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Fundamental analysis is a method of analysing financial markets with the purpose of price forecasting. Forex fundamental analysis focuses on the overall state of the economy, and researches various factors including interest rates, employment, GDP, international trade and manufacturing, as well as their relative impact on the value of the national currency they relate to.
The core premise of fundamental analysis in Forex, as well as other financial markets, is that the price of an asset may differ from its value. For this reason, various markets may sometimes misprice an asset, overprice, or underprice it in the short run. Fundamentalists claim that despite being mispriced in the short-term, the assets will always return to the correct price eventually. The end goal of performing fundamental analysis is to discover the true value of an asset, to compare it to the current price, and to locate a trading opportunity.
This also nicely demonstrates the key difference between fundamental and technical analysis. While technical analysis barely pays attention to anything but the current price, fundamental analysis researches everything but the current price. Whilst it is true that fundamental analysis may not be the best tool for a short-term trader in day-to-day markets, it is the fundamental Forex factors and how they are analysed that answer what happens in the long-term.
FX fundamental analysis isn’t just about comparing the current data of single economic indicators to previous data. There are a great number of economic theories which surround fundamental Forex analysis, attempting to put various pieces of economic data in context, to make it comparable.
The most popular economic theories of currency fundamental analysis babysit the notion of parity – a condition of price at which currencies should be exchanged when adjusted, according to their local economic factors, such as inflation and interest rates.
Understanding Fundamental Analysis
The following video explains how fundamental analysis is used to monitor major news releases, and what traders can expect to happen in the financial markets when certain data has been released:
Good News – Bad News
You may have noticed that from the very practical standpoint of an average Forex trader, it is news reports that produce movements on the markets. How and why does this happen? There are several economic indicators that financial experts observe because they can provide hints on the health of the economy.
These indicators are found in news reports and news outlets. Some are released weekly, most are released monthly, and a few quarterly. You can track such announcements and developments through our Forex calendar. Now let’s compare technical and fundamental analysis by the frequency of data updates.
In the case of currency trading fundamental analysis, new data arrives every second in the form of a price quote, while fundamental indicators are only published once a week at the most. Capital flows gradually from countries where it accumulates at a potentially slower rate, compared to the countries where it could accumulate at a potentially faster rate.
That has everything to do with the strength of an economy. If an economy is forecast to hold strong, it will appear as an attractive place for foreign investment, because it is more likely to produce higher returns in the financial markets.
Following that thought, in order to invest, investors will first have to convert their capital into the currency of the country in question. Buying more of that currency will push the demand, and force the currency to appreciate. Unfortunately, economics is not that simple, which is why examples of healthy economies showing weakening currencies are not exactly unknown to history. Currencies are not like company stock, that directly reflects the health of the economy.
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Currencies are also tools that can be manipulated by the policy makers – such as central banks and even private traders like George Soros.
When economic reports are released, traders and investors will look for signs of strengths or weaknesses in different economies. If prior to the news releases, the market sentiment leans in one direction, changing the price before the release is known as a ‚priced in market‘. It often causes a little commotion upon the actual data release.
Conversely, when the market is unsure – or the data results vary from what was anticipated – severe market volatility may occur. That is why Forex rookie traders are generally advised to stay away from trading around the news when practising fundamental analysis.
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Major Economic Indicators
Economic data may hint towards shifts in the economic situation of a respective country.
Interest rates are a major fundamental Forex analysis indicator. There are many kinds of interest rates, but here we will focus on the nominal or base interest rates set by central banks. Central banks create money, that money is then borrowed by private banks. The percentage or the principle that private banks pay central banks for borrowing currencies is called a base or a nominal interest rate. Whenever you hear the phrase ‚interest rates‘, people are usually referring to that concept.
- Manipulating interest rates – a big part of the national monetary or fiscal policy – is one of the primary functions of central banks. This is because interest rates are a great leveller of the economy. Interest rates are perhaps stronger than any other factor, and they influence currency values. They can have an impact on inflation, investment, trade, production and unemployment.
Here is how it works:
The central banks generally wish to boost the economy and reach a government-set inflation level, so they decrease interest rates accordingly. This stimulates borrowing by both private banks and individuals, as well as stimulating consumption, production and the economy in general. Low interest rates can be a good tactic, but a poor strategy.
