Fundamental Analysis: 12 Ratios, a Worked Example, 5 Steps

A share price tells you what a stock costs, not what the business is worth. Fundamental analysis closes that gap. It reads the balance sheet, the income statement and the cash flow statement and turns them into an estimate of value that you can hold against the price.

This guide walks you through the twelve ratios that matter, each with its formula and a rule of thumb. Then we calculate all twelve with real numbers: Microsoft’s annual report for the year to June 2026 and its closing price on November 10, 2026. You also get a five-step process, a comparison with technical analysis and an honest look at what AI tools can and cannot do here. This article follows our editorial policy.

Fundamental analysis in 30 seconds

• The idea: estimate what a company or asset is worth from economic data, then compare that value with the market price.
• The signal: a price well below the estimate may mean the stock is undervalued; a price well above means you pay for expectations.
• The tools: ratios such as P/E, P/B, price to cash flow, the PEG ratio, equity ratio, dividend yield and margins. None of them works alone as a buy signal.
• Two routes: top-down (economy, then sector, then company) and bottom-up (company first, then sector and economy).
• Who uses it: long-term investors cannot do without it; many traders combine it with chart analysis to choose what to trade and when.
• AI helps, but checks stay yours: tools such as ChatGPT, Claude and Perplexity speed up reading, but they can get numbers wrong.
• The origin: Benjamin Graham and David Dodd laid the foundation with “Security Analysis” in 1934. Graham’s best-known student is Warren Buffett.

What is fundamental analysis?

Fundamental analysis is a method of valuing stocks and other assets from economic data such as financial statements, with the aim of estimating their intrinsic value and comparing it with the market price.

The approach rests on two assumptions. First, every listed company has an intrinsic value that comes from its business model, its assets, its earnings and its prospects. Second, prices move toward that value over the long run. In the short run, news, fear and greed push prices around; over years, the business results tend to win.

Fundamental data covers everything that tells you about a company’s economic health. That includes the numbers in the financial statements, but also qualitative factors such as the business model, the quality of management and the company’s position against its competitors.

Fundamental analysis asks a different question from technical analysis. Chart analysis looks at price and volume and asks where the price is likely to go. Fundamental analysis asks what the business is actually worth. The section on the two approaches compared shows how traders use both.

How fundamental analysis works

There are two routes to the same goal, and they start at opposite ends. Both end with a view on one company, but they differ in what you look at first: the economy or the business.

Top-down: from the economy to the company

The top-down approach starts with the big picture. You first look at the economy: growth, interest rates and inflation. Then you pick the sectors that should do well in that setting, and only then do you study the companies inside those sectors.

For beginners, top-down often feels more natural, because it works with things you hear about every day. A cut in interest rates, rising commodity prices or a change in trade policy are easier to judge than a balance sheet. Our guide to sector rotation shows how to follow money moving between sectors with ratio charts.

Bottom-up: from the company to the economy

The bottom-up approach reverses the order. You study the financial statements, the ratios and the business model of one company before you look at its sector and the economy. The idea behind it: an outstanding company can do well even in a weak industry or a slow economy.

Most professional analysts and portfolio managers work bottom-up. The usual order is the business first, then the finances, and the valuation last, so that the current share price does not color the analysis. Rule-based methods such as CAN SLIM combine both sides and demand that earnings and the chart confirm each other.

Quantitative and qualitative analysis

Whichever route you take, you work with two kinds of information. The quantitative side uses numbers from the financial reports: the P/E ratio, the equity ratio, cash flow. These are objective and can be compared across companies.

The qualitative side covers what no balance sheet shows. How strong is the business model? Does the company have a lasting competitive advantage, an economic moat, for example through patents, network effects or a strong brand? How capable is management? Only when both sides point the same way do you have a solid judgment.

The three financial statements

Every listed company publishes three core financial statements, and almost every ratio comes from them. In the United States they are part of the annual report on Form 10-K and the quarterly Form 10-Q, which are free on the SEC’s EDGAR database.

