Fundamental Analysis or Fundamental Research refers to the process of evaluating the basic characteristics of a security to determine its intrinsic values. Fundamental Analysis focuses on qualitative, quantitative, economic and financial factors associated with a particular security. Fundamental Analysis can not only be applied to stock but also bonds, currencies, cryptocurrencies, and even whole economies.
Why Perform Fundamental Analysis?
The primary objective of the fundamental analysis is to establish a quantitative value that can be used for valuation of securities, such as stocks and bonds. Additionally, fundamental analysis can be used to forecast a security’s price evolution and make projections on a company’s expected performance. Fundamental analysis is also used to evaluate a business’ management and make critical decisions.
Most investors use fundamental analysis to determine which stocks they should buy and hold in order to grow their assets base. Some other investors focus on identifying under-valued stocks and invest in them in the hope that they will grow. Managers also use fundamental analysis to determine the economic cycle with an aim of identifying the right conditions for buying or selling.
What are Company Fundamentals?
Company fundamentals refer to financial information and management commentaries as reported by the company. Balance sheets, income statements, cash flow reports, press releases, statements, and reports are some of the metrics used in establishing company fundamentals. Ideally, company fundamentals evaluate the health of a company and its prospective growth.
Strong company fundamentals indicate that the business has a viable governance and financial framework. Weak company fundamentals suggest that a business has issues with cost control, debt obligations, and overall management. Generally, companies with strong fundamentals are more likely to withstand negative events like recession compared to weak companies.
Key Accounting Ratios
In the fundamental analysis, the bottom line for every investor is earnings. How much is a company making? How much will it make in the future? Calculating earnings alone, however, is not a smart move since they can not tell the whole story. There are a few fundamental analysis tools that investors should consider before making a conclusion, they include:-
- Earnings per share (EPS) – this refers to the profits assigned on each share, it is calculated as the net income minus dividends against the outstanding shares.
- Price to Earnings Ratio (P/E) – this metric indicates the dollar amount an investor is expected to invest in order to receive a dollar of the company earnings.
- Projected earnings growth(PEG) – determines the relative trade-off between the price of a stock, the EPS, and the company’s expected growth.
- Price to sale ratio – values a company’s stock price as compared to its revenues.
- Price to book (price to equity) ratio – compare a shares’ current market price to the last quarter’s book value.
- Dividend payout ratio – compares dividends paid out to the stockholders to the company’s total net income.
- Dividend yield – indicates yearly dividends expressed as a percentage of a current share price.
- Return on equity – the amount of net income returned as a percentage of shareholders’ equity.
Alternatives to Fundamental Research
Aside from Fundamental Analysis, investors can use Technical Analysis to determine the viability of securities and stocks. Technical analysis examines charts, stock pricing, volume data, and historical data to determine and predict patterns and trends. Technical analysis acts under the assumptions that; stock price indicate everything about a company; movements are not random and pattern always repeat themselves. Technical analysis and fundamental analysis are often used to compliment each other.
Due to the complicated and tedious nature of the fundamental analysis, recent technology advancements have seen the automation of the analysis process. Today, there are several applications that have been developed to cut time on time and resources spent in fundamental analysis.