How to do a fundamental analysis

Learn Fundamental Analysis - How professionals do a company valuation using stock metrics

Fundamental analysis is the observation of a company on the basis of its published company key figures.

There are two basic approaches to evaluating companies and their value or performance on the stock exchange. One of them is fundamental analysis. Here, figures from the annual reports / annual financial statements are used and interpreted. One would like to determine whether a share price is justified or whether it is to be viewed as overpriced / too low in relation to the company's key figures. On the basis of this, a well-founded decision to buy, flat or sell can be made.

The annual report: the most important basis of fundamental analysis

The company's quarterly, semi-annual or annual reports form the basis for the analysis. Two parts of the reports are particularly considered here: the balance sheet and the income statement (also P&L or P&L, income statement, profit and loss statement, earnings report, P / L statement, SoE). On the basis of the information contained in it, a lot of conclusions can be drawn about how the company is doing, how it could develop and what a reasonable price would be.

The balance

The balance sheet is a detailed list of all assets and liabilities. Here you can find the current values ​​as well as the values ​​from the previous period.

  • Value of the production goods
  • Value of the intangible assets (such as brand value)
  • Value of the business equipment (computer, equipment, but also real estate, land, etc.)
  • Amount of investments made
  • Cash holdings (or liquid equity)
  • Debt (or outside capital from loans, etc.)

A trained eye can use these key figures to determine how the company has developed. Has the value of a company increased? Has the debt increased? Has more been invested?

The income statement

In the income statement the most important details are too

  • Sales revenue
  • Production costs
  • Borrowing costs
  • Tax burden
  • Dividends
  • Profit
  • Capital return (also "margin")

specified. Here too, with a trained eye, developments over the past and penultimate year can be seen quickly.

The CEO's comment

The balance sheet and income statement consist of bare figures. You can already read a lot from this, but not infrequently it happens that only the management's comment brings the whole thing to life.

For example, it can be seen from the balance sheet that the debt item has skyrocketed (= loans were taken out), but it is usually not clear why this was done. There can be a wide variety of reasons why a loan has to be taken out: Is the company not doing well and does it need to secure liquid capital quickly? Or are major investments planned that will advance the company? This knowledge makes the difference between positive and negative evaluations in fundamental analysis.

The management must / should express an opinion on such events. Even if important or unpleasant points are not addressed in the comment (such as lost sales or goals not achieved), this is a (bad) sign for the investor. Because then he knows that the company's management is not 100% honest with its shareholders. So what else could the manager conceal?

Some reports have achieved cult status because of the comment section. Anyone who has ever dealt with Berkshire Hathaway and Warren Buffet knows pretty well what I'm talking about. Shareholders are eagerly awaiting the day of publication and soak up every word from the buffet like a sponge. They are making a pilgrimage to Omaha to hear their oracles speak!

The most important fundamental numbers

The picture of the company is made up of the figures from the two reports on the basis of fundamental analysis. If you want to know exactly what the whole numbers mean, you should educate yourself with the help of a corresponding book. This one is especially suitable for people who already have basic business administration knowledge. This book by Susan Levermann is simpler and also provides an interesting commercial approach. In the following I have compiled a selection of the most important fundamental key figures. In order to be able to evaluate international companies, the common terms used in English-speaking countries are important. That's why I wrote them in brackets:

Balance sheet: Shareholders Equity

Equity is the amount that actually belongs to the company, and thus theoretically owed to the shareholders if the company were to be split up. The partner, of course, wants to see this amount increase from year to year. The more it rises, the faster the company's “value” rises. The equity capital therefore has a particularly important role in fundamental analysis.

Balance sheet: debt capital (debt, lending)

If the company has borrowed or borrowed from it (or an external source of money with no right to profit sharing), the amount can be found in this item. Debts, provided they are taken on for investment reasons, are not to be regarded as bad. However, it should be noted that too much outside capital cannot be a good thing, as there is a very high level of dependency on external financiers.

But what is “too much” in the sense of fundamental analysis and what is “still okay”? Of course, that depends on the size of the company. Because a billion dollar company can have billions of dollars in debt without getting into trouble, while a small business would collapse under the burden of debt. Therefore, one tries to relate equity and debt capital (equity ratio, we will come to that later).

Balance sheet: assets, assets (total assets, fair value, book value)

A company's assets are its assets. These consist primarily of current assets (items for short-term use of less than a year, current assets) and fixed assets (items that are permanently available in business operations, non-current assets). As a rule, the more a company grows, the more these items also increase.

