● What it is: Fundamental analysis is a method of determining a stock's intrinsic value. It uses publicly available data to see if a stock, and the issuing company, are valued correctly by the market.
● How it works: Fundamental analysts look at a company's financial statements and broader economic indicators to figure out the true worth of a company. If a stock's fair market value is more than the market price, the stock is undervalued and it’s recommended to buy it. If the fair market value is less than the market price, it’s overvalued, and the recommendation may be to not buy the stock, or sell it if you already own it.
● Why it’s important: By understanding the fundamentals of a company, investors can look past short-term price fluctuations and focus on the factors that drive the company's operations and long-term performance.
● Types of fundamental analysis:
○ Quantitative: measurable characteristics of a business often taken from financial statements.
○ Qualitative: less tangible factors such as the quality of the management team, brand-name recognition, patents, and proprietary technology.
● How it's different from technical analysis: Fundamental analysts believe there is an intrinsic value that the market can miss, while technical analysts believe the market sets prices. Technical analysis uses historical data to predict short-term future trends.
● Where to find information:
○ Company filings
○ Company websites
○ Financial platforms (Yahoo! Finance, Google Finance, MarketWatch)
○ Broker research reports
○ Financial data providers (Bloomberg, FactSet, Morningstar)
○ Industry trade journals
● Limitations:
○ Time-consuming: requires collecting data, making calculations, and interpreting financial metrics
○ Lagging indicator: based on historical data, so stock price may have already adjusted by the time changes in fundamentals are reflected in the financial statements
○ Subject to accounting practices: depends on the company's financial statements being accurate and transparent
○ Difficult to value intangibles: intangible assets like brand reputation are hard to quantify
○ Economic assumptions: based on assumptions about future economic conditions, which may change
○ Overlooked short-term opportunities: misses short-term trading opportunities
● Tools for fundamental analysis:
○ Financial reports
○ Ratios from reports
○ Spreadsheets
○ Charts
○ Graphs
○ Infographics
○ Government agency reports on industries and the economy
○ Market reports
● Key financial ratios to consider:
○ Profitability: gross profit margin, operating profit margin, net profit margin, return on assets, return on equity
○ Liquidity: current ratio, quick ratio
○ Solvency: debt-to-equity ratio, debt-to-assets ratio, interest coverage ratio
○ Efficiency: asset turnover ratio, inventory turnover ratio, receivables turnover ratio
○ Valuation: P/E, price-to-book ratio, price-to-sales ratio, dividend yield
Qualitative fundamentals to consider: business model, competitive advantage, management team, corporate governance and board structure, industry trends, and stakeholder satisfaction
Three layers of fundamental analysis:
○ Economic analysis
○ Industry analysis
○ Company analysis
You can start with economic analysis and go down to company analysis (top-down) or you can start with company analysis and go up to economic analysis (bottom-up)
