Below are the fundamental indicators to help deceiver a companies quality versus their price.
Net Income – The company’s net income is the earnings it reports quarterly. Sales minus expenses, interest, and taxes are how to calculate net income, and there is a lot of accounting going into this number.
Free Cashflow – Free cash flow is the cash company generates after accounting for cash outflows to support operations and maintain its capital assets. Free cash flow is a measure of profitability, and the free cash shows how much working capital is on the balance sheet and its changes. The free cash can show fundamental problems in the company before they show up on the net income statement as if it’s decreasing, it could indicate problems for the companies profits.
Shares Outstanding – Shares outstanding is how much stock is held by all shareholders. In essence, the shares equal 100% ownership of the company if added together. It shows how large the company is, and we use it to figure out how much earnings there are per share. The shares may change over time.
P/E – Price to earnings ratio. The stock price is divided by the company’s earnings—market value per share / Earring price per share. The typical Price per earnings is the TTM or the trailing 12 months earnings per share.
P/B – Price to book ratio. The stock price per share is divided by the equity per share of the company. The company’s underlying equity is the total assets minus total liabilities on the balance sheet. A book value less than one could mean the market has misunderstood or wrongly valued the assets, and it also could signal lousy management.
P/S – Price to sales ratio. Market value per share divided by sales pre-share. It doesn’t show if the company is profitable, but combined with earnings, you can see if there have a healthy revenue stream and is undervalued. Sales are challenging to manipulate, so this is an excellent ratio to consider. When you see an extremely high price per sale, the market expects incredible growth. Ten times price per earnings is an insane valuation. The company would have to pay you 100% of revenues for the next ten years, assuming limited growth. The underlying assumption is they pay no tax, no employees, no cost of sales, and without spending money on R&D, can maintain the sales number. It is incredibly speculative.
Current Ratio: The current ratio of a company shows the ability of the company to pay its short-term debt obligations. Current Ratio = Current Assets / Current Liabilities. It takes the assets versus the liabilities due within one year. It would help if you compared this within the companies industry; the ratio is less useful for comparison with multiple industries. The higher the ratio, the more easily a company can pay off its short-term debt obligations, meaning less risk for a near-term default. The company has more short-term liquidity.
Return on Equity: Return on Equity is a percentage of the companies return on its assets. Return on equity = net income / shareholders equity. It shows in a percentage how the company assets have been increasingly showing how profitable the company has been. One should compare ROE within an industry. The S&Ps average has been 14%, a good starting point.
Debt to Equity: The debt to equity ratio is about how many liabilities a company has versus the underlying assets. D/E = Total liabilities / Shareholder Equity. Debt to equity, similar to return on equity, is better compared within the industry. Across industries, it is less reliable. The higher number, the higher risk as the company has more leverage.
Free Cashflow / Net Income – This ratio explains the quality of the earnings. The more cash flow within a company, the more cash generated from business activities. Companies report on earnings calls on net income or earnings, which companies can manipulate easier with accounting. The closer to one, the better the ratio. When the ratio is less than 50%, it isn’t a good sign; it shows they create debt or use accounting to make their earnings. One should take the P/E with a grain of salt in this case.