detail the different types of Bonds offered by your 401k.

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What stocks should I buy!?!

401k invest wisely - advice for investing imageMany people want to start off investing by building their own portfolio of individual stocks, which is perfectly fine, however, it can be much more confusing and difficult than simply investing in mutual funds (we will discuss mutual funds in the next lesson) offered through your 401k plan and or other defined contribution plan like an IRA or Roth IRA (if your company doesn’t offer a 401k). Basically, with your 401k plan, you must choose from various mutual funds offered by the investment firm your company is working with (so, you don’t have a choice here, if you want to invest additional money over and above what you are contributing to your 401k plan – you can and should do so by building a larger portfolio of additional individual stocks and bonds).

Back to the question I hear (about picking individual stocks) so often, it’s probably more common than screaming is in my house. The problem is this, I can’t answer that question for you – and neither can anybody else without your specific information, only you can. Now hold on, don’t call me a jerk or retard or whatever else because I’m not giving you the information you think you want, listen to my reasoning:

Without knowing your age, the amount of risks you are willing to take, what your current portfolio of stocks and bonds are, how long you want to invest, and various other factors – I, nor anyone else could tell you if one stock is better for you than another. In future lessons however, I will teach you much more about investing through buying individual stocks (for those who don’t have a 401k, or whom want to invest additional money outside of their 401k or other defined plan).

An example of my above thoughts: An uncle of mine was asking me about various specific stocks and if I thought they were good buys. In many cases the stocks were good buys for me, but not for him. How could that be? Well, many of the stocks he was looking at required a much longer time commitment than he had. He is only 5 years from retirement and the stocks he was looking at were long term investments (meaning he would have to remain invested with them for a long time – maybe over 10 years in some cases to realize the returns on his investments that he wanted). In his short time frame, it was not likely he would generate the returns he was wanting. On the other hand, I could hold on to the stock for 10 years, and would likely make good money doing so.

It is worth repeating a million times, if anyone gives you advice on specific stocks without knowing a damn thing about you, their advice is pretty much worthless to you. The information you use to decide if one stock is better for you than another should be based upon your needs, not somebody elses or what they think is “the hot stock” of the day, month, year, or whatever.

So, you are asking, “then what good is this site if it can’t help me pick a stock.” Once again, in future lessons, I will help you learn about the tools you can use if you choose to build your own portfolio. But for now, we will move our focus to the options an average new/existing 401k investor has to choose from (mutual funds) when they go to setup their 401k plan.

Please proceed to the next lesson, this will become much more clear after that, I promise.

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