What is Micro Fundamental Analysis?

Micro Fundamental Analysis is analysis of the characteristics that directly influence a company internally and externally.

External Factors to be Considered

• Industry trends - consider where the industry is in its life cycle (i.e. new , high growth, mature, in decline)
• Long-term industry growth rates - (i.e telco -3-4% vs industrials 8-10%)
• Company market share within industry - (i.e. 5% and room to grow or 70% and at maximum capacity)
• Regulation within the industry - high & restrictive regulation or low and pro business regulation, also consider taxes

Internal  Factors to be Considered

Financial ratios used to measure internal performance are listed below.

EPS & EPS Growth

Earnings Per Share (EPS) is a measure of a company's profits per share. EPS Growth measures the increase in profits per share from one period to another. EPS growth is a better measure of increased profitability than Net Profit Growth, because it considers dilutionary impacts a company might sustain while trying to grow the business.

For example, if a company earns $100m per annum and they have 100m shares on issue (i.e. $1.00 EPS), and they acquire another business that earns $100m per annum, but to pay for that business they issue another 100m shares, then NPAT (DEFINE NPAT.......) will increase from $100m to $200m (100% increase), but because the number of shares has also doubled, EPS will stay flat at $1.00 per share ($200m profit / 200m shares).

Investors should look for high EPS growth rates. The higher the EPS growth the faster the company is potentially growing the amount each share is earning each year.

P/E Ratio

The price to earnings ratio (P/E Ratio) is the most commonly referenced measure of financial performance. In simple terms, it is the price of the share, divided by the earnings per share. The P/E Ratio aims to show the underlying value of a company based on its earnings.

A higher P/E means an investor is paying more for each unit of net income, so the stock is more expensive compared to one with a lower P/E. Likewise a lower P/E means you are paying less for each unit of net income. Normally, stocks with high earnings growth are traded at a higher P/E.

It is usually not enough just to look at the P/E of one company. It is important to look at a company’s P/E compared to the industry it is in, the sector it is in, as well as the overall market. This will provide you with an idea of how the company you’re interested in compares to other companies within the sector. Also, during a bull market, P/E’s will rise due to investor sentiment. The same company in a bull market, will trade at a higher P/E than it would during a bear market, simply due to market sentiment. Always use the P/E of next years earnings as the previous years P/E can be deceptive and not a true reflection of the value of the business.

Dividend Yield

It is a ratio that will tell you how much a company pays out each year relative to its share price. It is calculated by dividing the annual dividend by the current share price. Historically, investors prefer stocks with higher dividend yields; however this ratio must also be used in conjunction with other assessment tools. A stock may have a high dividend yield, but its share price could be dropping while the dividend is staying the same, hence the high yield, but the company may not be able to afford to pay a dividend in the future. In general, older, well-established companies tend to payout a higher percentage than do younger companies. For a value investor, who is looking for dividend income, the dividend yield is a useful measurement.

Investors need to consider - is the dividend able to be maintained? What is the dividend growth going forward? Does the dividend have imputation (tax) credits? Can I get a better dividend yield elsewhere?

ROE Return of Equity

Return on Equity measures the amount of net income returned as a percentage of shareholders equity, or simply, ROE shows how well a company uses investment funds to generate earnings growth. To arrive at the figure you divide shareholders equity into net income. A higher ROE indicates that shareholders are receiving a greater percentage return for the money they are investing.

As with most financial ratios ROE is best used to compare companies within the same industry. It is important to note that not all high ROE make good investments. Some industries will have a high ROE because they require no assets whereas other companies such as oil refiners require a lot of capital therefore may have a lower ROE.

Gearing

Gearing is a measure of a companies financial leverage. Gearing levels can be calculated a number of ways, but the best method is to divide net debt (debt less cash) by shareholders equity.

Acceptable gearing levels vary depending on the type of company. Generally defensive companies can maintain higher levels of gearing, while more cyclical companies can only maintain a much lower level of gearing. Too high gearing is often the cause of companies becoming unstuck, so pay close attention to acompanies gearing rate and whether they can afford to repay their debt in a worst-case scenario.

Always consider trends in the above ratios.