Fundamental Analysis of a Stock

1. Fundamental Analysis
• What is Business?
• What is Market Cap?
• What is Revenue?
• What is Income?
• What is operating expenses?
• What is EPS?
• What is PE Ratio?
• What is stock buy back?
• What to look for in the Earnings Report?
• What is short float?
• What is Debt to Equity Ratio?

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What is Business?

A business is an organized effort to provide goods or services to people in exchange for money, with the goal of making a profit.

It is how people solve problems and needs in society, turning ideas into products or services that others are willing to pay for. Businesses can be as small as a single person selling handmade crafts, or as large as multinational corporations producing technology or managing services worldwide.

At its core, a business:

• Identifies a need or problem people have.
• Creates a solution (product or service).
• Exchanges that solution for money or value.
• Manages its resources to make a profit and sustain itself.

Understanding how businesses operate is key to understanding how the stock market and the economy function since the performance of businesses drives growth, jobs, and wealth in the world.

What is Market Cap?

Market Cap (short for Market Capitalization) is the total value of a company’s outstanding shares in the stock market.

It is calculated as:

Market Cap = Stock Price × Total Number of Shares 

Example:
If a company has:

• 10 million shares outstanding
• Each share is trading at $50

Then:

Market Cap=10,000,000×50=$500,000,000

So, the company’s market cap is $500 million.

Why it matters:

• Market cap helps investors quickly understand the size of a company.
• It is often used to categorize companies:
• Large-cap: Stable, mature companies (e.g., Apple, Microsoft).
• Mid-cap: Growth companies with higher potential and some stability.
• Small-cap: Smaller, often riskier, but higher potential growth companies.

In simple terms:
Market Cap tells you “how big” a company is in the eyes of the stock market.

What is Revenue?

Revenue is the total amount of money a business earns from selling its products or services before any expenses are taken out.

It is often called:

• “Top Line” (because it’s at the top of the income statement).
• Sales or Gross Sales.

Example:

If a bakery sells:

• 1,000 loaves of bread in a month
• At $5 per loaf

Then:

Revenue=1,000×5=$5,000

So, the bakery’s revenue for the month is $5,000.

Why it matters:

Revenue shows how much money is coming into the business from its core activities.
It helps investors and business owners understand:
✅ Demand for the company’s products/services
✅ Growth trends over time

Note: Revenue does not show profit. Expenses like rent, salaries, and materials are subtracted later to find profit.

In simple terms:
Revenue = Total money a business makes from sales before subtracting costs.

What is Income?

Income is the money a business keeps after paying all its expenses.

It shows how much profit the business actually made from its operations.

In accounting, “Income” often means:

• Net Income (or “Net Profit” or “Bottom Line”)
• It is found at the bottom of the income statement after subtracting:
• Costs to make and sell products (COGS)
• Salaries
• Rent and utilities
• Interest on debt
• Taxes

Example:

If a bakery has:

• Revenue: $5,000 (from bread sales)
• Expenses: $4,000 (ingredients, rent, salaries, etc.)

Then:

Income=$5,000−$4,000=$1,000

So, the bakery’s income (net profit) for the month is $1,000.

Why it matters:

✅ Shows how efficiently a business turns sales into profit
✅ Helps investors and owners judge if the business is healthy
✅ Used to calculate Earnings Per Share (EPS), which impacts stock prices

In simple terms:
Income = Profit a business keeps after paying all costs.

What are Operating Expenses?

Operating Expenses (OPEX) are the day-to-day costs a business pays to run its regular operations.

These are expenses not directly tied to making the product but necessary to keep the business running.

Examples of Operating Expenses:

• Rent for office or factory space
• Utility bills (electricity, water, internet)
• Salaries of employees (not directly making products)
• Marketing and advertising costs
• Office supplies
• Insurance
• Software subscriptions

What is not OPEX?
❌ The cost of raw materials to make products (this is COGS – Cost of Goods Sold)
❌ Buying equipment or buildings (these are capital expenses)
❌ Interest on loans or taxes

Example:

If a bakery:

• Pays $1,000 for rent
• $300 for utilities
• $700 for staff salaries (cleaning, cashier)

Then:

Operating Expenses=$1,000+$300+$700=$2,000

These are necessary to keep the bakery running, even if it sells fewer loaves in a month.

