Understanding Stock Fundamentals

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What You’ll Learn

• What fundamental analysis is and why it matters
• Key financial metrics (P/E ratio, EPS, revenue, profit margin)
• How to read a company’s financial statements
• Red flags that signal avoid this stock
• Green flags that signal strong company
• How to use Ape AI to analyze any stock
• Step-by-step research process for beginners

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Why This Matters

• 📊 You want to pick individual stocks (not just index funds)
• 🤔 You hear terms like “P/E ratio” and don’t understand them
• 🎯 You want to invest based on research, not guessing
• 😰 You’re afraid of buying a bad company
• 💡 You want to understand what you own

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What is Fundamental Analysis?

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The Simple Definition

• Guessing based on stock price movement
• Buying because everyone else is
• Following hot tips

• Analyze the business (what do they sell? Is it growing?)
• Review financial statements (are they profitable? Debt levels?)
• Compare to competitors
• Decide if current price is fair, cheap, or expensive

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Fundamental vs Technical Analysis

• Focuses on company’s financial health
• Looks at earnings, revenue, cash flow
• Long-term investing approach
• Answers: “Is this a good business?”

• Focuses on stock price patterns and charts
• Looks at volume, trends, indicators
• Short-term trading approach
• Answers: “Will price go up soon?”

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The Key Financial Metrics

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1. Price-to-Earnings Ratio (P/E Ratio)

• Stock Price ÷ Earnings Per Share
• Shows how much investors are paying per dollar of earnings
• Most common valuation metric

• Apple stock: $175
• Earnings per share (EPS): $6.00
• P/E Ratio: $175 /$6.00 = 29.2

• Investors are paying $29.20 for every$1 of Apple’s earnings
• Lower P/E = potentially undervalued (or troubled company)
• Higher P/E = potentially overvalued (or high growth expectations)

• P/E < 15: Potentially undervalued or low-growth
• P/E 15-25: Average/fair valuation
• P/E > 25: Potentially overvalued or high-growth
• P/E > 50: Very expensive (better be growing fast!)

• Tech stocks: Often P/E 25-40 (growth expectations)
• Mature companies: Often P/E 12-20
• Banks: Often P/E 8-15

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2. Earnings Per Share (EPS)

• Company’s profit divided by number of shares
• Shows profitability per share

• EPS = Net Income ÷ Total Shares Outstanding

• Apple earned $96 billion profit
• 16 billion shares outstanding
• EPS = $96B / 16B = **$6.00 per share**

• Higher EPS = More profitable
• Growing EPS over time = Good sign
• Declining EPS = Warning sign

• EPS growth year-over-year (want 10%+ annually)
• Consistent EPS (not wildly fluctuating)
• Positive EPS (negative = losing money)

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3. Revenue (Sales)

• Total money company brings in from selling products/services
• Before expenses

• Apple Q4 2023: $89.5 billion revenue
• Sold iPhones, iPads, Macs, Services

• Growing revenue = Business is expanding
• Flat revenue = Stagnant business
• Declining revenue = Trouble

• 20%+ annually: Excellent growth
• 10-20% annually: Strong growth
• 5-10% annually: Moderate growth
• 0-5% annually: Slow growth
• Negative: Declining (red flag)

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4. Profit Margin

• Percentage of revenue that becomes profit
• Shows efficiency and pricing power

• Profit Margin = (Net Income ÷ Revenue) × 100

• Apple revenue: $383 billion
• Apple profit: $97 billion
• Profit Margin = ($97B /$383B) × 100 = 25.3%

• Apple keeps 25 cents of every dollar in sales as profit
• Higher margins = More efficient, better pricing power
• Lower margins = Competitive pressure, less efficient

• Software/Tech: 15-40% (high margins)
• Retail: 2-8% (thin margins)
• Finance: 15-30%
• Manufacturing: 5-15%

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5. Debt-to-Equity Ratio

• Total Debt ÷ Shareholders’ Equity
• Shows how much company relies on debt vs equity

• Company has $50 billion debt
• Company has $100 billion equity
• Debt-to-Equity = $50B /$100B = 0.5

• 0.5 = For every $1 of equity, company has$0.50 debt (moderate)
• Lower is generally safer
• Higher = More risky (could struggle if business slows)

• < 0.5: Conservative, low debt
• 0.5-1.0: Moderate debt (most companies)
• 1.0-2.0: High debt (concerning)

• 2.0: Very high debt (risky)

• Banks naturally have high debt (it’s their business model)
• REITs often have high debt (leverage real estate)
• Utilities often have high debt (stable cash flows)

