What is fundamental analysis

What is Fundamental Analysis in trading? A complete guide

What is Fundamental Analysis?

Fundamental analysis is a method of assessing the intrinsic value of a stock. It combines financial statements, external influences, events, and industry trends. It is important to note that the intrinsic value or a fair value of a stock does not change overnight. Such analysis helps you identify key attributes of the company and analyze its actual worth, taking into account macro and microeconomic factors.

Fundamental analysis uses three sets of data:

  1. historical data to check how things were in the past
  2. publicly known information about the company, including announcements made by the management and what others say about the company
  3. information that is not known publicly but is useful, i.e., how the leadership handles crises, situations, etc.

For a stock, fundamental analysis typically includes reviewing many elements related to stock prices, including:

  • Performance of the overall industry the company participates in
  • Domestic political environment
  • Relevant trade agreements and external politics
  • The company’s financial statements
  • The company’s press releases
  • News releases related to the company and its business
  • Competitor analysis

If a company’s fundamental indicators suggest a negative impact, it will likely hurt its share price. On the other hand, if the data is positive, for instance, a favorable earnings report, it can boost the company’s share price.

What are the Different Types of Fundamental Analysis?

There are two main types of fundamental analysis –

  1. Qualitative: a study that involves brand value, management decisions, the financial performance of the company over a given period, and other similar factors.
  2. Quantitative: an analysis that is purely number-based and considers the company’s financial statements and concludes the share price from the observations.

Though the approaches are different, they are equally crucial for a comprehensive analysis of a company’s share price.

There are also two processes of fundamental analysis. One is top-down, and the other is a bottom-up approach.

The top-down approach looks into the macroeconomic factors first and then digs into the specific company. On the other hand, the bottom-up approach analyses the company first and then checks the effect of macroeconomic factors on the company’s performance.

What are the Basics of Fundamental Analysis?

Before conducting fundamental analysis of a stock, you need to consider a few basic factors. These factors are –

  • Company’s structure and revenue
  • Company’s profits over the years
  • Revenue growth over the years
  • Company’s debt
  • Corporate governance
  • Rate of turnover

Analysts look at these six factors while conducting a fundamental analysis of any security and determine its intrinsic value.

How to Do Fundamental Analysis of a Stock?

Here are some necessary steps to start a fundamental analysis of a company

  • Understand the company, its operations, business model, etc.
  • Use the financial ratios for initial screening.
  • Closely study the financial reports of the company.
  • Find the company’s competitors/rivals and study them.
  • Check the company’s debt and compare it with rivals.
  • Analyze the company’s prospects.

Importance and Benefits

Fundamental analysis of a company helps you get to its stock’s fair price, which may not always be trading at its fair value. Often it is overpriced or underrated.

Fundamental analysis helps in predicting the long-term trends in the market. It is generally used for long-term investments as it enables you to understand the price that the stock should reach. It also allows you to find good companies for investment, such as those with strong growth potential.

Additionally, the analysis helps with one of the most critical but intangible factors – business acumen, which is highly beneficial in investment analysis as it can tell you about the future of the business.

Fundamental Analysis (FA) vs. Technical Analysis (TA)

Many investors get confused between two terms or use them interchangeably – technical analysis and fundamental analysis.

Fundamental analysis of a company seeks to make a studied guess on a company’s cash flows based on how the economy, industry, and the company will perform. With this, the investor gets an idea of what the company/stock is worth.

On the other hand, technical analysis looks at internal market data such as price and trade volume. The focus of technical analysis is on identifying patterns and trends that will repeat so that the trader can capitalize on them.

Fundamental Vs. Technical Analysis:

Technical analysis uses past data of a stock to predict future price movements. Fundamental analysis instead looks at economic and financial factors that influence a business. So, let’s dive into the details of how fundamental analysis and technical analysis differ. Technical analysis uses past data of a stock to predict future price movements. Fundamental analysis instead looks at economic and financial factors that influence a business. So, let’s dive into the details of how fundamental analysis and technical analysis differ.

  • The first step to technical analysis starts with charts, whereas fundamental analysis it starts with the company’s financial statements. In fundamental analysis, you will have to determine a company’s intrinsic value by looking at its income statement, balance sheet, and cash flow statement. The intrinsic value of a stock can be determined by discounting the value of future projected cash flows to the net present value. If the stock trades below the company’s intrinsic value, you can invest in it. But, technical analysts believe that a stock’s price already reflects everything that has or could affect a company.
  • The time horizon in fundamental analysis is often long-term, as opposed to a short-term approach taken by technical analysis. With the approach of fundamental analysis, you should wait for a long time before a company’s intrinsic value is reflected in the stock market. In technical analysis stock charts can be delimited into weeks, days, or even minutes.
  • Technical analysts and fundamental analysts have very different goals in their minds. Technical analysis will demand that you identify many short- to medium-term trades where you can earn a profit, whereas fundamental analysis demands you to make long-term investments.