In the long-term, low interest rates can over-inflate the economy with cash, and can create economic bubbles, which as we know, sooner or later will set a toppling chain reaction across the economy, if not entire economies.
To avoid this, central banks can also increase interest rates, thus cutting borrowing rates and leaving less money for banks, businesses and individuals to play around with. From a Forex fundamental analysis standpoint, the best place to start looking for trading opportunities is in the changing interest rates.
News releases on inflation report on the fluctuations in the cost of goods over a period of time. Note that every economy has a level of what it considers ‚healthy inflation‘. Over a long period of time, as the economy grows, so should the amount of money in circulation, which is the definition of inflation. The trick is for governments and central banks to balance themselves at that self-set level.
Too much inflation tips the balance of supply and demand in favour of supply, and the currency depreciates because there is simply more of it than demanded. The converse side of the inflation coin is deflation. During deflation, the value of money increases, whilst goods and services become cheaper.
In the short run it may be a positive thing, but for the economy in the long run, it can be a negative thing. Money is fuel for the economy. Less fuel equals less movement. At some point deflation may have a drastic impact on a country, to the extent that there will hardly be enough money to keep the economy going, let alone to drive the economy forward.
Gross domestic product (GDP) is the measurement of all goods and services a country generates within a given period. GDP is believed to be the best overall economic indicator of the health of an economy. This can seem odd, especially considering GDP is basically a measurement of the supply of goods and services, yet it has nothing to do with the demand for these goods and services.
The general idea is that it takes a great deal of knowledge of both supply and demand to make reasonable, accurate estimations. It would be unwise to believe that GDP reflects both sides of the market. Therefore, an increase in GDP without a corresponding increase in gross domestic product demand or affordability, is the very opposite of a healthy economy, from a fundamental Forex analysis perspective.
Interest rates, inflation, and GDP are the three main economic indicators employed by Forex fundamental analysis. They are unmatched by the amount of the economic impact that they can generate, compared to other factors such as retail sales, capital flow, traded balance, as well as bond prices and numerous additional macroeconomic and geopolitical factors. Moreover, economic indicators are not only measured against each other through time, but some of them also correlate cross-discipline and cross-borders.
You can learn more about this with our article on ‚ The Best Forex Fundamental Indicators Explained, Part 1‘
It is important to understand that there is a lot of economic data released that has a significant impact on the Forex market. Whether you want to or not, you need to learn how to make Forex fundamental analysis a part of your trading strategy to predict market movements.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
Forex Fundamental Analysis
Изменение баланса спроса и предложения, которое определяется под воздействием различных экономических факторов, является причиной для движения котировок валютных пар и других торговых инструментов. Это аксиома. Фундаментальный анализ Форекс позволяет спрогнозировать вероятное развитие рыночной ситуации на основе существующих и возможных изменений в политической и экономической жизни общества. Рассматриваемый анализ учитывает самые разнообразные показатели. Среди них главными являются данные по инфляции, уровню безработицы, процентная ставка в конкретной стране, показатели торгового баланса и т.д. В данном разделе Вашему вниманию представлен фундаментальный профессиональный анализ, выполненный опытными и квалифицированными экспертами рынка форекс.
Актуальная информация на сегодня и каждый день!
Обращаем внимание, что многие основные финансовые показатели для проведения фундаментальной аналитической работы находятся в свободном доступе и публикуются в средствах массовой информации. Найти эти данные Вы можете в тематических журналах, официальных сайтах государственных учреждений, ресурсах независимых научных организаций и т.д. Фундаментальный анали Форекс является достаточно сложным. Чаще всего начинающим Forex трейдерам самостоятельно выполнять такой анализ весьма трудно. Это неудивительно, поскольку для его проведения необходимо досконально знать теоретические основы и учитывать множество указанных выше и других взаимосвязанных финансовых факторов, которые нередко могут даже противоречить друг другу. В такой ситуации практически незаменимым становится фундаментальный качественный анализ, уже подготовленный профессионалами валютного рынка Forex.
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Investing in stocks becomes more and more accessible every day because of the technological progress we witness on a daily basis. Approach every stock trade with due diligence. Your analysis is what helps you decide whether a stock is a good investment or not.