• The balance sheet: assets, liabilities and shareholders’ equity on one date. It feeds the price-to-book ratio and the equity ratio.
• The income statement: revenue against costs over a period, down to net income. It feeds the P/E ratio, the price-to-sales ratio and the operating margin.
• The cash flow statement: the cash that actually came in and went out, split into operating, investing and financing activities. Cash is harder to shape with accounting choices than profit, which is why many analysts trust price to cash flow more than the P/E ratio.

The twelve key ratios of fundamental analysis

Ratios make companies comparable, but no single ratio is enough for a decision. Only together, and compared with peers in the same industry, do they give a useful picture. The values in the third column are common screening examples, not limits: what counts as cheap depends on growth, risk, interest rates, accounting and the comparison group.

Ratio	Formula	Rule of thumb
P/E ratio	Share price ÷ earnings per share	compare with peers and the stock’s own history
Price to book (P/B)	Share price ÷ book value per share	below 1 may mean undervalued
Price to sales (P/S)	Share price ÷ revenue per share	lower is cheaper
Price to cash flow (P/CF)	Share price ÷ operating cash flow per share	below the P/E is a good sign
PEG ratio	P/E ÷ earnings growth in %	below 1 is often read as cheap for the growth
Equity ratio	Equity ÷ total assets × 100	higher is more stable
Dividend yield	Dividend per share ÷ share price × 100	depends on the sector; check very high values
Operating margin	Operating income ÷ revenue × 100	only meaningful against peers
Return on equity (ROE)	Net income ÷ average equity × 100	above 15% is a common screen
Return on assets (ROA)	Net income ÷ average total assets × 100	depends on the sector
Liabilities to equity	Total liabilities ÷ equity × 100	compare with peers; check what is included
Payout ratio	Dividend per share ÷ earnings per share × 100	30 to 60% is a common screen

You do not have to calculate these ratios yourself, but you should know what is behind them. Stock screeners and data sites show them ready-made. Knowing the formula tells you when a number is distorted, for example by a one-off gain, a buyback or a different fiscal year.

P/E ratio (price to earnings)

The P/E ratio tells you how many years of current earnings you pay for with today’s share price. It is the best-known ratio in fundamental analysis and often the first look at a stock.

Formula: share price ÷ earnings per share

Example: a stock costs $100 and the company earns $10 per share, so the P/E is 10. There is no universal fair P/E. The number means little without its industry, the company’s growth and the level of interest rates: a P/E of 40 can be reasonable for a fast-growing software company and a warning sign for a steelmaker.

P/B ratio (price to book)

The price-to-book ratio compares the share price with the book value of equity per share.

Formula: share price ÷ book value per share

Example: book value is $50 per share and the stock trades at $75, so the P/B is 1.5. A P/B below 1 means the stock costs less than the equity on the books, which can point to undervaluation. For software and other asset-light companies the ratio says little, because their book value hardly reflects what the business is worth.

P/S ratio (price to sales)

The price-to-sales ratio is the tool for companies that do not make a profit yet. It relates the share price to revenue per share, so it still works when earnings are negative or distorted by one-off items.

Formula: share price ÷ revenue per share

Start-ups and fast-growing companies often lose money because they invest heavily. Their P/E ratio would be negative and therefore useless. The P/S ratio still lets you compare the valuation. How this looks for companies without a listed share is shown in our OpenAI stock guide, which compares revenue multiples.

P/CF ratio (price to cash flow)

Price to cash flow works like the P/E ratio, but uses operating cash flow instead of accounting profit.

Formula: share price ÷ operating cash flow per share

Example: a stock costs $120 and operating cash flow is $20 per share, so the P/CF is 6. The advantage: cash flow is harder to shape than profit. Depreciation, provisions and other accounting choices change earnings, while cash flow shows the money that actually moved. The Microsoft example shows why you should also look at free cash flow.

PEG ratio

The PEG ratio adds expected earnings growth to the P/E ratio, the one thing the P/E leaves out. It was made popular by the fund manager Peter Lynch and suits growing companies best.

Formula: P/E ÷ expected annual earnings growth in %

Example: a P/E of 16 and expected growth of 18.4% give a PEG of 0.87. A PEG below 1 suggests the stock is cheap for its growth, above 2 is usually seen as expensive. A company with a P/E of 30 that grows 35% a year suddenly looks cheap on the PEG. The weak spot is the growth forecast itself.

