Fundamental Analysis: Overview
Basic analysis analyses factors such as its revenues, profits, industry position and strengths.
You also examine the macroeconomic variables including economic conditions of the company and its demand in the market.
It also has an understanding of the efficiency of the company’s managerial personnel.
Management effectively is capable of managing various difficulties and adjusting to the changing environment in order to enhance company’s performance and its value.
To the strategist, this vantage point is extremely helpful because it breaks through the hype of market fads created by investors and company promotions to reveal whether the company has sustainable competitive advantage.
With fundamental analysis, you can then determine if the position of the security is over or undervalued in the market.
How it works?
A simplified breakdown of how fundamental analysis is usually done is by beginning with the consideration of balance sheets, income statement, and flow of funds.
That is why the information highlighted in such materials can be used for the financial analysis of a company, and the determination of its intrinsic value.
Some such financial tools included here are the P/E ratios, EPS, ROE, D/E ratios and many more.
Such measures help the fundamental analysts to decide whether a particular stock is either under or overpriced in relation to the current market prices and rivals.
Besides, FA often seeks at Gross domestic product, Inflation, Unemployment rate, Industry or Sector currents affairs, and competition.
In other words, fundamental analysis looks into how a company should behave in the market and as an enterprise producing persona and products.
In order to establish the corporeal economics of the company, it is necessary to examine the macro-conditions in the economy, factors of the industry level, the valuation of the company, and organizing an outlook of the future performance.
This approach is also used to identify companies not only takes into account the economic and financial indicators, but also may include the analysis of its business model, efficiency of management, the company’s identification and awareness, and the possibilities for further growth and profitability.
Why Is Fundamental Analysis Important?
Earnings enable investors to dismiss occasional strange movements of price and focus on what works behind and in a business.
The primary advantage of fundamental analysis is in trying to establish a means of giving a concrete value to a company and, by extension, to its stocks. Patently, financial statements present quantifiable information for profitability, solvency and efficiency of a business concern.
Such information, reviewed together with the evaluation of the quality of the company’s management, key strengths and advantages, as well as tendencies in the industry, provides the fair or target value of the enterprise.
Therefore, the use of these measures enables investors to make the right decisions when it comes to getting, owning or disposing an equity share.
Fundamental analysis can also used in determining company whose stocks have been undervalued in the market.
Using the values of sales growth rate and market share and observing available product portfolios investors can assess the potential of the given company to generate increased profits in the future and to increase shareholder value.
This will mean that investors will be able to reap from steady values over the long run as well as exploiting emerging values. Value investors, especially, pay special attention to underpriced shares compared to their fair value.
Last but not the least, there is an ability to identify bad signs or declining valuations in using this fundamental analysis.
This way the investors can easily avoid the stocks of such a company which is in a weak financial situation or has a poor market standing and hence more likely to offer poor performance or more tendency of big fluctuations.
This is especially true during economic instability or market swings when the true capacity of a firm can be the key between surviving a downturn and getting forcible pushed out of the market.
Where to Find Fundamentals for a Company
Company filings
Listed companies are under regulatory obligation to file some forms with the SEC including Form 10-K (annual report), Form 10-Q (quarterly report) and Form 8-K (current event report).
These statements include financial statements which disclose financial position and operation results, management discussion analysis which provides the overview of company,
among other documents that contains important information about the company. These filings can be obtained from the sec Edgar database free of charge.
Company website
A majority of modern companies with a public float have an investor relations area offering financial statements, quarterly earnings, presentations, and other materials for investors.
Creating written texts makes the use of intently transcribed earnings calls especially useful since key company spokespeople often feel compelled to discuss short company weaknesses with journalists.
Financial platforms
Yahoo! Some among them include finance, Google finance, MarketWatch financials as well as fundamental belonging to the world’s publicly traded companies, balance statements, and key ratios, analysts’ recommendations.
Broker research reports
Most brokerage houses make available to themselves and customers research notes on the companies they cover, and many of these contain fundamental analyses and/or recommendations.
Financial data providers
There are numerous companies, including Bloomberg, FactSet, and Morningstar, all of which provide extensive fundamental data and analysis on companies and more broadly industries and markets.
They can be rather costly in which they are used commonly than individual traders but mostly among professional traders and research analysts.
Industry trade journals
Trade magazine that specialize in certain economic sectors are useful sources of information on the state of an industry, competitive forces and events specific to firms in the economy.
Just as a quick reminder, while engaging in a FA approach, it is always recommended to gather data from as many sources as possible to obtain a more or less objective picture of the company financial outlook and to stay alert to conflicts of interest within the availability of information.
Principles of Fundamental Analysis
Gross of basic research is the belief that markets for financial securities can be inefficient at any given time.
In essence, by analyzing information contained in financial statements, structure, and business environment, analysts seek opportunities to reveal various underpriced assets.
