Fundamental analysis consists of analyzing a company’s financial statements, its overall condition and business environment. A company’s financial statements include the balance sheet, the income statement and the cash flow statement. Fundamental analysis is not limited to financial reports. Fundamental analysis is concerned with the company’s management effectiveness, its competitive advantages and weaknesses as well as its competition and growth opportunities. As with most stock picking methods, the objective is to derive a forecast (or the company’s fair value) and make money from future price movements.
To forecast future stock price movement or determine the firm’s fair value, fundamental analysis combines economic, sector/industry, and company data and facts. In the case where the fair value is not equal to the current stock price, a fundamental analysis practitioner believes that the stock price will finally move towards fair value. A stock price that do not correctly reflects all available and relevant information, may be either undervalued or overvalued. Fundamental analysis is very popular among traders and investors. Fundamental analysis can be used alone or in conjunction with other tools such as technical analysis.
The fundamental analysis process usually starts with an assessment of the overall economic conditions. Factors such as the Gross Domestic Product (G.D.P.) growth rate, inflation rate, unemployment rate and credit conditions can help the investor form an opinion on the current and future economic conditions. The majority of industries and sectors are closely related to overall economic conditions. A poor economic outlook indicates negative sales and profit growth rates. However, a number of sectors and industries such as Utilities and Drugs are not affected by overall market conditions, and in most cases outperform the market portfolio.
As a next step in the process, the analyst has to determine which sectors and industries are likely to outperform taking into consideration current and expected economic conditions. Analysts and investors have to consider other factors as well, such as political, social and geopolitical factors. In general, some industries tend to outperform during economic expansions, and some other industries tend to outperform during economic contractions (recessions).
In the final step, the fundamental analyst analyzes the financial reports of candidate companies. The analyst can examine various financial figures and ratios such as sales and earnings growth, debt and equity, liquidity ratios, profitability ratios, the price to earnings ratio (P/E ratio), the price to book ratio (P/BV) and many others. The analyst can then compare companies within a particular sector or industry and pick the most attractive ones.
There are two categories of fundamental analysis practitioners: value investors and growth investors. Value investors try to determine the fair value of a stock, and then compare fair values with current stock prices. If the estimated “fair value” is under the market price then the stock is considered to be overvalued. On the other hand, if the estimated “fair value” is higher that the market price, then the stock is considered to be undervalued. Thus, value investors search for companies that are undervalued. Growth investor, focus on sales and earnings growth, and search for companies with above average growth rates. Stocks with higher than average growth rates and average risk are likely to outperform the market portfolio in the future.
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To forecast future stock price movement or determine the firm’s fair value, fundamental analysis combines economic, sector/industry, and company data and facts. In the case where the fair value is not equal to the current stock price, a fundamental analysis practitioner believes that the stock price will finally move towards fair value. A stock price that do not correctly reflects all available and relevant information, may be either undervalued or overvalued. Fundamental analysis is very popular among traders and investors. Fundamental analysis can be used alone or in conjunction with other tools such as technical analysis.
The fundamental analysis process usually starts with an assessment of the overall economic conditions. Factors such as the Gross Domestic Product (G.D.P.) growth rate, inflation rate, unemployment rate and credit conditions can help the investor form an opinion on the current and future economic conditions. The majority of industries and sectors are closely related to overall economic conditions. A poor economic outlook indicates negative sales and profit growth rates. However, a number of sectors and industries such as Utilities and Drugs are not affected by overall market conditions, and in most cases outperform the market portfolio.
As a next step in the process, the analyst has to determine which sectors and industries are likely to outperform taking into consideration current and expected economic conditions. Analysts and investors have to consider other factors as well, such as political, social and geopolitical factors. In general, some industries tend to outperform during economic expansions, and some other industries tend to outperform during economic contractions (recessions).
In the final step, the fundamental analyst analyzes the financial reports of candidate companies. The analyst can examine various financial figures and ratios such as sales and earnings growth, debt and equity, liquidity ratios, profitability ratios, the price to earnings ratio (P/E ratio), the price to book ratio (P/BV) and many others. The analyst can then compare companies within a particular sector or industry and pick the most attractive ones.
There are two categories of fundamental analysis practitioners: value investors and growth investors. Value investors try to determine the fair value of a stock, and then compare fair values with current stock prices. If the estimated “fair value” is under the market price then the stock is considered to be overvalued. On the other hand, if the estimated “fair value” is higher that the market price, then the stock is considered to be undervalued. Thus, value investors search for companies that are undervalued. Growth investor, focus on sales and earnings growth, and search for companies with above average growth rates. Stocks with higher than average growth rates and average risk are likely to outperform the market portfolio in the future.
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