Fundamental Analysis in Investing

Introduction

In stock trading how you analyze the market or the asset matters too and not just the indicators which is why fundamental analysis will be the topic of this discussion.

Definition of Fundamental Analysis

Fundamental analysis has to do  with evaluating a firms financial statements and some broader economic indicators to find out the intrinsic value of a security.

Historical context and development

Fundamental analysis has been there ever since stocks have existed and its right up there with technical analysis as one of the first analytical methods to be used within the industry.

Importance in investment decision-making

Besides the price and volume, the company or brand underlying that investment matters too as it’s only a matter of time before a company with the wrong fundamentals sees its stocks decline into obscurity even if it does enjoy some up trends before.

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Core Principles of Fundamental Analysis

Lets now look at some of the core aspects or principles rather of fundamental analysis.

Intrinsic value concept

Intrinsic value would be the calculated or anticipated value of a firm, currency, a stock or product which can be determined via fundamental analysis and can include intangible and tangible factors.

Economic, industry, and company-specific factors

Then there will be factors relating to the economy itself and the industry and whether they’re performing well or not or it could even relate specifically to the company itself.

Long-term investment approach

Fundamental analysis can also be used as a way to see whether or not that long term investment is worth purchasing due to it being undervalued or worth selling due to it being overvalued.

So it can be tailored  to a long term approach as well basically.

Key Components of Fundamental Analysis

Earlier we went over some of the principles now we’ll look at some other key components underlying this type of analysis.

Economic Analysis

Economics can have a key role to play here and queries about how the market has been performing economically should always be considered.

Macroeconomic indicators

Then there can be some macroeconomic indicators as well that pertain to what your governments and states do which have a broader impact on the economy.

Having that in mind is just as important.

Monetary and fiscal policies

And speaking of governments the things that they can do which can influence your stock’s price can include fiscal and monetary policies that seek to impact demand and money supply within an economy basically.

Global economic trends

No matter what your government does to affect its economy global economic trends can still impact the country’s economy in some way or another and you should factor that in too.

The 2008 financial recession is a good example of that.

Industry Analysis

The industry the stock is in can play a role too.

Industry life cycle

What life cycle the industry is currently going in? Is it in a decline or is it doing well? Queries like this should inform your decisions.

Competitive landscape

How is the competition or is it getting too competitive? If so how does the company handle that and is it in a favorable position in the industry?

In times of high competition some players are weeded out or negatively impacted so be on the lookout for that.

Regulatory environment

Sometimes the regulatory environment surrounding a particular industry can impact the stocks within it too.

Look into the tobacco industry and its history if you want to better understand this.

Company Analysis

Then there is the company itself too and how it is performing obviously. You can’t forget that now.

Financial statement analysis

The financial statement of the firm assuming that it has disclosed it to the public should be looked into as that will show how it’s performing.

Management quality assessment

Who exactly is the management behind the firm and is the team talented or skilled or experienced enough to tackle various challenges?

Such assessments should be a part of your analysis as well.

Competitive advantages and market position

Again how the company handles competition and where does it rank should be factors worth considering.

Financial Statement Analysis

The financial statement includes both the balance sheet and the income statement each of which presents a picture of the firm’s financial health.

Income Statement Analysis

Income statements offer this overview of expenses, revenues, earnings and more during a certain time.

Revenue trends

This should no doubt include the total revenue earned over a certain time and how its state has been during it.

Profit margins

Profits are calculated by subtracting the revenue and the expenses and no doubt that should be a part of your analysis here.

Earnings growth

You should also see whether or not some growth has occurred in the firm’s earnings or not.

Balance Sheet Analysis

The balance sheet includes the assets, the liabilities and more.

Asset quality

Asset value is a no brainer and the worth of that would be a good thing to factor in.

Debt levels

This goes without saying that debt levels are a must if you want to know what the firm really is worth without all its liabilities.