There are several key principles of fundamental analysis:
Earnings and Revenue Growth
Fundamental analysts analyze the firms’ revenues, as well as its growth rates, for earnings to understand its ability to produce profits.
Valuation
Among the basic objectives there is a question of whether a stock is over or under valued. Some ways of doing this are by comparing P/E ratios with others in the sector and P/B ratios with the other inside the sector.
Management and Corporate Governance
The overall aptitude of managerial staff to guide the corporation is an essential part of fundamental analysis.
Economic and Industry Factors
According to analysts, macro factors including inflation rates, GDP, and unemployment have an indication on the best performing company.
Debt Levels
Leverage is compared to a company where the focus is given to a company’s capability of managing and repaying its obligations.
Times or conditions such as the current economic calamity maybe very perilous when high levels of debt are in place.
Types of Fundamental Analysis
Top-Down Analysis
This approach covers the whole economy with a flying start and then moves on to focus on particular industries and corporations.
When starting an analyst, he/she first considers factors of macroeconomic which may include, among others, GDP growth rate, interest rates, inflation and industrial output.
They examine the sectors and the industries before getting to specifics by evaluating the macroeconomic possibilities of different companies.
Example: An analyst might look at a sector for example renewable energy and then expand it to the few companies such as Tesla or NextEra Energy.
Bottom-Up Analysis
While on the contrary, the bottom-up approach is used when analyzing individual companies.
Providers differentiate between earnings, management, and competitive positioning and assess these factors independently of the market environment.
This approach is preferred for stock-screeners who have a trading strategy of finding value stocks irrespective of the prevailing market condition.
Example: For instance, an investor can decide to invest in a small-cap firm, Zoom Communications, due to efficiency despite low performance in the tech sector.
Quantitative Analysis
This method involves the analysis of quantitative data from financial statement with a view of determining the financial health of the company.
These include; PEG ratio, earnings per share (EPS), price earnings growth (PEG), price to book (P/B) and price/cash flow (P/CF). Meanwhile, Quantitative analysis is based on numerical factors that help make prediction about future performance.
Example: When a company has a consistent record of the growth of its revenues and has a low P/E ratio, it may be overvalued according to the quantitative outlook.
Qualitative Analysis
Quantitative analysis is confined to the numerical or measurable parameters where as quality analysis is more of a subjective wherever or not indicators that are hard to quantify like organizational culture, quality of leadership and brand equity.
Although some of these aspects can be measured in a difficult way, they have a major influence on the company’s performance.
Example: Brand equity and the firm’s innovative control are key drivers that support its capability of charging premium in the technology industry, according to the qualitative FA.
FAQ’s
1) What are the key tools used in fundamental analysis?
Financial Statements: Statement of Profit & Loss, Balance Sheet and Statement of Cash Flows.
Ratios: Such ratios as: Price earnings ratio (P/E), Debt/equity (D/E), Return on equity (ROE), etc.
Economic Indicators: Gross Domestic Product, rate of unemployment, inflation and interest rate.
Industry Analysis: Trends, competition and the level of market share.
Company-Specific Metrics: Profits, stakeholders’ dividends, and the performance of managers.
2) What programs or applications are applied in carrying out a simple analysis?
The most common way to gather fundamental data is through some of the financial terminals and aggregators such as Bloomberg Terminal, Yahoo Finance, Morningstar, and others.
3) What is the fundamental analysis essential concepts?
Intrinsic value of an asset is different from its market price.
Hypothesis markets contrary to the theory are not always perfectly efficient and may misprice assets.
It is for this reason that it is often said that long term performance is found in the fundamentals of an asset.
4) What part does quantity have to do with it?
Quantitative Factors: Liabilities, stock performance and future potential of profitability.
Qualitative Factors: This includes uncontrollable factors such as management quality, known brand, and industrial location.
5) Which two approaches are used in conducting fundamental analysis?
Top-Down Analysis: Moves from the overall broad economic forces right to the individual business organisations.
Bottom-Up Analysis: Caters for individual firms before it takes a look at the industry and the macroeconomic environment factors.
6) What distinguishes qualitative and quantitative fundamental analysis?
Qualitative Analysis: Assesses the qualitative factors such as management, environment and competitive position.
Quantitative Analysis: Specializes in aspects of an organization’s financial performance.
7) What are the procedures of engaging in fundamental analysis?
Step 1: Be knowledgeable of the company’s business model and its operating environment.
Step 2: Examine specific accounting data, and compute specific efficiency coefficients.
Step 3: Make assessments of economic and industries factors.
Step 4: Find out which stock can be purchased at a lower price, intrinsically valued.
Step 5: In its place, make an investment decision based on the established research.
8) How can one measure intrinsic value?
Some of the complexes used in calculating Intrinsic value includes: the discounting cash flow (DCF), the relative valuation and the dividend discount model (DDM).