Stock Fundamentals

"Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down" - Warren Buffett

"Price is what you pay. Value is what you get." - Warren Buffett

It is impossible to have a discussion about stock fundamentals and value investing without mentioning the great Warren Buffett. The 'Oracle of Omaha' built his business empire from nothing into one of the biggest titans in the financial world.

Part of Berkshire Hathaway's success has been the old man's dedication to value investing. Value investing - first created by Benjamin Graham, one of Warren Buffett's mentors - is a strategy for investing predicated on finding undervalued stocks with good financials and business model, and snagging them while you can. Value investors don't care about the current price of the stock, they care about the value the asset creates.

Price to Earnings Ratio (P/E)

If you've been investing for a while, it's almost certain that you've heard about 'P/E ratios' (Price per share divided by Earnings per share). The P/E ratio of an equity is one of the most important values that value investors consider when purchasing stocks and evaluating an asset. A P/E ratio that is too high potentially means the asset is extremely overvalued. A P/E ratio that is low, or non-existent denotes a company that either has no earnings, or is losing money, and is also a bad buy.

A good P/E ratio should be around 15, though a ratio from 10-25 isn't horrible. It's considered alright to invest in a stock with a reasonably high P/E ratio if you believe that the company will grow to accommodate it in the future.

Price to Book Ratio (P/B)

The slightly more complicated P/B ratio, nevertheless just as important, is calculated by taking the price per share divided by the book value of the company. Book value is simply the total amount of assets the company owns minus debt and liabilities.

Like P/E ratios, a P/B ratio is used to potentially identify undervalued stocks. A P/B ratio under 1 is considered optimal, but anything under 3 is great as well.

Debt to Equity Ratio (D/E)

The Debt to Equity Ratio is an important metric that value investors use to identify how potentially risky a stock could be. Many companies take on debt to fund purchases of new assets, and this could be risky if the company doesn't generate enough revenue to pay off the debt later.

Debt to Equity is calculated by taking the amount of debt a company has and dividing it by the total amount of equity.

A "good" Debt to Equity ratio is hard to calculate, and varies depending on the industry. A bank is obviously more likely to take on more debt and liabilities than a supermarket chain. However most investors consider a D/E ratio under 1 to be a safe purchase, though anything under 2 isn't particularly risky either. A negative D/E ratio signals a company that has more debt than assets and is likely to go bankrupt.

Free Cash Flow (FCF)

Free Cash Flow is a metric many investors use to identify companies that are in good health. Free Cash Flow is calculated by seeing the amount of cash that a company has left over after paying all operating expenses. It goes without saying that a large amount of Free Cash Flow is typically considered a good sign on Wall Street.

Revenue Growth

Revenue growth is obviously the percentage increase in revenue that a company experienced for the business year. It is the simplest metric to understand, but arguably one of the most important, as growing revenue every year is a sign of an increasingly more valuable company.

Conclusions

None of these fundamentals are guarantees that a stock will increase tremendously in value, however, they give you a great starting point on your search. Always do your own research beyond these metrics and use your own judgement to find the stocks that are best for you.