LESSON - FUNDAMENTAL ANALYSIS - RULE OF THUMBS -

I mainly use FINVIZ.com to find fundamentals and SimplyWallSt is also a good source to find past and future revenue and margins

It can also tell you some insider buying and selling and who are the majority shareholders.

Fintel.com is also very useful.

Company reports are also a great source, each company will have an Investor Relations section on their website with all of they publicly available reports, it is worthwhile familiarising yourself with these, it’s a great source to be able to identify trends such as cost and margin changes.

So here are some useful rules of thumb when investing using fundamental analysis:

1. Price-to-Earnings (P/E) Ratio

• Rule of Thumb: A P/E ratio between 15 and 20 is generally considered reasonable. A low P/E ratio can indicate that a stock is undervalued, while a high P/E can suggest overvaluation.

• Tip: Compare the P/E ratio to peers and the industry average to get better insights.

2. Debt-to-Equity Ratio

• Rule of Thumb: A Debt-to-Equity ratio of less than 1 indicates that a company is using less debt relative to its equity, which is generally safer. For capital-intensive industries (e.g., utilities), higher ratios might be acceptable.

• Tip: Check the company’s cash flow to ensure they can service their debt.

3. Current Ratio (Liquidity Measure)

• Rule of Thumb: A Current Ratio of 2:1 is considered healthy. It shows that the company has twice the amount of current assets to cover current liabilities.

• Tip: Too high of a ratio might suggest the company isn’t using its assets efficiently.

4. Revenue Growth

• Rule of Thumb: Look for consistent revenue growth over 5-10 years. This indicates a stable business.

• Tip: Sudden jumps or declines in revenue may suggest market disruption or inconsistent performance.

5. Earnings Per Share (EPS) Growth

• Rule of Thumb: Look for a company with steady or rising EPS over time. Growing EPS indicates increasing profitability.

• Tip: EPS should grow in tandem with revenue to ensure growth is not coming from cost-cutting or accounting tricks alone.

6. Return on Equity (ROE)

• Rule of Thumb: A ROE of 15% or higher is considered good, as it indicates how efficiently management is using equity capital.

• Tip: Compare ROE to peers in the same industry to understand if the company’s management is performing well.

7. Dividend Payout Ratio

• Rule of Thumb: A payout ratio under 60% is generally considered sustainable. This means the company is paying less than 60% of its earnings as dividends, leaving room for reinvestment.

• Tip: A very high payout ratio may suggest that the company is using too much of its profits for dividends, leaving little room for growth.

8. Price-to-Book (P/B) Ratio

• Rule of Thumb: A P/B ratio below 1 might suggest that a stock is undervalued, as it indicates the company’s market value is less than its book value.

• Tip: For asset-heavy industries, the P/B ratio can be a better valuation measure than P/E.

9. Free Cash Flow (FCF)

• Rule of Thumb: Always ensure that a company has positive and growing free cash flow. FCF is essential for dividend payments, debt repayment, and reinvestment in the business.

• Tip: Free cash flow per share is a more reliable indicator than earnings in some cases since earnings can be manipulated with accounting methods.

10. Growth vs. Value Stocks

• Rule of Thumb: Growth stocks typically have high P/E ratios and focus on capital appreciation, while value stocks have lower P/E ratios and are seen as undervalued in relation to their earnings.

• Tip: Value stocks can offer more safety in down markets, while growth stocks are riskier but may offer higher rewards during strong markets.

11. Diversification

• Rule of Thumb: Don’t put more than 5% of your portfolio into a single stock. Diversifying helps reduce unsystematic risk (risk tied to a specific company or industry).

• Tip: Spread investments across different industries and asset types (stocks, bonds, real estate) to hedge against volatility.

12. Industry Comparison

• Rule of Thumb: Always compare key metrics within the same industry. A P/E or ROE might look attractive in isolation, but it’s crucial to evaluate it against competitors.

• Tip: Each industry has its norms for key metrics, so context is essential.

Final Thought:

Fundamental analysis is about understanding a company’s financial health and long-term prospects. These rules of thumb serve as starting points, but deeper analysis is always necessary to make informed decisions. Avoid relying on any one metric—take a holistic view of a company’s performance.

By following these guidelines, you can identify potentially undervalued stocks with strong growth potential while avoiding common pitfalls.