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6. Free Cash Flow (FCF)

• Cash generated after paying for operations and capital expenditures
• The “real” cash available for shareholders

• FCF = Operating Cash Flow - Capital Expenditures

• Apple operating cash flow: $110 billion
• Capital expenditures: $10 billion
• FCF = $110B -$10B = $100 billion

• Positive FCF = Company generates cash (good!)
• Negative FCF = Company burns cash (concerning)
• Growing FCF = Business becoming more cash-generative

• Earnings can be manipulated with accounting
• Cash flow is harder to fake
• FCF shows actual cash the company can:
  • Pay dividends
  • Buy back stock
  • Pay down debt
  • Reinvest in growth

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7. Return on Equity (ROE)

• How efficiently company generates profit from shareholders’ equity
• Profitability metric

• ROE = (Net Income ÷ Shareholders’ Equity) × 100

• Company net income: $20 billion
• Shareholders’ equity: $100 billion
• ROE = ($20B /$100B) × 100 = 20%

• For every $1 of equity, company generates$0.20 profit
• Higher ROE = More efficient at generating profit

• ROE > 15%: Excellent
• ROE 10-15%: Good
• ROE 5-10%: Average
• ROE < 5%: Poor

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8. Dividend Yield (For Income Investors)

• Annual dividend per share ÷ stock price
• Shows income return from dividends

• Coca-Cola stock: $60
• Annual dividend: $1.84 per share
• Dividend yield = ($1.84 /$60) × 100 = 3.1%

• If you buy at $60, you earn$1.84/year in dividends (3.1% yield)
• Paid quarterly usually

• 0-2%: Low yield (growth companies)
• 2-4%: Moderate yield (balanced)
• 4-6%: High yield (mature companies)
• 6%+: Very high yield (risky? or REIT/utility)

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How to Read Financial Statements

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The Three Key Statements

• Revenue (sales)
• Cost of Goods Sold
• Gross Profit
• Operating Expenses
• Operating Income
• Taxes and Interest
• Net Income (Bottom line profit)

• Growing revenue year-over-year
• Growing net income
• Improving profit margins

• Assets (what company owns):
  • Cash
  • Inventory
  • Property, equipment
  • Investments
• Liabilities (what company owes):
  • Debt
  • Accounts payable
  • Other obligations
• Shareholders’ Equity (Assets - Liabilities)

• Growing cash reserves
• Manageable debt levels
• Growing equity over time

• Operating Cash Flow (from business operations)
• Investing Cash Flow (buying equipment, acquisitions)
• Financing Cash Flow (debt, dividends, stock buybacks)

• Positive operating cash flow
• Free cash flow growth
• Not burning cash

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Where to Find Financial Statements

1. Company investor relations page
   • Google: “[Company] investor relations”
   • Find annual report (10-K) and quarterly reports (10-Q)
2. Yahoo Finance
   • Search ticker symbol
   • Click “Financials” tab
   • Shows income statement, balance sheet, cash flow
3. Seeking Alpha
   • Search company
   • “Financials” section
4. Ask Sage:

Sage, show me Apple's key financial metrics.
What's their revenue growth? Profit margin? P/E ratio?

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The 5-Minute Stock Research Process

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Quick Fundamental Check (Any Stock)

Sage, analyze [Company Name / Ticker].
Is this a fundamentally strong company?
What are the key metrics I should know?

• Business overview (what they do)
• Key metrics (P/E, revenue growth, margins)
• Strengths and weaknesses
• Fair value estimate

• Revenue growth (past 3-5 years)
• EPS growth (past 3-5 years)
• Both growing = good sign
• Both declining = red flag

• Search “AAPL”
• Click “Financials”
• See revenue by year:
  • 2019: $260B
  • 2020: $275B
  • 2021: $366B
  • 2022: $394B
  • 2023: $383B
  • Trend: Strong growth, slight dip in 2023 (normal)

• Find company P/E ratio
• Compare to competitors
• Compare to industry average

• Apple P/E: 29
• Microsoft P/E: 32
• Google P/E: 24
• Tech industry average: ~25
• Apple is fairly valued relative to peers

• Look at Debt-to-Equity ratio
• If > 2.0 and not a bank/utility → Be cautious
• If < 1.0 → Generally safe

• ✅ Is revenue growing?
• ✅ Is company profitable (positive EPS)?
• ✅ Is P/E reasonable for the industry?
• ✅ Is debt manageable?
• ✅ Do I understand what this company does?

