Fundamental Analysis is a technique used to determine a security’s value by focusing on the underlying factors that affect a company’s business and growth prospects using information from various sources stemming from company management, financial statements, competitive advantage and overall health of the business and sector.
Utilising the fundamentals on a company is extremely important in deciding in which stocks to invest in, as is utilising Technical Analysis to determine an entry and exit strategy as explained further below.
Fundamental Analysis is generally performed using historical and present data, in turn attempting to forecast future value. Fundamental Analysis serves to answer questions, such as:
- Is the company profitable?
- Is management in line with the overall mission of the company?
- What is the company’s return on equity (ROE)?
- Does the company have any debt and will it be able to repay it?
- Is the company’s revenue growing?
- Is the company undervalued?
- Is the business sustainable?
The above are just some examples needed whilst considering the fundamentals surrounding a successful company and there are hundreds more to consider which is why knowing which underlying factors to consider is very important when making an investment decision.
At the end of the day it comes down to one question:
Is the company’s stock a good investment?
Breaking down a company’s financial statements, evaluating its management and attempting to forecast a company’s future value is a time consuming and arduous process, ensuring that you have the skills, time and correct advisor is key to successful fundamental analysis.
In simple terms Fundamental analysis is basically researching the fundamentals of the company, but determining this can also be arduous when you do not know what the fundamentals are.
Fundamentals can include anything related to the economic well-being of a company.
There are two categories which fundamentals are factored into:
Quantitative – arenumeric, measurable characteristics of a business. The biggest source of quantitative data is the financial statements. From financial statements you can measure profits, revenue, cash flow, assets and more with greater precision
Qualitative – are less tangible factors surrounding a business; such as a company’s management team, directors and key executives, its brand-name recognition etc.
One of the key assumptions of fundamental analysis is that the price of the stock market does not fully reflect a stocks real value.
The key is that the stock market fluctuates on a daily basis and in most cases so does a company’s share price but if the share price was always a true indication of a company’s “real” value then we would have no need for price analysis, therefore financially speaking we refer to this as “intrinsic value”.
“Intrinsic value” in simple terms is the true value of a company, based on both tangible and intangible factors. The value may not always be the same as the current share price of the company which is why the use of fundamental analysis to find opportunities at a discounted price is so popular.
Theoretically if you invest in a fundamentally sound company below its intrinsic value then over time the investment will pay off as the market catches up to the fundamentals.