An Introduction to International Capital Markets: Products, Strategies, Participants, Second Edition

9

Equity Fundamental Analysis

9.1 CHAPTER OVERVIEW

When assessing the current condition and future prospects of a company, investors, and analysts often tend to start by assessing the information contained in the financial statements. This is known as fundamental analysis. Although the analysis is typically based on current and historical data, this is normally used as a starting-off point to make forecasts about the future. This chapter looks at the key items in a company’s balance sheet and income statement (profit and loss account). It sets out the balance sheet equation and explains the concept of accruals accounting. It explores what is meant by shareholders’ equity as it appears in a balance sheet, and compares it with market capitalization. Equity analysts use a range of financial ratios to extract information about a company from its financial statements. The chapter defines the main ratios and illustrates how they are used. In attempting to value shares and make investment recommendations, equity analysts use a range of valuation multiples. This chapter looks at the most widely used, the price/earnings ratio, and explores the applications and limitations of this measure. Finally, it considers some alternative valuation tools including the price/book ratio and a measure that is now widely used by professional equity analysts, the firm value/EBITDA multiple. All of these multiples are based on accounting numbers, although EBITDA is the closest to cash flow. The following ...