Why it matters:

✅ Shows how much it costs to run the business daily
✅ Lower OPEX (while maintaining growth) often means higher profits
✅ Helps track efficiency and manage budgets

In simple terms:
Operating Expenses = Daily running costs of a business that are not directly tied to making products.

What is EPS?

EPS stands for Earnings Per Share.

It shows how much profit a company makes for each share of its stock.

How is EPS calculated?

EPS=Total Number of Outstanding SharesNet Income−Dividends on Preferred Shares

Simple version:
EPS = Profit per share

Example:

If a company has:

• Net income: $1,000,000
• 500,000 shares outstanding

Then:

EPS=500,0001,000,000 =2

So, EPS = $2 per share.

Why EPS matters:

✅ Helps investors see how profitable a company is on a per-share basis
✅ Used to compare companies of different sizes
✅ Higher or growing EPS often indicates a healthy, growing business
✅ Used in calculating P/E Ratio (Price/Earnings Ratio), which helps judge if a stock is expensive or cheap

In simple terms:
EPS = The profit a company makes for each share you own.

What is P/E Ratio?

P/E Ratio stands for Price-to-Earnings Ratio.

It shows how much investors are willing to pay for each $1 of a company’s earnings.

How is P/E Ratio calculated?

P/E Ratio=Earnings per Share (EPS)Price per Share

Example:

If a company:

• Stock price = $50
• EPS = $5

Then:

P/E=550 =10

This means investors are paying $10 for every $1 of the company’s earnings.

Why P/E Ratio matters:

✅ Helps investors know if a stock is expensive or cheap compared to its earnings
✅ Useful for comparing companies within the same industry
✅ A high P/E may indicate:

• Investors expect high future growth
• Or, the stock may be overpriced
  ✅ A low P/E may indicate:
• The stock is undervalued
• Or, the company may have low growth prospects

In simple terms:
P/E Ratio = How much you pay for $1 of a company’s profit.

What is Dividend?

A dividend is a portion of a company’s profits paid to its shareholders, typically in cash.

It is one way for companies to share their profits with people who own their stock.

How does it work?

• When a company makes a profit, it can:
• Reinvest it back into the business for growth, or
• Distribute part of it to shareholders as dividends.
• Dividends are usually paid quarterly (every 3 months) but can also be paid monthly or annually.

Example:

If a company declares:

• A dividend of $0.50 per share
• You own 100 shares

You will receive:

0.50×100=50

So, you get $50 in dividends.

Why dividends matter:

✅ Provide regular income while holding stocks
✅ Show that a company is profitable and financially stable
✅ Reinvesting dividends can accelerate long-term wealth growth (Dividend Reinvestment Plan – DRIP)

Key terms related to dividends:

• Dividend Yield: Shows how much you earn in dividends relative to the stock price. For example, if a $100 stock pays a $5 annual dividend, the yield is 5%.
• Ex-Dividend Date: The date you must own the stock to receive the next dividend.

In simple terms:
Dividend = Profit shared with you by the company for owning its stock.

What is Free Cash Flow?

Free Cash Flow (FCF) is the cash a company has left over after paying for its operating expenses and necessary capital expenses (like equipment or buildings).

It shows how much cash a business can use to pay dividends, reduce debt, or reinvest for growth.

How is Free Cash Flow calculated?

Free Cash Flow = Operating Cash Flow − Capital Expenditures

Example:

If a company has:

• Operating Cash Flow: $1,000,000
• Capital Expenditures (equipment, maintenance, etc.): $300,000

Then:

FCF=1,000,000−300,000=700,000

So, the Free Cash Flow is $700,000.

