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Fundamental analysis: a complete guide

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Last editedNov 20202 min read

As the name suggests, a fundamental analysis describes the process of breaking down a business to its absolute basics. It’s a method for taking stock of financial health in all aspects of the company.

A quick fundamental stock analysis is beneficial for investors, who can gain some perspective on what a company’s stock might trade for in comparison to similar companies. Fundamental analysis is also useful for the business managers themselves, highlighting areas for improvement.

Understanding fundamental analysis

There’s a multitude of factors that can go into fundamental analysis, both external and internal. This analytical process not only takes financial statements and company earnings into account, but also external market factors and influences.

Fundamental analysis measures an asset’s intrinsic value by shining a spotlight on everything from company management to the current state of the economy. The end goal should be a clear picture of whether the asset is overvalued or undervalued.

The first data point that most investors look at is a company’s earnings statements. This gives a quick overview of how much money the company is making and whether these earnings are consistent. Consistent profit growth leads to higher stock prices and dividends, while a drop in earnings can cause stock value to plummet.

However, there’s far more to a fundamental analysis than earnings alone. Analysts look at the bigger picture, both from a macro and microeconomic perspective. For bonds, this might include interest rates and credit ratings. For stocks, this analysis might consist of earnings, revenues, profit margins, and return on equity.

Fundamental vs. technical analysis

The other major way to track asset value is through technical analysis. A technical analyst bases their investments on stock momentum – that is, the price and movements of a company’s stocks. Technical analysis is a process that utilises statistics and charts, without regarding the fundamentals of a business.

Fundamental analysis strategy

There’s more room for research in fundamental analysis, because the term ‘fundamental’ can include anything related to a company’s economic health. To break these down and create a workable fundamental analysis strategy, you can divide them into quantitative and qualitative factors.

Quantitative factors relate to information shown in numbers or volumes. These include factors like:

Income statements

An income statement gives a strong indication of the company’s performance over a specific period. It shows quantifiable data, including expenses, revenue, and profit during this time.

Balance sheets

A company’s balance sheet records all of its equity, liabilities, and assets at any given point. Assets include any resources that the business owns, such as inventory, machinery, equipment, property, and cash. Liabilities include factors like debt, while equity refers to money that has been put into the business over time.

Cash flow statements

Finally, cash flow statements form an important factor in any fundamental analysis. These documents record cash used in investing, financing, and generated during day-to-day operations. A cash flow statement is useful for investors because it shows a snapshot of the company’s everyday performance.

Qualitative factors pertain to the quality or nature of the company. These include:

Business model

A business model gives detailed information about the company itself. It describes how the business makes its money.

Company management

Smart investors look at a company’s management before purchasing any shares. Even a strong business model can fail if leadership is inadequate. To work this research into fundamental analysis, the analyst might look at the board members’ CVs and investing behaviour.

Company charter

Analysing the company charter gives you some idea of the business’s policies and stakeholder relationships. This helps build a more in-depth picture of the company’s fundamental ethics and efficiency.

Fundamental analysis: the bottom line

While a technical analysis only looks at stock movements, a fundamental analysis draws information from all of these different sources to create a big-picture perspective of the company’s growth potential. The process can be time-consuming, but it gives investors a long-term view of the asset’s place in the market.

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