Investopedia youtube channel does a great job explaining fundamental analysis, or what I like to call homework; and just like school, you will not make pass/make money, if you do not do your work. So, I believe this is the most important part of your investing. Study Hard and reap the rewards.
The price of stocks is just like shopping. Jim Cramer gives a perfect example, “If you go to Macy’s and there are two cable-knit sweaters, one by Polo made by cashmere and one by Macy’s house brand made of polyester and cotton, both selling for $100, you would know that something is wrong with the price of the two items. The Polo cashmere should be $400. The poly-cotton should be $49.
However, it is a lot harder to determine bargains and rip offs when it comes to prices of stocks is because those prices are not an actual reflection of the value of the company. However, the value or price of the stock can be defined with a basic ratio.
This is best understood with an example. Now, lets say that Nike recently traded at 100.00/share, and Adidas traded at 50.00/share. Now which stock is cheaper? At first glance you would say that Adidas is by $50.00. But they could be in actually the same price. WHAT MATTERS IS THE PRICE-PER-SHARE and not the price of the share.
To find the price per share you must first take the number that is found next to the stock symbol, (in the newspaper, websites, etc.) and divide that by the earnings the company had in the previous year. This will tell you how much money on a per share, Nike or Adidas made.
So, last price paid by EPS–Income statements also report earnings per share (or “EPS”). This calculation tells you how much money shareholders would receive if the company decided to distribute all of the net earnings for the period. (Companies almost never distribute all of their earnings. Usually they reinvest them in the business.). Therefore, if we were looking at Nike versus Adidas, and Nike sold at 100 and had a 5 EPS, therefore, they would have a multiple of 20. While Adidas sold at 50 and had an EPS of 2 they would have a multiple of 25. You are paying 25 times the Maytag’s previous earnings per share for each share that you buy. The real price.
The equation is basically E x M = P (remeber this equation).
Ultimately, if we have the price we have the future earning estimates we can measure whether we are paying too much M or too little M for the stock right now versus the competition. For our example, Adidas is more expensive than Nike. This gives you an idea of how much a stock is actually worth.