There are 2 types of analysis related to stock trading — technical analysis and fundamental analysis. We’ll give you the best research tools to conduct fundamental analysis and show you how to use them.
Main Takeaways: Using Fundamental Analysis
- Technical analysis and fundamental analysis are the 2 main types of analysis-related stock trading. Fundamental analysis evaluates certain securities to create forecasts about its price in the future.
- This type of analysis uses specific indicators. These include EPS, P/E ratios, beta and more. We explore what each of these are, and the role they play, below.
- A great company to use for technical analysis is Amazon. We break down an example below as well.
What is Fundamental Analysis?
Fundamental analysis is the process of evaluating security for creating forecasts about its future price. Fundamental analysis includes estimations based on many components related to stock, including:
- The global industry
- Company financial statements
- Company press releases
- News releases
- Domestic political conditions
- Trade agreements and external politics
- Competitor analysis
If some fundamental indicators of a company show data that has a bad impact, this is likely to negatively reflect the share price. On the other hand, if there’s a positive data release, like an outstanding earnings report, for example, this can boost the stock price of the respective company.
Here are some examples of key performance indices that are commonly used to analyze stocks fundamentally:
- Earnings per share (EPS)
- Price-to-earnings (P/E) ratio
- Price-to-book (P/B) ratio
- Return on equity
Each of these key performance indices gives information that is helpful for conducting a price analysis. You can buy the stock on the assumption that the price will increase if your analysis shows that the price of the stock is about to increase.
A Detailed Example of Fundamental Analysis
There’s no right way to do fundamental analysis, as stock trading is not as accurate as a math problem. The same information in different industries and different stocks will never mean the exact same thing. Here are a few of the most important fundamental indicators.
Earnings Per Share (EPS)
The earnings per share relate to the portion of profit allocated to each of the company’s shares. The EPS is an indication of the company’s profitability. The higher the earnings per share, the better it is for the investor. A higher EPS is a symbol of a healthy company.
At the same time, if the earnings per share are unusually high, this could mean one of the following things:
- Earnings can decrease and get back to normal.
- The price of the stock can increase to normalize the stock price compared to the earnings.
Price-to-Earnings Ratio (P/E Ratio)
The price-to-earnings (P/E) ratio shows the company payouts compared to the price of the stock. In other words, the P/E ratio shows whether a share of stock pays well compared to its price. We calculate the P/E ratio by dividing the price per share by the earnings per share.
For example, imagine that the price per share is $30 and the stock pays $2 earnings per share:
The lower the P/E ratio, the higher the earnings compared to the stock price.
At first sight, the lower the P/E ratio, the more attractive the stock. But if we think carefully we will realize that unusually low P/E ratio could show extra potential.
If the P/E ratio is too low, below 10 for example, this means that the price per share is low compared to the earnings. This might mean that the stock is undervalued in price and it can increase its price. The opposite is in force for the high P/E ratio.
Price-to-Book Ratio (P/B Ratio)
The price-to-book ratio is an indication that shows how much the stock worth compared to the book value of the company. If a company worth $10 million and has 500,000 shares outstanding, it will have a book value per share of:
10,000,000 / 500,000 = $20 book value per share
If the stock trades at $80 per share, then the price-to-book ratio is:
80 / 20 = 4 P/B ratio
The P/B ratio = price per share divided by the book value per share.
If the P/B ratio is more than 1, this means investors believe that the stock will grow at a faster pace, which is the reason why its price is higher than its book value. In some cases, you can even see P/B ratios of 100 and more. This could be a common parameter for the growth stocks.
Return on Equity (ROE)
The return on equity is a measurement that determines how efficient a company is when using the shareholders’ equity. You calculate the ROE by dividing the shareholders’ equity by the company’s net income. If a company has generated $5 million this year and the shareholder equity is $50 million, this means the ROE is:
50,000,000 / 5,000,000 = 10%
Note that you should calculate the ROE result as a percentage.
The higher the ROE, the more efficient the company is. If a company generates a less than $5 million income this year (say $2 million) with the same shareholders’ equity, this means it is less efficient:
50,000,000 / 2,000,000 = 4%
Here, the company has a lower ROE with the same shareholder’s equity, meaning that it is less efficient.