Equity ratio

The equity ratio shows what share of a company’s total assets is financed with its own capital.

Formula: shareholders’ equity ÷ total assets × 100

The higher the ratio, the less the company depends on lenders and the better it can survive a crisis. A very low ratio points to high debt. Healthy levels differ widely: banks work with low equity ratios by nature, industrial companies usually with higher ones.

Dividend yield

The dividend yield tells you how much cash you receive each year relative to the share price.

Formula: annual dividend per share ÷ share price × 100

Example: a company pays $4 a year on a $80 share, so the yield is 5%. What counts as normal depends on the sector. A very high yield is often a warning: the price may have fallen because the market expects a dividend cut. Always check it against the payout ratio below.

Operating margin (and EBIT margin)

The operating margin shows how many cents of operating profit a company keeps from each dollar of revenue.

Formula: operating income ÷ revenue × 100

The margin is most useful against peers and over several years. If it rises, the company earns more from its core business. If it falls, look for the cause: pricing pressure, higher costs or a shift in the business mix. Many analysts use EBIT (earnings before interest and taxes) instead; it can differ from operating income because it may include non-operating gains and losses.

Return on equity (ROE)

Return on equity measures the profit a company earns on its shareholders’ capital.

Formula: net income ÷ average shareholders’ equity × 100 (start and end of the year)

Many investors use an ROE above 15% as a screen for a strong business. In his 1979 letter to shareholders, Warren Buffett called a high earnings rate on equity capital “the primary test of managerial economic performance”. But a high ROE on very thin equity, for example after large buybacks, can flatter a company. More on his approach in our Warren Buffett profile.

Return on assets (ROA)

Return on assets relates profit to everything the company owns, financed by equity and debt alike.

Formula: net income ÷ average total assets × 100 (start and end of the year)

ROA also counts the assets financed by creditors, so it is harder to flatter with debt than ROE. Financing costs and changes in the asset base still affect it. Compare it only within one industry: a bank and a software company have completely different asset bases.

Liabilities to equity (and debt to equity)

Liabilities to equity sets everything a company owes against its shareholders’ equity.

Formula: total liabilities ÷ shareholders’ equity × 100

Total liabilities are more than borrowing. They include accounts payable, deferred revenue from customers who paid in advance and tax liabilities. The narrower debt to equity ratio uses only interest-bearing debt, which shows how much the company depends on lenders when rates rise. Data sites use both versions, and some add leases, so check which one you see and compare only like with like.

Payout ratio

The payout ratio shows what share of profit goes to shareholders as dividends.

Formula: dividend per share ÷ earnings per share × 100

A payout between 30 and 60% is often called healthy. Below 30%, the company keeps most of its profit for growth or buybacks. Above about 70%, little is left for bad years, and a dividend cut becomes more likely.

Worked example: all twelve ratios for Microsoft

Rules of thumb only become useful when you apply them to a real company. We took Microsoft’s annual report on Form 10-K for the fiscal year that ended on June 30, 2026 (filed with the SEC on July 29, 2026) and the closing price of $533.16 on November 10, 2026 (daily data from Alpha Vantage). Per-share figures use the 7.453 billion diluted shares from the report; book value uses the 7.426 billion shares outstanding on July 23, 2026. ROE and ROA use the average of the balances at the start and end of the fiscal year; debt is long-term debt including its current portion, without leases.

Ratio	Microsoft, fiscal 2026	How it is calculated
P/E ratio	29.7	$533.16 ÷ $17.95 diluted earnings per share
Price to book	8.9	$533.16 ÷ $59.58 book value per share
Price to sales	12.0	$533.16 ÷ $44.52 revenue per share ($331.8bn revenue)
Price to cash flow	21.7	$533.16 ÷ $24.55 operating cash flow per share ($182.9bn)
PEG ratio, historical	0.94	29.7 ÷ 31.6% growth in diluted EPS in fiscal 2026 (from $13.64)
Equity ratio	58.3%	$442.4bn equity ÷ $758.4bn total assets
Dividend yield	0.68%	$3.64 dividends declared for the year ÷ $533.16
Operating margin	46.8%	$155.2bn operating income ÷ $331.8bn revenue
Return on equity	34.0%	$133.7bn net income ÷ $392.9bn average equity
Return on assets	19.4%	$133.7bn net income ÷ $688.7bn average total assets
Liabilities to equity	71.4%	$316.0bn total liabilities ÷ $442.4bn equity (debt alone: $40.3bn, 9.1%)
Payout ratio	20.3%	$3.64 dividends per share ÷ $17.95 earnings per share

