Earnings Per Share, Dividend Yield and Price to Earnings Ratio are the best fundamental indicators for stocks. Specially, fundamental indicators are used by investors. If you are an investor, you must follow these 3 best fundamental indicators in order to pick the best stock.
Table of contents
To clear understanding for these three fundamental indicators, I have selected an example. Let’s clear the 3 best fundamental indicators for R.M Company- an imaginary company.
Example of fundamental indicators
R.M company has 200000 shares outstanding for the financial year end in 2021. It’s net profit for the year end is 1200000 dollars. Market value of each share is at $ 200. Face value of R.M company’s share is at $50.
It also has 50000 preferred shares in the stock market. Preferred shares dividend is 10% on per value of shares. At the end of the year, company has decided to give 20% cash dividend for general investors.
1. What is the preferred shares dividend?
Preferred Stock Dividend =Number of Preferred Stock * Rate of preferred stock.
For R.M Company, preferred stock dividend is (50000*0.10) = $ 5000. Earnings for preferred share holders is at fixed percentage. It is one type of debt in nature. A loan provider gets fixed interest on loan.
On the other hand, a preferred stock holder gets fixed return on investment. On the contrary, common stock holders get profit after preferred stock holders’ dividend.
Actually, common stock holders are the owner of the company. If you have little ideas about stock market, you need to acquire stock market basic knowledge.
2. What is EPS
The number one fundamental indicator is Earnings Per Share (EPS) EPS=(Net Income – Preferred Dividends)/Number of shares outstanding for the year.
EPS for R.M company is (1200000-5000)/200000= $5.98. Does R.M company good for long-term investment? To get the answer, you need to proceed.
3. What is dividend yield?
The second fundamental indicator is Dividend Yield. Dividend Yield =Annual Dividends Paid Per Share/Market Price Per share.
R.M company’s Dividend is $10 (50*0.2) at 20%. Dividend Yield is ($10/$200)*100= 5%. Actual return on R.M company is 5%. That’s not bad. At least, dividend yield should 5% to 10 % for long term investment.
4. What is P/E ratio?
The third fundamental indicator is Price to Earnings Ratio. P/E ratio =Market Price /EPS.
R.M company’s P/E is ($200/$5.98) =33.44.An investor can expect maximum 1 dollar if he invests 33.44 dollars. But, how much investors will get from dividend that depends on how much a company shares its earnings to shareholders.
For long term investment, P/E ratio is utmost important issue. Investor should invest on those companies, which have P/E ratio is small.
If you can get 1 dollar return on 33.34 dollars investment, why don’t you invest on R.M company? R.M company’s P/E is comparatively small.
Why does Earnings Per Share (EPS) matter?
Day trader or swing trader does not think about EPS or some other fundamental indicators. Traders buy and sell styles are different from investors. As traders focus only realized gain, they have no interest on EPS.
But for long-term investment, EPS is a big issue. If a company earns more, it will give more dividend.
At the end of the year, long term investors want attractive dividend and capital gain. So, fundamental indicators are most important issues for investors. As a long term investor, you must pick large dividend paying stocks.
How can analysis EPS as fundamental indicator?
You can compare EPS in sector basis. Choose highly dividend paying sector and pick the best company from this sector. Less volatile sector is suitable for long-term investing. You should learn how to buy stock for long term investment.
Why does dividend yield matter for long term investment ?
Dividend is calculated on face value of a stock. But, you cannot buy stock on face value in secondary market unless you get stock from IPO.
Hence, dividend yield is the best indicator for you. In the above example, you have learnt what is dividend yield. You should choose high dividend yield stock.
Why does Price to Earning Ratio (P/E) matter as fundamental indicator?
P/E ratio high means you paid more to get less. If your target is 10% return, you should buy a stock at 100 dollars. You must buy at this P/E ratio = (100/10)=10x. Try to buy a good fundamental stock as cheap rate as possible. But, if you are a trader, you can follow your selling styles to gain in short term.
In Short
You can get all the information in annual report to analyze these three important fundamental indicators. All the calculations are done by the company. You just need to find out the best company from a number of companies. You also can get all the information in stock exchange website.
Never take any decision without achieving sufficient knowledge about stock market. You can read how to invest in stock market.
Founder of The Financial Ask