The beta gives information about the stock price’s correlation to the industry it operates in. This happens by comparing the stock to a benchmark index. The beta usually varies between -1 and 1. Sometimes values can go much lower than -1 or much higher than 1.
Values above 0 mean that the stock correlates to the benchmark index. The higher the beta, the higher the correlation. But the higher beta also means that the volatility is higher as well, meaning that the risk of the asset increases.
Values below 0 mean that the stock is inversely correlated to the benchmark index. It won’t be as a mirror image, but the ticks are likely to match. The lower the beta, the higher the inverse correlation. However, the lower the beta, the lower the volatility.
Fundamental Analysis of Amazon
Amazon is the ultimate symbol of the tech sector. The company has shown exponential growth, revenue and earnings over time.
Another important fundamental indication is that Amazon has beaten the EPS estimates in the past 4 years, and the outreach is exponential.
This earnings data shows that Amazon is healthy and aims for growth every year. And the best is that they are succeeding for now.
Earnings per share: $17.85
Notice that earnings per share of Amazon are very low compared to the stock price. This leads to the extremely high P/E ratio.
P/E ratio: 98.1
This tells us that a very small part of the earnings actually goes to the shareholders. This is totally normal for an IT company of Amazon’s rank. They constantly expand and reinvest funds in research and development. Some of the fields Amazon is currently working actively is robotization and artificial intelligence. Since the company spends a lot there, there’s not much left for the shareholders.
This offers up further information, however. Since Amazon invests a lot and aims to expand more, we can expect the company to grow even further, dragging the stock price up. After all, during the past 4 years, Amazon has grown in stock price by more than 40% on average.
P/B ratio: 19.88
A P/B ratio of nearly 20 is very high. This means investors are currently paying nearly 20 times higher price for an Amazon share compared to the book value of the company.
The return on equity of Amazon is high for the sector. Here’s a general comparison with other top tech companies from the S&P 500:
- Facebook ROE: 25%
- Microsoft ROE: 23.1%
- Google ROE: 11.6%
- PayPal ROE: 13.8%
Amazon is more efficient financially compared to the 4 companies above. Note that this doesn’t mean that Facebook, Microsoft, Google and PayPal are not efficient. It means they are efficient but less so than Amazon. In comparison, Apple has an ROE of 48.7%.
Amazon is a stock that is very correlated to the benchmark and the beta confirms this. Not only is it correlated, but it’s also one of the top 10 stocks of the S&P 500. A beta of 1.63 means that the stock is very volatile, which isn’t unusual for a huge multinational corporation that dynamically reinvests its funds.
Fundamental Analysis vs. Technical Analysis: What’s the Difference?
Fundamental analysis relies on the company’s parameters as you saw in our analysis above. Technical analysis, on the other hand, takes into consideration only price action and past price data.
Investors perform technical analysis on a chart. The goal of the technical analysis is to make assumptions based on past stock price performance. Pure technical analysts don’t rely on company data and fundamentals. They analyze charts and try to find patterns for recognizing future behavior.
At first sight, the technical analysis might sound unreasonable. However, there is a strong psychological correlation between price action and the psychology of market participants. Since the price of a stock formulates based on supply (sell) and demand (buy), turning points related to the price of a stock are likely to have an impact on the attitude of the market participants.
An example of this is the round number levels on a chart. If a stock approaches from below $100 per share, this level is likely to have a psychological impact on market participants. Many investors might think that the company has no capacity to expand above $100 per share and can sell their assets, creating supply and reducing the price of the stock.
Technical analysts use various tools to analyze the price action of stocks. Some of these are:
- Candle patterns
- Chart patterns
- Trend lines
- Price momentum
- Trading volume
Each of these tools and indicators has a different meaning and tells a story. But when matching signals from different indicators, a technical analyst attain signals with higher reliability.
The Best Research Tools for Fundamental Analysis
In most of the cases, your broker will supply you with the most important data you will need to conduct a fundamental analysis of a stock.
One of the best online brokerage agencies with a very comprehensive research section is TD Ameritrade. Its advanced trading platform, thinkorswim, includes stock data research.
The platform includes a stock screener which lets you filter stocks based on different fundamental parameters. TD Ameritrade also harvests a lot of fundamental data and investing newsletters from sources like CNBC and Yahoo! Finance.