Microsoft is priced as a very profitable company with high expectations. A P/E near 30 and a P/B near 9 mean investors pay a lot for each dollar of profit and book value. In return, an operating margin near 47%, a return on equity of 34% and little interest-bearing debt describe an unusually strong business. Whether the premium is justified depends on future growth and on what peers and interest rates offer, not on a fixed band.

Our PEG of 0.94 looks back, while the classic PEG looks forward. It uses the 31.6% rise in diluted earnings per share in fiscal 2026, not an expected growth rate. Part of that jump came from outside the core business: non-operating income swung from a loss of $4.9 billion in fiscal 2025 to a gain of $10.7 billion in fiscal 2026, while operating income grew 20.8%. Before you trust a low PEG, check whether the earnings growth behind it will repeat.

Cash flow tells the most interesting part of the story. Operating cash flow rose 34% to $182.9 billion, which gives a comfortable price to cash flow of 21.7. But Microsoft spent $115.9 billion on property and equipment, mostly data centers, 80% more than a year earlier. Free cash flow fell from $71.6 billion to $67.0 billion, and on free cash flow the stock trades at about 59 times. Whether that spending pays off is the central question for any valuation of Microsoft today, and no single ratio answers it.

Two notes on the dividend and the date. Microsoft declared $0.98 for the quarter to September 2026, up from $0.91, so the annualized yield at the same price is about 0.74%. And the report covers a fiscal year that ended in June; the 10-Q for the quarter to September, filed on October 28, 2026, already contains newer numbers, so trailing figures on data sites will differ from ours.

Fundamental analysis in practice: five steps

This five-step process follows what professional analysts actually do. It works the same way for every stock, from a large cap to a small company, and it keeps the share price out of your view until the last step.

1. BusinessRead the reportsStart with the latest 10-K and 10-Q: what the company does, how it makes money, which risks it names.
2. BusinessJudge the qualityBusiness model, competitive advantage and management, for example with a SWOT analysis.
3. NumbersCalculate and compareThe key ratios against three to five competitors from the same industry.
4. ValuationEstimate the valueMultiples of peers, or a discounted cash flow model for advanced users.
5. PriceDecideValue against price: buy, wait on a watchlist or look elsewhere.

The valuation comes last on purpose, so that the current share price does not color the analysis.

• Step 1, read the reports: start with the annual report and the latest quarterly report. The “Risk Factors” and “Management’s Discussion and Analysis” sections of a 10-K explain the business in the company’s own words.
• Step 2, judge the quality: check the business model, the competitive advantage and management. Many analysts use a SWOT analysis (strengths, weaknesses, opportunities, threats) to structure this step.
• Step 3, calculate and compare: without a peer comparison, ratios have no context. A P/E of 15 can be cheap or expensive depending on the competitors, and sometimes another company in the group turns out to be the better buy.
• Step 4, estimate the value: the most common method compares valuation multiples with peers. Advanced investors also build a discounted cash flow (DCF) model; our value investing guide works through one and shows how sensitive it is to its assumptions.
• Step 5, decide: if the price is well below your estimate, that may be a buy signal. If it is above, you wait. If you like the company but not the price, it goes on a watchlist.

Tools and data sources for fundamental analysis

Calculating ratios starts with the raw data, and for listed companies most of it is free. The primary source in the US is SEC EDGAR, where every 10-K, 10-Q and 8-K is filed. Most companies also publish their reports and earnings slides on their own investor relations pages.

Free data sites save you the arithmetic. Yahoo Finance and stockanalysis.com show income statements, balance sheets and cash flows for many years, and Morningstar adds its own fair value estimates. To filter a whole market by P/E, growth or dividend yield, use a screener such as the TradingView stock screener or Finviz. If you need the data in your own code, a provider such as Financial Modeling Prep delivers financial statements through an API. For analyst estimates and fair value models in one place, see our InvestingPro review.

