Whenever you consider investing in a stock, you’ve got to build a case for why that particular one is a good choice. To do so, one must separate the daily short-term noise from the underlying performance. That’s where Fundamental Analysis comes into play.
So, what is Fundamental Analysis, exactly? It’s a rigorous examination of all of the factors that could potentially impact the price of an asset. The factors can be of macroeconomic magnitudes, such as the overall state of the economy, or as minuscule (microeconomic) as the reputation of the CEO. The latter is more meaningful for fundamental trading, while the former carries more weight in long-term investment considerations.
The economic factors affecting equity stocks can be split into two categories: quantitative and qualitative.
Quantitative fundamentals in the stock market refer to everything that can be presented in hard numbers. These are the measurable characteristics of a business: its earnings per share, price-to-earnings ratio, net profit, return on equity, projected growth, etc. Basically, the sort of information you can gather from a company’s financial statement.
Qualitative characteristics focus more on the quality of the company’s product or service. Things like brand recognition, the CEO’s reputation, the management team, the business model. The analysis of this sort of information will produce varying results due to the investor’s subjective interpretation.
Still, both qualitative and quantitative analyses are equally useful in their own respects, which is why investors often consider them together when evaluating stocks fundamentals.
Understanding fundamental analysis
The goal of Fundamental Analysis is to determine the “intrinsic value” of a stock, as it’s called in finance. Intrinsic, in layman terms, means the true value of a company’s stock outside of what its market price may be on any given day.
It’s that discrepancy between the actual market price and the estimated intrinsic value that makes for a good investing opportunity. A smart investor is looking for a stock that is undervalued to take up a long position and reap the benefits of the company’s profitable future.
Coming to the opposite conclusion — that the stock you’ve been analyzing is overvalued — can be equally beneficial. Not only can it save you from making a reckless investment, but it can also get you on high alert if you’re already holding a position. Keep checking your stock fundamentals every now and again to know when it’s time to let go of a stock or to perform a portfolio rebalancing.
Here are 5 key business performance metrics that are commonly used in fundamental investor analysis to determine a stock’s intrinsic value:
- Earnings per share (EPS)
- Price-to-earnings (P/E) ratio
- Price-to-book (P/B) ratio
- Debt to equity (D/E) ratio
- Return on equity (ROE)
The list, of course, is not exhaustive. You can find plenty more financial fundamentals on each company on dedicated resources (like stocks apps for Android and IOS), but this, combined with technical analysis, should give you a pretty good idea of where the stock is headed.
Examples of fundamental analysis
There’s no standard way of doing fundamental analysis, since stock trading is not an exact science, yet there are still certain guidelines on how to evaluate a stock that you could follow.
A good place to start is to evaluate the industry sector the company you’re interested in investing in belongs to. The goal is to determine if it has potential for growth. Has any favorable legislation been put forth recently? Is there much competition?
Once the economic conditions are figured out, you can move on to the more quantitative factors. Look up their annual and quarterly reports, investor’s presentations, and conference call transcripts. You want to know their profit and losses, net income, and growth, of course. A few years of growth year over year is a very good sign. Struggling to overcome dept quarter after quarter — a red flag.
Next, time to research the company’s product or service. How unique is it? Does it have much competition? Does the company have plans of expanding its market? If you plan to hold a company’s stock long-term (say, you’re making an ISA investment), you absolutely must evaluate its prospects.
And lastly, do look into the company’s management team and style. Does the company have a frequent turnover in its top-tier management? Have there been any scandals involving their chief officers? Those are the people you’re basically handing your money over to, so they better be trustworthy.
And there you have it — a comprehensive stock analysis based on investing fundamentals.
- Stock investing using Fundamental Analysis can help you make better-informed decisions. It’s the means to get a bird’s eye view of the stock you’re about to take on.
- Determining the intrinsic value of a stock through this type of economic analysis is crucial to making a profitable long-term investment.
- One must consider both qualitative and quantitative fundamentals when examining a stock to form an opinion on its potential.