Why Free Cash Flow matters:

✅ Shows how much real cash a business generates, not just accounting profits
✅ Helps investors see if the company can:

• Pay dividends
• Buy back shares
• Pay down debt
• Invest in new opportunities
  ✅ Companies with consistent and growing FCF are often financially healthy

Free Cash Flow vs. Profit:

• Profit (Net Income) includes non-cash items like depreciation.
• FCF shows actual cash available after necessary spending.

In simple terms:
Free Cash Flow = Real cash left over after a business pays its bills and maintains its operations.

What is Debt-to-Equity Ratio?

The Debt-to-Equity Ratio (D/E) measures how much a company borrows (debt) compared to the money invested by its shareholders (equity).

It shows the company’s financial leverage — how much it relies on debt versus its own funds to run the business.

How is Debt-to-Equity Ratio calculated?

Debt-to-Equity Ratio=Total Shareholders’ EquityTotal Debt

• Total Debt includes loans, bonds, and other borrowings.
• Shareholders’ Equity is the money invested by shareholders plus retained earnings.

Example:

If a company has:

• Total Debt = $2,000,000
• Shareholders’ Equity = $4,000,000

Then:

D/E=4,000,0002,000,000 =0.5

This means the company has 50 cents of debt for every $1 of equity.

Why Debt-to-Equity Ratio matters:

✅ Shows how risky a company’s financing is — higher debt means higher risk
✅ Helps investors understand if a company can meet its debt obligations
✅ Different industries have different normal ranges for D/E — some industries like utilities have higher debt levels

In simple terms:
Debt-to-Equity Ratio = How much a company owes compared to what shareholders have invested.

What is Return on Equity (ROE)?

Return on Equity (ROE) measures how effectively a company uses shareholders’ money (equity) to generate profit.

It tells you how much profit a company makes for every dollar invested by its shareholders.

How is ROE calculated?

ROE=Shareholders’ EquityNet Income ×100%

Example:

If a company has:

• Net Income = $500,000
• Shareholders’ Equity = $2,500,000

Then:

ROE=2,500,000500,000 ×100%=20%

This means the company generated a 20% return on shareholders’ invested money.

Why ROE matters:

✅ Shows how efficiently a company uses equity to make profits
✅ Helps compare profitability between companies regardless of size
✅ A higher ROE often indicates better management and business performance
✅ But extremely high ROE can sometimes signal higher risk or excessive debt

In simple terms:
ROE = How well a company turns shareholders’ money into profit.

What is a Stock Buyback?

A stock buyback (or share repurchase) happens when a company buys back its own shares from the stock market.

This reduces the number of shares available to the public.

Why do companies do buybacks?

• To return cash to shareholders without paying dividends
• To increase earnings per share (EPS) by reducing the total shares
• To signal confidence that the company believes its stock is undervalued
• To improve financial ratios and stock price performance

Example:

If a company has:

• 1,000,000 shares outstanding
• Then buys back 100,000 shares

Now, only 900,000 shares remain publicly traded, increasing the value of each remaining share.

Why it matters to investors:

✅ Can lead to a higher stock price
✅ Makes each share represent a bigger ownership slice of the company
✅ Shows the company has enough cash to invest in itself

In simple terms:
Stock Buyback = When a company buys its own shares to give more value to the remaining shareholders.

What is Short Float?

Short Float is the percentage of a company’s available shares (the float) that investors have borrowed and sold short.

Breaking it down:

• Float: Shares available for trading by the public (excluding insider holdings).
• Short selling: When investors borrow shares to sell them now, hoping to buy them back later at a lower price to make a profit.

How is Short Float calculated?

Short Float=Total FloatNumber of Shares Sold Short ×100%

Example:

If a company has:

• 10 million shares in the float
• 1 million shares have been sold short

Then:

Short Float=10,000,0001,000,000 ×100%=10%

Why Short Float matters:

✅ A high short float means many investors expect the stock price to fall (bearish sentiment).
✅ Can lead to a “short squeeze” if the stock price rises suddenly, forcing short sellers to buy back shares quickly, pushing the price up even more.
✅ Helps gauge market sentiment and potential volatility.

In simple terms:
Short Float = The percent of a company’s tradable shares that investors are betting will go down.