2. What is Fundamental Analysis?
● Method of valuing securities such as stocks and
bonds
● Attempts to find out their intrinsic (true) values
● If undervalued → Long (Buy)
● If overvalued → Short (Sell)
3. EXAMPLE 1 : Slot Machine
● Jack buys a £1 500 Poker
Machine and takes £1 000 loan
at 5% annual interest rate
● He places the machine to a
local barber shop and promises
to give 20% of the earnings to
the shop owner
● The machine starts earning him
£300/month
● How much is Jack's business
worth? £500? £1000? £1 500?
4. Some Ratios
● P/E ratio (price-to-earnings ratio)
- How long it takes that the investment pays itself back
- Market Price per Share* / Annual Earnings per Share (EPS)**
*EPS = Net Earnings / Number of Shares
**Market Price = Market Capitalisation
● P/B ratio or PBV (price-to-book-value ratio)
- How much tangible asset (+ goodwill) you get for the
money you invest
- Market Price per Share / Book Value per Share***
***Book Value = Value of Total Assets
5. More Terminology
● (Shareholder's) Equity = Assets – Debt
● Net Gearing (%) = Net Debt / Equity
● EBITDA = Earnings before interest, taxes,
depreciation (e.g.repairs), and amortisation
(e.g.patents,copyrights)
● EBIT = Earnings before interest and taxes
● Net Income/Profit = Earnings after taxes
● Dividend Yield (%)
= Dividend per Share / Market Price per Share
● Dividend Payout Ratio(%) = Dividend per
Share / EPS
6. Some More Ratios
● Profit Margin (%) = Net Profit / Net Sales
● Return on Equity (ROE) (%)
- Annual increase in shareholder's equity
- ROE = Net Income (After Tax) / Equity
- Double ROE → Double P/E
● Return on Assets (ROA) (%)
- ROA = Net Income / Total Assets
● PEG Ratio (Price/Earnings-to-growth)
- PEG = (P/E) / (Annual EPS Growth)
- e.g.company growing 30% a year with P/E=30 → PEG=1
7. EXAMPLE 2 : More Slot Machines
● What if Jack invests all
his earnings to new
Poker Machines and
places the machines in
new barber shops?
● What if we take into
account the risk that
hooligans break his
machine?
8. Top-Down Stock Selection
● World View
- Recognising the trend using
e.g. leading
indicators (building permits,
UMCSI)
● Industry View
- Which sectors are going to
thrive given the world view?
● Business View
- Which stocks within the
industry are most suitable based
on their ratios and our world view
9. Rules of Thumb (by Peter Lynch)
● Market Cap < £5 billion
● PEG ratio < 1.2 (PEG=1 is fair
value)
● Earnings Growth > 15%
● Gearing (Debt Ratio) < 35%
● Institutional ownership < 65%
● Pays Dividend
● Not a penny stock
● Careful with cyclical stocks
(e.g. construction, automobile)
