Fundamental Analysis for Mutual Funds

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Fundamental Analysis for Mutual Funds

Daniel Cross May 12, 2016

Understanding how to analyze a financial product is an essential skill that investors need to cultivate in order to be successful. Financial ratios are useful for comparisons and there’s no lack of detail available. But not all investments are the same. The key statistics you need to properly compare and understand the value of a stock aren’t the same you would use to analyze a mutual fund.
The design of a mutual fund, a managed collection of investments, necessitates different valuations than a single stock. While some fundamental ratios are the same, many more are different, and knowing what they mean can be the difference between choosing a winning fund and one that’s struggling.

Zeroing in on Mutual Fund Statistics

Most investors are familiar with the price-earnings (P/E) ratio. In a stock it represents how much investors are willing to pay for a future stream of earnings. If a stock trades at $25 per share and has annual earnings of $2.50 per share, then its P/E ratio would be calculated as 10.

Mutual funds use the same ratio, but it’s expressed as the average of all the individual P/Es of the stocks held within the fund. This figure can help you identify whether the fund is geared towards growth or value and how expensive it is compared to its peers. But aside from the P/E ratio, mutual funds have some specific fundamental qualifiers with which investors should be familiar.

Sharpe Ratio

This ratio is also known as the reward-variability ratio. It’s calculated as follows:
Sharpe Ratio Equation
  • Am = Arithmetic mean of portfolio being evaluated.
  • Rf = Risk-free rate.
  • Std = Standard deviation of portfolio being evaluated.

This ratio can be used to determine whether a fund has “beaten” the market or not based on its risk parameters. It examines performance relative to the risk associated with the assets held in a portfolio. In other words, it will tell an investor whether a fund’s excess returns are a result of smart mangement decisions or simply a result of holding too much risk.

Treynor Ratio

Also known as the reward-volatility ratio, the Treynor ratio is calculated as such:
Treynor Ratio Equation
  • Mr = Market’s return.
  • Rf = Risk-free rate.
  • B = Beta of portfolio being evaluated.

This ratio is a great comparative tool to see if a mutual fund truly outperformed the market based on the risk it took on or not. Imagine the S&P 500 gained 12% last year and the risk-free rate was 2% – the beta of the market is assumed to be 1. That gives it a Treynor ratio of 10%. Now take a mutual fund that returned 8% but its beta was only 0.5. That means the fund’s Treynor ratio is 12% thus beating the market from a risk-reward standpoint.


This ratio tells investors how much of a fund’s performance is tied to its benchmark index. Calculated on a scale of 0 to 100, anything under 70 generally means the portfolio being evaluated doesn’t perform in line with its benchmark. The higher the R-squared is, the more trustworthy its beta.

The Bottom Line

Other things can be equally important when evaluating the fitness of a mutual fund. The tenure of the fund’s manager can let you know how accurate past performance is. If there’s a lot of management turnover, then long-term track records don’t hold as much value since many different mangers presided over those times.

Putting it all together, comparing these ratios against other mutual funds will help you select the ideal one for your portfolio.

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