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Red Flags: Avoid These Stocks

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🚩 Red Flag #1: Declining Revenue for 2+ Years

• Business is shrinking
• Losing market share
• Dying industry

• Company revenue:
  • 2020: $100B
  • 2021: $90B
  • 2022: $80B
  • 2023: $75B
• Red flag: Consistent decline

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🚩 Red Flag #2: Negative or Declining Earnings

• Company is losing money
• Or profits are shrinking

• EPS history:
  • 2020: $5.00
  • 2021: $3.50
  • 2022: $1.00
  • 2023: -$0.50 (loss!)
• Red flag: Profitability collapsing

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🚩 Red Flag #3: Very High Debt

• Company could struggle if business slows
• High interest payments
• Risk of bankruptcy if recession

• Debt-to-Equity: 4.0
• $100B debt, only$25B equity
• Red flag: Highly leveraged

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🚩 Red Flag #4: Negative Free Cash Flow

• Company burning cash
• Can’t sustain operations without raising money
• May dilute shareholders

• Operating cash flow: $50M
• Capital expenditures: $200M
• FCF: -$150M (burning$150M annually)
• Red flag: Cash burn

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🚩 Red Flag #5: P/E Ratio > 100 (For Mature Companies)

• Extremely overvalued
• Market expectations are unrealistic
• Small disappointment = massive drop

• Mature retailer with P/E of 150
• No growth story to justify it
• Red flag: Bubble valuation

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🚩 Red Flag #6: Frequent Management Changes

• CEO or CFO rotating frequently
• Instability
• Potential problems

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🚩 Red Flag #7: Accounting Irregularities

• Restated earnings
• SEC investigations
• Auditor changes
• Fraud concerns

• “Company restates earnings for past 3 years”
• Massive red flag: Potential fraud, avoid completely

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Green Flags: Strong Companies

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✅ Green Flag #1: Consistent Revenue Growth (10%+ Annually)

• Business is expanding
• Market share growing
• Successful products/services

• Apple revenue CAGR: 8% over 10 years
• Microsoft revenue CAGR: 12% over 10 years
• Green flag: Sustained growth

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✅ Green Flag #2: Growing EPS and Profit Margins

• Not just growing sales, but growing profits faster
• Becoming more efficient
• Pricing power

• Revenue up 10%
• Profits up 15%
• Green flag: Margin expansion

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✅ Green Flag #3: Strong Free Cash Flow

• Generates real cash
• Can fund dividends, buybacks, growth
• Financial flexibility

• Apple FCF: $100B+ annually
• Can return cash to shareholders
• Green flag: Cash machine

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✅ Green Flag #4: Low to Moderate Debt

• Conservative balance sheet
• Can weather recessions
• Financial stability

• Debt-to-Equity: 0.3
• Minimal debt risk
• Green flag: Strong balance sheet

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✅ Green Flag #5: Competitive Advantage (Moat)

• Something competitors can’t easily copy
• Pricing power
• Customer loyalty

• Apple: Brand loyalty, ecosystem lock-in
• Coca-Cola: Brand recognition, distribution
• Google: Search dominance, network effects
• Visa: Payment network, scale

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✅ Green Flag #6: Consistent Dividend Growth

• Paying and increasing dividends for 10-25+ years
• Reliable cash generation
• Shareholder-friendly management

• Johnson & Johnson: 60+ years of dividend increases
• Green flag: Dividend aristocrat

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Comparing Companies: Stock A vs Stock B

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Example: Coca-Cola vs PepsiCo

• P/E Ratio: 24
• Revenue Growth: 3% annually
• Profit Margin: 23%
• Debt-to-Equity: 1.9
• Dividend Yield: 3.0%
• ROE: 40%

• P/E Ratio: 26
• Revenue Growth: 5% annually
• Profit Margin: 10%
• Debt-to-Equity: 2.6
• Dividend Yield: 2.7%
• ROE: 48%

• PepsiCo growing faster (5% vs 3%)
• Coca-Cola more profitable (23% vs 10%)
• Similar valuations (P/E 24 vs 26)
• Both high ROE (excellent)
• Both have moderate-high debt

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Using Ape AI for Fundamental Analysis

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Ask Sage to Analyze Any Stock

Sage, analyze Microsoft stock. Is it a good investment?
What are the key fundamentals I should know?

Sage, compare Apple and Microsoft fundamentals.
Which is better valued right now?

Sage, I'm considering investing in Disney.
Break down their revenue streams, profit margins,
debt levels, and growth prospects. Should I buy?

Sage, I heard about [Company]. Are there any red flags
in their financials? Declining revenue? Too much debt?

