What Fundamental Analysis Measures
Fundamental analysis examines a company's financial performance, business quality, growth prospects, and valuation. The goal isn't to find the lowest stock price — it's to understand what you're paying for and whether the underlying business can support its current market valuation. Five of the most commonly used metrics:
| Metric | Primary question |
|---|---|
| P/E ratio | How much are investors paying for each dollar of earnings? |
| PEG ratio | Is the valuation reasonable relative to expected earnings growth? |
| EPS | How much profit is attributable to each common share? |
| Revenue growth | How quickly is the company expanding its sales? |
| Free cash flow | How much cash remains after operating and capital expenditures? |
No single metric establishes whether a stock is attractive. Investors evaluate valuation, growth, profitability, cash generation, financial condition, and risk together.
Valuation, Growth, and Quality Metrics
Fundamental metrics generally fall into three categories: valuation (P/E, forward P/E, PEG, price-to-sales, price-to-FCF, EV/EBITDA) measures what investors are paying; growth (revenue growth, EPS growth, FCF growth) measures business expansion; quality (gross/operating/FCF margin, ROE, ROIC, debt-to-equity) measures durability and efficiency. A company can look attractive under one category and weak under another — a stock might have rapid revenue growth, negative free cash flow, and heavy dilution, while another has slow growth, strong cash flow, and a durable dividend. Neither is automatically better; it depends on the business model and your objectives.
The Core Formulas
P/E ratio = stock price ÷ earnings per share. A $60 stock with $3 diluted EPS trades at 20× earnings. Full P/E guide →
PEG ratio = P/E ÷ expected annual EPS growth rate (growth entered as a whole number). P/E of 24 with 12% expected growth = 2.0 PEG. Full PEG guide →
Basic EPS = (net income − preferred dividends) ÷ weighted-average common shares. ($500M − $20M) ÷ 200M = $2.40. Full EPS guide →
Revenue growth = (current revenue − previous revenue) ÷ previous revenue × 100. $4B to $4.6B = 15% growth. Full revenue growth guide →
Free cash flow = operating cash flow − capital expenditures. $1.2B − $350M = $850M FCF. Full FCF guide →
How the Five Metrics Work Together
Consider two fictional software companies. Company Alpha: P/E 22, PEG 1.6, EPS growth 14%, revenue growth 10%, FCF margin 20%. Company Beta: P/E 38, PEG 1.3, EPS growth 29%, revenue growth 25%, FCF margin 8%. Alpha has the lower valuation and stronger cash-flow margin; Beta has faster growth and a lower PEG because its expected earnings growth is much higher. The better investment can't be determined from these numbers alone — you'd also need to evaluate growth durability, competitive position, debt, dilution, and forecast reliability. See the full comparison framework →
Common Fundamental Analysis Mistakes
- Treating a low P/E as automatically cheap — it may reflect declining earnings or real business risk
- Treating a high P/E as automatically expensive — a high-quality, durable-growth company may justify it
- Using unreliable growth estimates in PEG — the ratio is only as good as the growth forecast
- Ignoring share dilution — net income can grow while EPS stays flat if shares outstanding rise
- Focusing only on revenue growth without checking profitability or cash flow
- Comparing unrelated industries — a bank, utility, and software company naturally trade at different multiples
Fundamental Metrics Checklist
Before comparing companies, collect: current price, market cap, trailing and forward P/E, PEG, basic and diluted EPS, EPS growth, revenue growth, operating margin, operating cash flow, capital expenditures, free cash flow, FCF margin, debt, cash, share-count growth, and analyst estimates.
Frequently Asked Questions
What are the most important fundamental stock metrics?
Important metrics include revenue growth, earnings growth, EPS, free cash flow, profit margins, debt, return on invested capital, and valuation multiples.
Is a low P/E ratio always good?
No. A low P/E can indicate undervaluation, but it can also reflect shrinking earnings, high debt, cyclicality, or structural business problems.
Is revenue growth more important than EPS growth?
It depends on the company's stage and business model. Early-stage companies may prioritize revenue growth, while mature companies are generally expected to produce profits and cash flow.
Why is free cash flow important?
Free cash flow shows how much cash remains after operating activities and capital expenditures. It can be used for debt repayment, dividends, share repurchases, acquisitions, or reinvestment.
Which metric is best for comparing stocks?
No single metric is best. Comparisons should combine valuation, growth, profitability, cash flow, financial strength, and business quality.