AI-supported fundamental analysis

Since 2022, large language models have changed how investors work through company data. They read a long annual report in seconds and answer questions about it in plain language. Three uses stand out.

• Research and summaries: Perplexity offers finance pages with P/E, market value and analyst views, and you can ask for stocks in plain English, for example “tech stocks with a P/E below 20 and revenue growth above 15%”. It also summarizes earnings calls.
• Analysis and understanding: ChatGPT and Claude help you work through a report. Upload a 10-K as a PDF and ask for the key figures, the main risk factors or a SWOT analysis.
• Screening with AI scores: some research tools rank stocks with their own models; our Kavout review shows what such a score contains and where it ends.

AI can invent numbers, so check every figure that matters against the report itself. Language models can return outdated or simply wrong figures with full confidence. Use them as a starting point and confirm every number you base a decision on in the original filing.

Fundamental analysis vs technical analysis: what and when

The two methods answer different questions. Fundamental analysis asks what an asset is worth; technical analysis asks when to buy or sell. They are not opposites; they complement each other.

	Fundamental analysis	Technical analysis
Focus	What is it worth?	Where is the price going?
Data	Financial statements, economic data	Prices, volume, chart patterns
Time horizon	Medium to long term	Any time frame
Goal	Estimate intrinsic value	Find entries and exits
Typical users	Value investors, position traders	Day traders, swing traders
Strength	Grounded valuation	Fast reaction
Weakness	Says nothing about timing	Ignores value

In practice, the line between the two is blurred. Warren Buffett hardly looks at charts. Paul Tudor Jones trades mainly on price and uses the 200-day moving average as his main exit signal. Most traders sit somewhere in between: they use fundamentals to choose what to trade and the chart to decide when. John Murphy’s standard work on the other side is covered in our review of Technical Analysis of the Financial Markets.

At Kagels Trading we trade mainly on charts, but we always know the fundamental calendar. We follow the news, central bank decisions and economic data in forex, commodities and indices, and we adjust our trading to them. Fundamental events move prices whether you like it or not: wars re-rated defense stocks, conflicts in the Middle East move oil, and a single post by a president can move whole indices. If you know the economic calendar, you know when these events are due.

A short history of fundamental analysis

Benjamin Graham and David Dodd laid the foundation of modern fundamental analysis with “Security Analysis” in 1934. Graham’s later book “The Intelligent Investor” (1949) made value investing accessible to private investors and is still a standard work today.

Graham’s best-known student, Warren Buffett, took over the core principles and built one of the most successful investment records in history on them. His approach can be put in one sentence: buy excellent companies at a fair price, and always keep a margin of safety. Our guide to the best trading books lists further classics.

Fundamental analysis in forex, commodities and crypto

Fundamental analysis is not limited to stocks. The data changes with the asset class, but the principle stays the same: estimate the true value of an asset from economic facts.

Asset class	Sources	What matters
Stocks	Company reports	Ratios, cash flow, quality of the business
Forex and commodities	Central banks, economic data	Rates, growth, inflation, purchasing managers’ indices
Crypto	On-chain data, white papers	Network activity, tokenomics, team

• Forex and commodities: here the fundamentals are monetary policy, growth, inflation and jobs. Our guides to the Fed interest rate decision and the nonfarm payrolls report explain the two biggest US dates. For commodities, inventories, seasonal patterns and geopolitics come on top; the COT report shows how large traders are positioned in the futures markets.
• Crypto: there are no balance sheets in the classic sense. Investors look at on-chain data such as transactions and active addresses, at the tokenomics (supply, issuance and distribution of the coins) and at the quality of the development team. Data platforms such as CoinGecko collect many of these figures.
• Commodity stocks: they combine both worlds, the commodity price and the company’s own costs. Our oil stocks guide compares producers with figures from their own reports.

Advantages and limits of fundamental analysis

Fundamental analysis has clear strengths and equally clear limits. If you know both, you use it where it carries weight and do not rely on it where it is silent by design.

