Fundamental Analysis
What is fundamental analysis?
Fundamental analysis (FA) is a method of measuring the intrinsic value of a security by examining its economic and financial factors. Fundamental analysts study everything that can affect the value of a stock, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors such as the efficiency of business management.
The ultimate goal is to find a number that an investor can compare to the current price of a stock to see if the stock is undervalued or overvalued.
This method of stock analysis is considered to be different from technical analysis, which predicts price direction through analysis of historical market data such as price and volume.
KEY SUMMARY
Fundamental analysis is a method of determining the actual or “fair market” value of a security.
Fundamental analysts look for stocks that are currently trading at prices above or below their real value.
If the fair market value is greater than the market price, the security is considered undervalued and a buy recommendation is given.
Conversely, technical analysts ignore the fundamentals in favour of a study of the historical evolution of share prices.
Quantitative and Qualitative Fundamental Analysis
The problem with defining the word fundamentals is that it can cover anything relating to the economic well-being of a business. They include numbers like revenue and profit, but they can also include anything from a company’s market share to how well it is run.
The different fundamental factors can be grouped into two categories: quantitative and qualitative. The financial meaning of these terms is not much different from their standard definitions. Here’s how a dictionary defines terms:
Quantitative – “relating to information that can be displayed in numbers and amounts”.
Qualitative – “relative to the nature or standard of something, rather than its quantity”.
In this context, quantitative fundamentals are difficult numbers. These are the measurable characteristics of a business. This is why the largest source of quantitative data is financial statements. Income, profits, assets and more can all be measured with great precision.
The qualitative foundations are less tangible. They can include the quality of a company’s top executives, brand recognition, patents, and proprietary technology.
Neither qualitative nor quantitative analysis is inherently better. Many analysts consider them together.
Does fundamental analysis still work?
No. Like any other investment strategy or technique, fundamental analysis is not always successful. The fact that the fundamentals show that a stock is undervalued does not guarantee that its stocks will soon reach their intrinsic value. Things are not that simple. indeed, the behaviour of real prices is influenced by a myriad of factors that can undermine fundamental analysis.
Investors and analysts often use a combination of fundamental, technical and quantitative analysis to assess a company’s potential for growth and profitability.
Qualitative Foundations to Consider
There are four fundamental principles that analysts always consider when dealing with a business. All are qualitative rather than quantitative. They include:
The business model: what exactly is the company doing? It’s not as easy as it sounds. If a company’s business model is based on selling fast food chicken, is it making money that way?Or is it just royalty and franchise fees?
The long-term success of a business is largely determined by its ability to maintain and maintain a competitive advantage. Powerful competitive advantages, such as the Coca-Cola brand and Microsoft’s dominance over the personal computer operating system, create a divide around a business that allows it to keep its competitors at bay and profit from growth and opportunities. profits. When a company can gain a competitive advantage, its shareholders can be well rewarded for decades.
Some people think that management is the most important criterion for investing in a company. It makes sense: Even the best business model is doomed to failure if company leaders fail to execute the plan properly. While it is difficult for retail investors to truly meet and assess managers, you can check the company’s website and view the resumes of senior executives and board members. How well did they perform in previous jobs? Have they emptied much of their stock lately?
Corporate governance describes the policies in place within an organization that denote the relationships and responsibilities between management, directors and stakeholders. These policies are defined and determined in the articles of association and regulations of the company, as well as in the laws and regulations of the company. doing business with a company that is managed in an ethical, fair, transparent and efficient manner. Note in particular whether management respects the rights and interests of shareholders. Make sure their communications to shareholders are transparent, clear and understandable. If you don’t understand, it’s probably because they don’t want you to understand it.
It is also important to consider the industry of a firm customer base, market share between firms, industry-wide growth, competition, regulation and business cycles. Learning how the industry works will give an investor a deeper understanding of a company’s financial health.
Does Fundamental Analysis Always Work?
No. Like any other investment strategy or technique, fundamental analysis is not always successful. The fact that fundamentals show a stock to be undervalued does not guarantee that its shares will rise to intrinsic value any time soon. Things are not so simple. In reality, real price behaviour is influenced by a myriad of factors that may undermine fundamental analysis.
Investors and analysts will frequently use a combination of fundamental, technical, and quantitative analyses when evaluating a company’s potential for growth and profitability.