Shareholder equity

This just represents that money that may be returned to shareholders if every asset is liquidated with every single  debt paid off essentially.

Cash Flow Statement Analysis

As the name implies it shows how much cash is earned and spent.

Operating cash flow

The OCF is  cash that’s generated or consumed during a specific period from the firm’s operating activities.

Free cash flow

Now the free cash flow is money that’s on and can be freely used to settle some of those  obligations and liabilities.

Cash flow sustainability

Cash Flow Sustainability refers to how capable the firm is to have this continuous revenue stream and for how long it has done so.

Key Financial Ratios and Metrics

Lets discover some other metrics by which to gauge a firm’s or stock’s performance.

Profitability ratios

Profitability ratios are literally one of the most popular metrics and are used to evaluate a business’s ability to produce earnings relative to operating costs, revenue, shareholder equity and more.

Liquidity ratios

These ratios are just metrics that you could use to find out whether or not a debtor can pay off his existing debts or obligations without having to raise  external capital.

Solvency ratios

Solvency ratios have to do with long term debts and whether or not an enterprise can meet them.

Valuation ratios

This is  used to measure that relationship a firm has between its market value and some foundational financial metric like earnings.

Valuation Methods

Outlined below are a few other valuation methods you’d want to dive into.

Discounted Cash Flow (DCF) analysis

The DCF is typically used to find what the asset’s value is today based on some projections of whatever money the investment will produce in the future.

Comparable company analysis

This should be self evident in that you should learn to compare companies with one another and what each does that the other doesn’t.

Dividend Discount Model

The DDM model is based on that theory which states that the firm’s value is basically the present day worth of the total of those future dividend payments it will make.

Asset-based valuation

This form of valuation looks at the worth of a firm’s assets after deducting liabilities.

Qualitative Factors in Fundamental Analysis

Lets dive into some qualitative factors now.

Corporate governance

It has to do with the boards of directors that task themselves with the governance of the company.

Looking into that should lend you an insight on where the company could be directed towards in the future.

Brand value and intellectual property

These involve assessing the value and popularity  of the firms brands or other intellectual property rights.

Research and development capabilities

You’re essentially looking into the R&D capabilities of the firm and seeing if the firm is looking to innovate or grow.

Integrating Fundamental Analysis with Other Approaches

Fundamental analysis can be combined with many other forms of analysis and you should consider it too if you want to make the most out of it.

Combining with technical analysis

It could be blended with technical analysis which focuses more on price and volume.

Incorporating market sentiment

You could try including how investors are feeling about the product too.

Using fundamental analysis in portfolio management

 Or you could use it as a way to better manage your portfolio by selling stocks that arent performing well and buying those that are for instance.

Challenges and Limitations of Fundamental Analysis

Like anything fundamental analysis has its share of limitations too! And you should factor those in if you’re sensible.

Information asymmetry

This will always be a possibility where one party possesses considerably more information than the other and you could just as well be among the less informed ones.

Accounting manipulations

Accounting manipulations happen too where firms deliberately twist their financial statements to present a fraudulent  picture.

Rapidly changing market conditions

It is subject to market conditions just like technical analysis and those conditions can rapidly change too so thats not good if you’re ill prepared to deal with  the challenge.

The Future of Fundamental Analysis

Below is a brief dive into what  the future could  possibly hold for this form of analysis.

Impact of big data and AI

Big data and AI advancements will nonetheless play an important part in automating some things.

ESG considerations in fundamental analysis

EGS considerations can be subject to constant change as anything that involves people will unlikely stay the same.

Evolving reporting standards and their implications

Sometimes how a company’s financial status is reported can change too  like some new method of investigation or  another metric being demanded  or some interviews requested of  former employees or something.

Conclusion

The enduring relevance of fundamental analysis

Fundamental analysis is here to stay and stay it will for quite a long while yet because of how relevant it can be.

Balancing fundamental analysis with other investment approaches

But you should consider balancing it out with some other approaches as you cant just rely on that on its own.