Finviz is a very adequate solution to screen fundamental stock data and has a sufficient free version.
This is what you will see when you search for a stock. The data includes the most important fundamental parameters of a stock.
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Yahoo is one of the oldest providers of stock fundamental data. When you go to the Yahoo! Finance site, you will see a search bar and once you see what interests you, this is what you will get.
You’ll see different tabs at the top which contain extra fundamental information related to historical data, financial reports and statistics.
Be Familiar with Fundamental Analysis
Fundamental analysis is essential in stock trading. You need to be familiar with the basic fundamental indicators if you want to start investing in stocks so you can build a picture of the financial condition in a company — whether it’s financially efficient, sustainable and profitable.
Although the stock analysis is important, it is always good to pair it with technical analysis data. Always mind the important psychological levels on the chart, which might be a turning point. Try to match technical data with fundamentals. If you find your way to understand both of these languages, your analysis will reach a new level of comprehension.
Looking to improve your stock trading strategy? Check out our guide on how to create an investment strategy, or the best online stock brokers for beginners if you’re just starting to build your portfolio.
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What is Fundamental Analysis?
While technical analysis evaluates the share price action of a stock, fundamental analysis evaluates the actual business operations to determine the financial health of the company, project future growth prospects and determine current and future valuation. Fundamental analysis can be performed quickly with various widely available financial tools or be extensive depending on how much time and effort the investor wants to commit.
How Does Fundamental Analysis Work?
Fundamental analysis uses publicly available information usually disclosed by the company through SEC filings to build an accurate assessment of the business. It is believed that a company’s fundamentals are the key long-term driver for share prices. While short-term market fluctuations impact immediate stock prices, the market will eventually price a stock correctly in the future. Fundamental analysis attempts to extract a fair valuation for the company to determine if the markets have overvalued or undervalued the shares. Based on this thesis, investors can decide if the shares are an attractive investment now or wait for a better valuation later.
Components of Fundamental Analysis
This various components of research include analysis of the earnings reports, company business model/strategy, catalysts, and financials including assets/liabilities, financing/debt obligations, credit facilities, rumors and press release documents. Additional research on the company’s sector/industry and peers can also be performed. It also involves staying current on any executive changes with the management and board of directors. Intensive fundamental analysis can be tedious and time consuming for an individual investor.
To attract and maintain clients, full service brokerage firms assign the heavy legwork to in-house financial analysts that specialize in specific sectors, industries and companies. Many online discount brokers have also beefed up their research departments to retain customers. The most widely followed analysts run intricate fundamental analysis through various qualitative and quantitative models to forecast future earnings results known as consensus analyst estimates. Meeting, beating or missing these estimates have an immediate and material impact on share prices.
Who is Fundamental Analysis For?
Long-term investors benefit the most with fundamental analysis, since valuations and stock prices ultimately reach parity in the longer run. Swing traders benefit depending on their holding period and premises for holding (IE: undervalued assets or buy the rumor, sell the news into a scheduled event). Intra-day traders are mostly affected when news, events or rumors trigger price volatility and spur momentum on heavy volume, often resulting in price gaps up or down in the pre and post-market. Earnings report releases generate the heaviest volume and price action, which is why traders look forward to each earnings season. For biotechnology companies, clinical trial data and FDA decisions tend to generate the most volatility.
Basics of Fundamental Analysis
Fundamental analysis requires information provided by the company to develop a thesis about the business. These are some of the factors that should be included in the thesis.
Understand a Company’s Real Value
Perception is reality in the financial markets. Different investors and analysts will have differing valuations for a company. Where one analyst sees a dying legacy pipeline, another may see an undervalued asset. For example, when retail big box stores suffered declining sales, private equity focused on the undervalued valuations of their real estate assets. This sparked a rally in the sector based on a new perception. However, the continued declining sales forecasts caused the sector to plummet, when the earnings reports revealed even larger revenue declines, as perception shifted negative again.
Sentiment Influences Perception
The markets are the ultimate judge and jury as to which valuation pricing prevails and when. Sentiment influences perception, which is why stocks tend to overshoot their valuations in strong bullish markets and undershoots during weak bearish markets, as the adage of a “rising tide lifts all boats” rings true. Astute fundamental analysts will work to develop their own valuation models using specialized metrics to calibrate them to any catalysts or events. Companies can be valued based on financial metrics as well as assets that may not be efficiently priced in. The “parts are worth more than the whole” is a common justification for under valuation, which assumes that the company may spin-off or sell certain assets to improve shareholder equity.