Sage, what's a fair price to pay for Amazon stock
based on fundamentals? Is it overvalued or undervalued?

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Step-by-Step: Research Your First Stock

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Example: Researching Nike (NKE)

Sage, analyze Nike stock (NKE).
What does Nike do? Are they financially strong?

• Nike designs and sells athletic footwear, apparel, equipment
• Revenue: $51B (growing 10% annually)
• P/E Ratio: 28 (slightly above market average)
• Profit Margin: 11% (healthy for retail)
• Strong brand moat, global presence
• Moderate debt levels
• Dividend yield: 1.5%

• Visit Yahoo Finance > NKE > Financials
• See 5-year revenue growth: ✓ Growing
• See 5-year EPS growth: ✓ Growing

Sage, compare Nike vs Adidas fundamentals.

• Nike P/E: 28, Adidas P/E: 35 → Nike cheaper
• Nike margin: 11%, Adidas margin: 8% → Nike more profitable
• Nike ROE: 38%, Adidas ROE: 15% → Nike much more efficient

• Debt-to-Equity: 0.7 → Moderate (✓ OK)
• FCF: Positive and growing → ✓ Good
• Revenue declining? No → ✓ Good
• Recent scandals? No → ✓ Good

• Strong fundamentals ✓
• Growing business ✓
• Better than competitor ✓
• No red flags ✓
• Reasonable valuation ✓

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Common Beginner Mistakes

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Mistake #1: Ignoring Fundamentals Entirely

• “Stock went up 20% this week, I’m buying!”
• No research on company
• Just chasing price

• Always do basic fundamental check
• Minimum 5-minute research
• Know what you’re buying

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Mistake #2: Paralysis by Analysis

• Reading 200 pages of annual report
• Analyzing 50 different metrics
• Never actually investing

• Focus on 5-8 key metrics (P/E, revenue growth, margins, debt, FCF)
• Good enough > perfect
• Buy quality company, even if not “perfectly” valued

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Mistake #3: Confusing Good Company with Good Stock

• “Apple is amazing company, so it’s always good buy!”
• Ignoring valuation (P/E ratio)

• Great company at terrible price = bad investment
• Good company at great price = good investment
• Price matters

• Check P/E ratio vs historical average
• Buy quality companies when reasonably valued

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Success Checklist

• ✅ I know what P/E ratio means and how to interpret it
• ✅ I can identify revenue and EPS growth trends
• ✅ I understand profit margins and why they matter
• ✅ I can evaluate debt levels (debt-to-equity ratio)
• ✅ I know what free cash flow is
• ✅ I can spot red flags (declining revenue, high debt, negative FCF)
• ✅ I can identify green flags (growing revenue, strong margins, moats)

• ✅ I know where to find financial statements (Yahoo Finance, company IR)
• ✅ I can perform 5-minute fundamental check
• ✅ I use Sage to analyze stocks before buying
• ✅ I compare stocks to competitors
• ✅ I won’t buy without basic research

• ✅ I’ll research every stock before buying
• ✅ I’ll avoid red flag companies
• ✅ I’ll focus on green flag companies
• ✅ I’ll ask Sage when uncertain
• ✅ I’ll continue learning and improving

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What’s Next?

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Continue Your Research Education

• Research a Stock’s Valuation →
• Your First $100 in Stocks →

• Sector Analysis and Rotation →
• Reading Earnings Reports →
• [Discovering Undervalued Stocks](<../../Pre-Investor/Getting Started/understanding-assets.md>) →

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Practice With Sage

Sage, I want to practice fundamental analysis.
Give me a stock to analyze, then I'll tell you
what I find, and you can teach me if I missed anything.

Sage, I'm interested in [Company]. Walk me through
a fundamental analysis step-by-step. Teach me how
to evaluate if this is a good investment.

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The Bottom Line

• ✅ How you separate good companies from bad
• ✅ The foundation of intelligent investing
• ✅ Learnable by anyone (not rocket science)
• ✅ Takes 5 minutes once you know what to look for

1. P/E Ratio (valuation)
2. Revenue Growth (business expansion)
3. EPS Growth (profitability)
4. Profit Margin (efficiency)
5. Debt-to-Equity (financial risk)
6. Free Cash Flow (real cash generation)
7. ROE (return efficiency)

• ✅ Growing revenue and earnings
• ✅ Positive and improving profit margins
• ✅ Reasonable P/E ratio for industry
• ✅ Manageable debt
• ✅ Positive free cash flow
• ✅ No red flags