How To Pick Stocks, Part 1. Fundamental Analysis

Fundamental analysis looks at the business, how well it’s doing and how much it’s earning. It answers the question 

WHAT to buy?

Technical analysis looks at charts and their behavior. It answers the question 

WHEN to buy?

If you have long-term intentions, you would mostly build your predictions on fundamentals.

If you have a short-term speculative view (less than 6 months), you would mostly look at charts, big news and disregard the general business.

Anyway, you will need to know both approaches for the wider picture. 

Fundamental analysis focuses on economical metrics such as revenue, earnings, debt, etc.  Various ratios of these numbers—multiplicators—show that a company has a strong profitable business, low debt, good prospects for growth and is undervalued by the market. Or the other way round—the company isn’t making money and is not worth investing in. Warren Buffet is the most famous advocate of fundamental analysis.

The truth is there is no magic formula for finding the perfect company. There are just too many factors affecting the growth of a business and it’s a challenge to keep them all in mind. But computers can do this and are so good at counting complex numbers. And that’s exactly what Gainy does. 

However, you can still take some simple steps to check a few metrics to increase your success rate.

Step 1. Check the EPS

EPS (Earnings Per Share) shows whether the company is making profits or losses.

To work out EPS, we need to divide the company’s earnings by the number of shares. As long as that number is greater than zero, we’re in business.

You can check a company’s EPS in Gainy by clicking “Market Data” and scrolling down. 

‍The higher, the better. But it needs to be higher than 0.

If you click EPS, you will see the dynamics of the metric. And it’s the most important piece of data. Logically, if a company’s earnings are growing year to year, the company is a promising investment. 

Furthermore, don’t discard the company straight away if you see a sudden loss. Think why it happened and what are the prospects of the business in general?

For example, at the beginning of the year, Disney's EPS was -2. It seems to be bad, but knowing about the closure of Disneyland, we can conclude that the company is receiving less profit. Will Disneyland open? Sure, and then the company’s growth will be restored.

Here is another example. Airbnb had an EPS of -10 in 2021. Can you guess the reason for this?
Of course, closed boarders and limitations on travelling all over the world because of the pandemic!

Task:
Find the EPS of Uber in Gainy and answer the following: Is Uber making money? Is it stable?

….

Did you find the answer? I hope you are confused about what conclusion to make about Uber so let me clear this up for you :)

The absence of profit in Uber doesn’t necessarily mean that it’s a bad company (remember Amazon with 9 years of losses).
The thing is there are 2 types of companies: growth and value companies. 

Value

• Already have stable earnings with little to no growth
• Growing steadily
• Usually pay dividends
• Will be the first ones to grow after the recession

Examples: Ford, Bank of America,  conservative industries like utilities, production

Growth

• Are expected to increase their profits in the future
• Have jumping growth
• Usually don’t pay dividends and reinvest in the business to drive the growth in earnings
• Will be the first to fall when the economy slows down

Examples: Google, Facebook, mostly tech companies and startups

Based on this description we can conclude that Uber might be a good investment because it’s a growth company and the stock price might jump dramatically if they manage to overcome losses. 

How to understand that a company has potential? Learn more about the business and their plans in the section right below the chart. 

Look out for positive news and strategic announcements. 

Step 2.1. Check PE (and it’s not Physical Education)

The P / E (Price / Earnings or Capitalization / Profit ratio) shows how many years the company will pay off with current profit or how much the investor pays for every dollar of the company's profit.

You can find this indicator if you scroll down the company’s page or if you click View more.

‍The lower the better. 

1 means that a company has a fair value. 26 like in the picture means that it would take 26 years with current profit to justify the current market value.

For example: a company is worth 1 billion on the market (it has 1 million shares that are worth $100). Its profit is $100 million. To recoup the market value of 1 billion, the company needs to make a profit in 10 years. Is it possible? Totally, and within our lifetime. Moreover, if the company doubles its profits, then the P / E will already be 5, which means that the company will pay for itself in 5 years.

If the P / E is very high, it means that the company is overvalued. Check Tesla below:

It would take it 397 years to justify its price!

Demand drives the prices and Tesla seems to be in demand because many people expect the company to start generating profits and paying for itself, but that may not happen. For example, it took Amazon 10 years to start making money, Tesla started to generate profits only this year. Last year P/E was more than 1000 years! 

If P/E is low it means that the company is undervalued and has the potential to grow up to the P/E of its competitors. 

Companies with low P/E are more attractive. 

NB! Sometimes the company isn’t generating earnings due to a crisis, it’s a new company or it’s specific to an industry. Think about biotechnological startups - many of them spend millions for R&D for years until they discover a cure, formula or get a patent. In this case, P/E will be unavailable and instead you can use EV/S (Enterprise Value / Sales).

Step 2.2. Compare P/E with the sector average

Overestimation/undervaluation of an individual company can be understood by comparing it with the sector average. The average is shown in the table below. For companies in the real estate, technology and healthcare sectors, P/E is very high. For energy and finances, vice versa.

So if you find a company with a P/E lower than the industry average, it has the potential to grow at least to the average value. 

Task: Find Intel’s P/E using Gainy. Is it lower or higher than the average for the Technology sector?

Step 2.3. Compare companies within one sector

Compare these two stocks:

Which one is overvalued? Which one is more attractive to invest in?

Obviously, the first. It costs less (P/E 11 years vs 37) and earns more (EPS $4.5 vs $2.84), so the first company is more attractive. I won’t tell you the company, but if you’ve done your homework, you will find it ;)

These are just two of the available metrics. There are over 30 of them starting from the straightforward “Revenue” to more complicated things like EV/EBITDA. 

Unless you want to become a professional stock trader, there is no need to learn them all. Our recommendations at Gainy take into account hundreds of metrics to offer you the most reliable and suitable TTFs. This will save you time, nerves and money.