Advantages	Limits
A rational basis for decisions that limits gut feeling and herd behavior	It takes time: reports, ratios and peer comparisons take hours, not minutes
Forces you to understand the business before you invest	Ratios describe the past, not the future
A view of years instead of days, less exposed to daily noise	Management quality and culture fit into no formula
Supported by research (see below)	Two analysts can read the same numbers in opposite ways
The raw data is free: every report is public	An undervalued stock can stay undervalued for years
	Shocks such as pandemics, wars and regulation are not on any balance sheet

Research supports the approach, with caveats. In “Agnostic Fundamental Analysis Works”, published in the Journal of Financial Economics in 2018, Söhnke Bartram and Mark Grinblatt valued US stocks mechanically from public quarterly accounting data. Buying the stocks that looked cheap against that estimate and selling the expensive ones earned risk-adjusted returns of up to 10% a year.

Joseph Piotroski’s F-score is a second well-known example. It ranks cheap value stocks by nine simple tests of financial strength. A 2017 bachelor’s thesis at Lund University by Bülow replicated it for the US market from 2003 to 2015 and found a market-adjusted return of 18.3% a year for strong companies against 4% for weak ones. That is a single student replication; a discussion paper by Krauss, Krüger and Beerstecher (University of Erlangen-Nuremberg, 13/2015) found that, after liquidity limits and estimated trading costs, the F-score strategies it tested became effectively unprofitable.

Critics point to the efficient market hypothesis. It says that all available information is already in the price, so fundamental analysis could not work. The studies suggest that markets are efficient enough to make it hard, but not so efficient that it is impossible. Costs and discipline decide how much of the edge is left.

Conclusion: start with one company

You do not need a finance degree to use fundamental analysis. If you know where to find the data and which ratios matter in which industry, you have a real advantage over investors who react only to price moves and headlines.

What is missing now is practice. Pick a company you know, download its latest 10-K from EDGAR, and work through the twelve ratios as we did for Microsoft. Compare them with two or three competitors, use an AI tool to help you read, check every number against the report, and form your own view.

Frequently asked questions about fundamental analysis

What does fundamental analysis include?

Fundamental analysis includes quantitative and qualitative information. The quantitative side is the financial statements and the ratios built from them, such as P/E, P/B and cash flow. The qualitative side covers the business model, management and competitive position. For markets as a whole, economic data such as growth, inflation and interest rates comes on top.

What does a fundamental analyst do?

A fundamental analyst estimates what a company is worth. The analyst reads annual and quarterly reports, calculates ratios, compares the company with its competitors and estimates a fair price. On that basis, analysts at banks issue buy, hold or sell ratings.

What is a good P/E ratio to buy a stock?

There is no single good P/E for buying a stock. A low P/E can mean a bargain or a business in decline; a high one can be justified by strong growth. Compare the P/E with the company’s competitors, with its own history and with the growth you expect, and check it against other ratios such as price to cash flow.

What is fundamental data?

Fundamental data is the economic and financial information that drives the value of an asset. For stocks, it is the balance sheet, income statement, cash flow statement and qualitative factors. In forex, it is economic data such as growth, inflation and central bank decisions. In crypto, it is on-chain data and tokenomics.

Is there a formula for fundamental analysis?

There is no single formula. Fundamental analysis combines several ratios, such as P/E, P/B, price to cash flow and the PEG ratio, each of which looks at a different side of the company. Which ratios matter depends on the industry and on your goal.

What is the difference between fundamental and technical analysis?

Fundamental analysis estimates the value of an asset from economic data; technical analysis studies prices and charts to find trends and timing. Many traders combine them, because one answers the “what” and the other the “when”. A good screener can filter by both kinds of criteria at once.

Which app is best for fundamental analysis?

No single app covers everything. For standard ratios, the stock pages of Yahoo Finance or your broker are enough; for screening by several criteria, a screener such as TradingView or Finviz; for independent fair value estimates, Morningstar. No app replaces the annual report itself, because the qualitative factors are only in the original text.

This article is market education, not investment advice. The Microsoft figures show how the ratios work on one date; they are not a recommendation to buy or sell the stock. Prices and reported figures change, so recalculate with the latest filing before you rely on any number.