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Fundamental analysis is used to forecast future price movements of a market based on the underlying factors that contribute to the supply and demand for that particular asset. The purpose of fundamental analysis is to delve into the financial history and current conditions of a company’s income, expenditure of their money, and provide some measurements as to how efficiently they manage their business.

Since there are a number of variables that fall into the fundamental analysis category, it is important to prioritize a number of these factors in order to assess a company’s strength. Some of the key fundamentals we will overview in this article include: earnings growth, earnings per share, earnings per share rank, P/E ratios, price to sales ratio, volume and accumulation/distribution.

A key method in assessing a stock’s profitability is to analyze a stock’s earnings growth over the last quarter. Companies release quarterly earnings reports that state how much earnings per share the company made that quarter. This indicator is measured annually and quarterly. It divides a company’s revenue by the outstanding shares. If a company starts to slump, you’ll definitely see it in the quarterly earnings growth reports. If revenues decline, companies have to start cutting costs and this could have a bearish implication.

Earnings per share is a widely used measurement of a company’s financial strength. It is calculated by dividing a company’s net earnings for common stock by the number of outstanding common shares. The resulting number can be compared to earnings per share of the same quarter in the last year to determine a company’s earnings growth. This comparison can be used to forecast an increase or decrease in the future price of the stock.

The earnings per share rank rating measures a company’s growth over the past two quarters in comparison to the same quarters in the past year and then factors in the past 3 to 5 year annual growth rate. The resulting number is then compared to other companies and given a rank of 1 to 99. The earnings per share rank basically tells a trader how profitable a stock is in comparison to the numerous stocks available to be traded.

Next is the price-to-earnings ratio, otherwise known as P/E, which is an important measurement that compares a company’s stock price to the amount of earnings per share. The comparison attempts to assign a rating to the difference between a company’s profits per share and the actual price of each stock share. The P/E ratio tells how many times the earnings a stock is trading at. To calculate the P/E of a stock, simply divide the current stock price by the latest 12-month earnings per share.

Tracking the price-to-sales indicator can help us understand when a stock is overpriced or undervalued. To calculate a stock’s price-to-sales ratio, divide the price of a stock by the company’s sales per share. Price-to-sales is more typically used for companies or industries without net income, or earnings, particularly when profitability is relatively far out into the future.

A stock’s volume represents the number of shares of each stock traded each day. This number is important when the volume is increasing significantly. If the stock has a high relative trading volume then you usually have a confirmation signal that the stock is making a move. When volume is decreasing or stable, the stock will likely go nowhere as interest in the stock is dwindling.

Finally, accumulation and distribution reflects a stock’s daily long shares compared to the number of short shares. This is important in that it attempts to evaluate two of the most important indicators of strength or weakness in a stock, which are the percentage changes of a stock’s price and volume. The accumulation and distribution ranking is calculated by multiplying a stock’s daily price change percentage by its volume. This number is then added or subtracted to the cumulative total for the stock depending on whether the price increased or decreased. This indicator can reveal the supply and demand of a stock which might trigger a rise or fall in the price.

These are just some of the more important indicators used in fundamental market research. The investor should take the time and familiarize themselves with many of the other fundamental tools and pick which ones that would best fit into their own fundamental analysis game plan.

Happy Trading.


Jeff Neal 
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
Visit Jeff’s Forum
Listen to Jeff at www.ProfitStrategiesRadio.com

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