P&L: Revenues

Revenues are all the money that has been earned within a period. Without deduction of any costs. If sales increase, this is a good indication of a growing company.

P&L: gross profit (gross profit, gross profit)

Of course, there should also be some left over from sales! The gross income is easily determined by subtracting the cost of goods and materials from the sales revenue mentioned above. Depending on the industry, this can be very different! While food manufacturers and retailers (= supermarkets) make a low gross profit, companies from the service or technology sector can often make a lot of profit in terms of material input.

P&L: operating result (earnings before interest and taxes, earnings before interest & tax (EBIT))

While the gross profit only subtracts the cost of materials, the operating result indicates the total annual profit. This is not just material, but also personnel expenses, operating expenses and depreciation (from fixed assets, the non-current asset). Additions are also made to the write-ups of fixed assets, such as the increase in the value of real estate or land.

P&L: cash in circulation (cash flow, cash flow)

The question: "How much cash do I have in the bag at the end?" Is answered with the cash flow. This is the net inflow of liquid funds during a period. From Gross cash flow taxes and private withdrawals are deducted (Net cash flow). If you now subtract investments from the net cash flow, you have all freely available liquid funds, the free cash flow (free cash flow). Ultimately, dividends are paid out from this pot.

If there is a very large discrepancy between net cash flow and free cash flow, this indicates high investments. So if you look at the free cash flow and if it is negative, the net cash flow should always be used as an explanation. If it's not that intoxicating either, the investor has a problem ...

P&L: dividend

The dividend is that part of the free cash flow that a company gives to its shareholders. In Germany, it is usually paid once a year, directly after the Annual General Meeting. In the US, on the other hand, 4 dividend payments per year are common. Some companies even pay out monthly surpluses.

Whether a dividend is paid at all always depends on the company itself. Some are happy and generous to pay out part of their surplus, others keep everything in order to be prepared for future investments. Both approaches can make sense.

Calculation of other important cross-sectional indicators

On the basis of the above-mentioned key figures, other interesting figures can be calculated, which make it possible to compare with other companies.

Equity ratio

This shows the percentage of equity in the company's total capital (total assets). Here an attempt is made to determine whether the debt is still within limits or whether it is already toxic. "Toxic" is, however, a vague term and very branch-dependent, so it can only be used as an indicator. The rule of thumb is 2 to 1: If the equity ratio falls below approx. 33%, that is not good. The fundamental investor should ask himself the question: Do I want to own a company that in fact hardly owns itself, i.e. that is very dependent on external whims?

Gross Margin and Return on Capital (Net Margin, Return on Asset (RoA))

Return on total capital is a percentage and is calculated by dividing operating income after tax by sales. The gross margin, on the other hand, is calculated by dividing gross profit by sales. The “leaner” a company is, the more these two values ​​are alike.

The total return on capital is thus to be seen as the percentage return on the capital employed that was generated in a period.

The amount of the margin is an important figure for the profitability of a company and is very suitable for companies same To compare industries with each other. If there is a company whose profit margin is significantly higher than that of others, it obviously has an advantage. Above a certain value one speaks of a "moat". Obviously, this advantage is so great that it is not easy for competitors to keep up.

A healthy figure should always be compared with other companies in the same branch. While extremely competitive markets can have a RoA of only 3%, in other (oligopoly or monopoly) markets it can be 15% or more. For example, Apple had a total return on investment of 14.10% at the beginning of 2017 (down from a maximum of 30%, by the way), while the gross margin was around 38.50%.

Price-earnings ratio (P / E ratio, price-earnings ratio, P / E ratio)

In the price-earnings ratio, the current share price is compared with the operating profit (per share). There is a multiple of the profit. For example, if the price is 100 euros / share and the operating profit per share is 10 euros / share, the PER is 10 (= 100/10). If the profit is only 5 euros / share, the P / E ratio is 20 (= 100/5).

Obviously, the higher the P / E ratio, the lower the profit in relation to the share price. Even more: The P / E ratio shows almost directly how many years a company has to work before it has "recovered" the purchase price based on the current profit. The lower a P / E ratio, the faster the acquisition of the company has paid off for the investor.

But as with all other key figures: That alone has little informative value, because a lot of factors play a role in this value. One should ask: Why would an investor be willing to prefer a company that (with a P / E of 40) only generates 2.5% investor return instead of one that promises 10% profit every year based on the current share price? The longitudinal data of the fundamental analysis play a role here. More on that later.

Dividend earnings ratio

The dividend / earnings ratio is the proportion of dividends related to free cash flow. The value shows how much of the annual profit is distributed to the shareholder as a percentage.

