Ch2. Stock Investing — Fundamental Analysis & Business Valuation

What Is Fundamental Analysis?

Fundamental analysis estimates a company’s intrinsic value to determine whether its stock is over- or underpriced.

Core premise: In the short term, stock prices are driven by psychology. In the long term, they converge to intrinsic value.

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Key Financial Statement Metrics

Income Statement

Metric	Formula	What It Shows
Revenue	—	Top-line sales
Gross Profit	Revenue − COGS	Product margin
Operating Income	Gross Profit − OpEx	Core business profitability
EBITDA	Operating Income + D&A	Cash generation power
Net Income	After interest and taxes	Bottom-line earnings

Operating margin = Operating Income / Revenue × 100

• 10%: Healthy; >20%: Excellent competitive position

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Valuation Multiples

P/E Ratio (covered in Ch1)

Historical sector averages:

• Banks/Financial: 8–12x
• Industrials/Manufacturing: 15–20x
• Technology/Growth: 25–50x+ (paying for future growth)

EV/EBITDA

EV (Enterprise Value) = Market Cap + Net Debt

EV/EBITDA = EV / EBITDA

Removes capital structure differences → better for cross-company comparison. The dominant metric in M&A analysis.

PEG Ratio (for growth stocks)

PEG = P/E / Annual EPS Growth Rate

• PEG < 1: Potentially undervalued relative to growth
• PEG > 2: May be expensive relative to growth

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DCF Valuation (Discounted Cash Flow)

Intrinsic Value = ∑[FCF_t / (1+r)^t] + Terminal Value

1. Estimate free cash flows for next 5–10 years
2. Determine discount rate (WACC or required return)
3. Calculate terminal value (Gordon growth model)
4. Sum all present values

DCF is theoretically sound but highly sensitive to assumptions — small changes in growth or discount rate produce large value changes.

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Warren Buffett’s Investment Framework

1. Circle of Competence: Only invest in businesses you genuinely understand
2. Economic Moat: Durable competitive advantage (brand, patents, network effects, switching costs, cost advantages)
3. Trustworthy Management: Managers who treat shareholders as partners
4. Reasonable Price: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”

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Chapter 3 Preview

Next: Technical Analysis — candlestick charts, moving averages, RSI, MACD, and support/resistance levels for timing decisions.