Fundamental stock analysis is the basis of stock market investing. Unlike technical stock analysis fundamental analysis mostly consists of analyzing financial statements, like balance sheet, income statement and cash flow statement, looking at revenues, expenses, profits, assets and debts of a company for example. This quantitative part of fundamental analysis is the easy part of it; the difficult part of fundamental analysis is the qualitative part, when it is necessary to evaluate intangible aspects of company business, which are difficult to measure. Fundamentalists, as we often call fundamental analysts, analyze all this data to get insight in the future prospects for the company. The purpose of this part of stock market for beginner's guide to investing is to get you familiar with the concepts behind fundamental analysis.
Basics of Fundamental Stock Analysis
The goal of fundamental analysis is to determine stock fair value (known as intrinsic value), based on several factors that affect company's business and future prospects. In broader terms, fundamental analysis covers industries and economies as well, while technical analysis refers to price movements only.
Fundamental analysis tries to answer investor the questions like is the company business profitable, are their revenues growing, how is the company controlling costs, what are company's competitive advantages and will they last in the future, what are the prospects of the industry in which company operates, has the company a valuable trademark, is the management trust worded, has the company to much debt, and similar.
Quantitative and Qualitative Fundamental Stock Analysis
Like already written, fundamental analysis is focused on researching company's fundamentals, which can be anything related with well-being of a company; it includes quantitative research like analyzing company statements and market share (things that can be measured and expressed in numerical terms) and qualitative research like evaluating quality of the management or the value of company's trade mark or patents for example (things that are difficult or impossible to measure).
If you take fundamental analysis of McDonalds' company for example, the quantitative part of research would examine its revenues, profit, price earnings ratio, price book ratio, growth, debt to equity ratio, price sales ratio and many other ratios. But the analysis would be incomplete if you would not take into account the value of the McDonalds' brand, which is recognized all over the world by millions of people. Still, it is very difficult to say how much is the brand exactly worth, we can only say that it is essential for ongoing success of selling hamburgers.
The Concept of Company's Intrinsic Value
Similar to technical analysis, fundamental stock analysis has also its own assumptions and one of the most important ones is that stock market does not reflect the true value of the stock in every moment (just opposite to technical analysis assumption). That means, that stock is most often undervalued or overvalued in relation to its true - fair value, know as intrinsic value in financial jargon. It rarely happens that stock intrinsic value is the same as its stock market price.
The second assumption of fundamental stock analysis is that stock market will price fairly the company on the long run. Therefore it makes sense to buy undervalued stock and wait for the market to realize its real worth. Sooner or later you will profit when stock market price will equal its intrinsic value, however, nobody knows how long you will have to wait for this to happen - can be few day or many years.
That is what fundamental stock analysis is all about - to estimate company's intrinsic value and buy the most undervalued stocks with great prospects. After that you can relax and wait for things to happen. Of course, you have to keep following the company and evaluate all new information to be sure, that situation didn't change that much, that intrinsic value hasn't dropped significantly and is not considered as prominent investment any more.
There are two major unknowns with fundamental analysis: when you estimate the company intrinsic value, you can't be sure, if your evaluation is correct and the second problem is that you never know when the market will realize the true value of the stock.
Critics of Fundamental Stock Analysis
As you can expect, the biggest group of critics of fundamental stock analysis comes from chartists - technical analysis, who believe that stock markets are efficient and that stock are fairly priced in every moment because market discounts everything.
You, as modern investor, should combine both approaches, fundamental and technical, when building you investing and trading strategy. Use logic common sense and a lot of sound skepticism before you act.
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Next step: Company and industry qualitative data analysis...
Written by: Goran Dolenc
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Where To Go Next?
Qualitative Data Analysis is the Secret of Quality Fundamental Research
Qualitative data analysis is researching company's business model, competitive advantages, management, customers, competition, regulation and others.
Financial Statement Forms Introduction
Reading financial statement forms like balance sheet, income statement and cash flow statement gives you an in-depth view of company's business performance.
Income Statement Analysis
Income statement analysis is related with research of company's revenues and expenses and comparing the figures to its past and industry peers.
Balance Sheet Analysis
Balance sheet analysis reflects the financial health of the company through research of its assets, liabilities and equity.
Cash Flow Statement Analysis
Cash flow statement analysis gives investor the information of "true" profit, because it relies on real cash transactions in the time they occur, which is different to revenues and expenses.
Introduction to Stock Valuation Methods
Discounted cash flow and ratio analysis are the most common used stock valuation methods used by Wall Street analysts. Let us have a look how they work.
Discounted Cash Flow Valuation in 5 Easy Steps
Discounted cash flow valuation is a useful method of calculating stock fair value, which is useful for long-term investors when taking investment decision.
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