Reading Financial Statements
Publicly traded companies are required to file financial statements with the United Stated Securities and Exchange Commission (SEC). Investors can access this information directly from the SEC website through the EDGAR database. The three key documents every self-directed investor should be familiar with are the 10-K quarterly report; most recent annual report and recent 8-K filings of material events.
Quarterly earnings are initially disclosed in a press release and filed as a 10-K document afterwards. Companies will usually pair the earnings release with a conference call an hour afterwards or the next morning. The conference call can be very revealing, especially the question and answer session with analysts. Often times the company may disclose a bombshell item in the conference call including future earnings guidance estimates which may be increased or decrease from consensus analyst estimates, regulatory issues, impending lawsuits and major contract wins or losses, which can result in significant share price volatility
Understanding Industry Trends
Stocks are segmented by sector and industry. To ascertain the true performance of a stock, it should be evaluated amongst its competitors within the industry. When a particular sector or industry is very strong, it tends to lift most of the companies within. The leaders in the particular industry usually establish the industry trends. Therefore, it is prudent to stay abreast of the industry trends for your particular stocks. An effective way to pursue this is by identifying the top three leaders in the sector or industry. The performance of the industry leaders sets the sentiment with the group. For example, when a leading stock in the heavy machinery industry slashes its earnings guidance, it generates a top-down ripple effect for the peer stocks as well. It is guilt by association until proven otherwise as share prices sell-off.
Accounting for Company Growth
There are two types of accounting that is used with earnings reports. The official numbers are reported under Generally Accepted Accounting Principles (GAAP), which take into account all expense items including non-cash compensation like restricted stock and options. Companies like to also provide non-GAAP numbers, which excludes non-cash items. The purpose is to allow shareholders to better gauge the growth of the core business without being sidetracked by factors that don’t affect cash flow. However, critics argue that non-GAAP accounting is deceptive. Any and all compensation must be accounted for especially when existing shareholders face further dilution in shareholder equity.
Using Financial Ratios
There are a number of widely used financial ratios that can be used to help investors gauge valuation and assess how a company stacks up against its peers. These ratios are standard on broker platforms as well as most popular search engines. Just as with technical analysis, financial analysis should be performed using multiple financial ratios to help paint a clearer picture of the operations.
Price-Earnings (P/E) is perhaps the most commonly used financial ratio. It measures the profitability of the company relative to the share price. All sectors have an average P/E, which can be found quickly by looking up the heaviest traded exchange-traded-funds (ETF) which track the specific index. This ratio can be used to compare a specific company with the industry, peers and or benchmark indices. For example, if the consumer discretionary sector has a P/E of 20 and your stock has a P/E of 55, it may be overvalued. Some sectors traditionally have higher P/Es than others, like technology compared to utilities. The S&P 500 has a historical P/E ratio of 21. Keep in mind that a company needs to generate profits in order to have a P/E. There are more ratios that can be used in the absence of profits.
Price-Sales (P/S) and Price-Book (P/B) are comparative valuation ratios that indicate if a stock is trading at a premium or discount compared to its peers and sector/industry. If a stock is trading at a very deep discount like .3 P/S compared to industry average of 2.5 P/S, then there could be an inherent structural problem with the business or could be overlooked by Wall Street and presents an undervalued investment situation and warrants further investigation.
Cash-Per-Share (CPS) and Book Value (BV) are two valuation ratios that can help determine if the stock has been overly punished by investors. When a company trades under the CPS or BV, it has virtually valued the business operations at zero presenting either a very undervalued situation or potential bankruptcy. The cash burn rate and debt should also be investigated. Biotech stocks are notorious for these situations. These ratios don’t apply well to financials like banks and insurance companies that tend to trade at or below CPS and BV, due to federal banking regulations and off balance sheet entities.
Keep in mind that every sector and industry has an average financial ratio, which can be used as a measuring stick. However, just because a stock has an aggressively high financial ratio doesn’t necessarily mean it is overpriced. Momentum stocks are notorious for exorbitant ratios.
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