A dividend investor asks himself whether the development of the dividend distribution from the past can also be maintained in the future (preferably more every year, of course). To do this, he can use the dividend / earnings ratio. If the dividend rises every year, but the share of profits stagnates, that's a good sign. Some companies pay out a fixed percentage of their free cash flow, while others try to pay higher dividends every year. Cost what it may! Sometimes it even happens that more dividends are paid than profit was made! Of course, this cannot be healthy in the long run.

Longitudinal data and their importance in fundamental analysis

Now you already have a good overview of the company's status. It becomes interesting if you not only look at the values ​​from this and last year, but also look back at the past. It is best to have data from at least the last 10 years.

Because every company can have good years and less good years. If a longitudinal section of the most important data is available, it is easy to see how continuously the whole thing is developing. Does the data fluctuate a lot or is it a continuous picture?

If sufficient longitudinal data is available, the investor can use them to calculate an annual percentage development. Developments that are as uniform as possible with high positive growth rates are advantageous. The investor must be particularly sensitive to the importance of the individual data. Some examples:

Development of equity

Equity is the current ownership of a company. That can be a lot or a little. But a single value doesn't tell a story. Only by looking at the past can one bring the numbers into relation. Has equity increased, stagnated, or even decreased? If a company doesn't grow, it has a problem. Nor is it understandable why an investor should get involved.

Development of the operating result

If the development of the historical operating result (compared to the direct competition) shows a high percentage increase, this means that the company has more money available each year than its competitors that can be invested in growth. In the sense of interest and compound interest, those who get the highest profit from their work have an extreme advantage in the long term!

And here the question about the sense of investing in stocks with a high P / E ratio is (partially) answered: If the operating profit grows very quickly, the investor TODAY has to cope with the fact that the P / E ratio is very high. For example, if the operating profit increases continuously by 20% every year, after 10 years this would amount to 620% of the current amount. At the purchase price today (100 euros / share, current PER of 40 = profit of 2.50 euros / share), the PER would be 6.45 (profit is 15.50 euros / share). If all factors are otherwise constant in the 10 years (the P / E ratio remains unchanged at 40 and supply and demand are roughly the same), the share price should therefore be 620 euros.

This explains why a lower P / E ratio is not synonymous with a cheap entry price: Investors have an expectation for the future. A lower P / E ratio could indicate that most people are expecting a company's growth to slow. So is the company's branch forward-looking, or rather backward?

Development of dividend payments

As a dividend investor, the most important point is the continuous development of dividends. If the distributions increase every year, this means an ever higher return on investment for the investor. You shouldn't underestimate that in the long run!

An (extreme) example: If you bought the shares of Drillisch Telekom at the beginning of 2009, you would not only have enjoyed a price rocket of around 5,500% (price increase from 1 euro to around 55 euros in 2017), but also every year on the dividend payment. This was increased from 0.30 euros / share (2008, in 2009 there was no dividend at all) to 1.80 euros / share in 2017. The shareholder currently receives an annual return of 180% on his invested capital as a dividend distribution!

The advantage of the continuous increase is easily forgotten if you just look at the actual data: Currently, the dividend yield for newcomers would be just 3.27%. Not bad in an interest-free market environment, but not particularly generous either. Some fundamentally exhibited investors use precisely this effect to generate good returns. There are several dividend strategies that I will discuss in later articles.

So what can you do with all the fundamentals?

Every investor follows his own strategy. And different metrics are used in each of these strategies.Sometimes the data contradict each other for different strategies. While a dividend investor swears, for example, that he doesn't care about the share price (the main thing is that the dividend is increased), others see it differently:

All the money the dividend cashier receives is not available to the company. This means that no more growth can be generated from this capital. This is not a problem, provided that the excess equity can only be used to generate a small return. The crux of the low return on investment mainly affects companies that (can) barely grow. Depending on whether you invest in growth-oriented or established companies, you have to adapt your strategy!

But only marginally. Basically, it is now up to the reader, i.e. you, what you want to do with it. In the following articles I will deal more closely with different approaches from fundamental analysis. Of course, I didn't come up with these myself, but are based on the knowledge and experience of many, in some cases VERY successful, investors and gurus who have already impressively proven that this type of investing works in the long term.


At first, fundamental analysis seems very complex and difficult to learn. But once you have familiarized yourself with the topic, you realize that the numbers and ideas behind the numbers have a very special appeal, provided that you, as a medium to long-term investor, pay less attention to the share price.