In order to find investment possibilities, fundamental analysis looks at the economic and financial variables that can influence the value of a security in the future. Two main approaches exist in the financial markets for determining a security’s worth: technical analysis and fundamental analysis. Statistical and historical price behavior constitute technical analysis, whereas cash flow, earnings, competitive variables, and macroeconomic outlook form the basis of fundamental research.
Why use fundamental analysis?
If you look into a company’s finances and other important “fundamental” aspects, you may estimate its short-, medium–, and long-term profits.
You can learn more about the stock’s true worth beyond the current price by doing fundamental research before buying. However, different people can develop different fundamental analyses for the same stock. Therefore, you shouldn’t rely on just one source (or even the company itself) for your research; you should consult a wide range of resources. While it’s impossible to anticipate every possible detail, familiarizing yourself with the basics of a company’s background, products, industry, and recent events can lessen the likelihood of being caught unawares.
Follow the leaders
As an investor, you run the risk of losing money if you are caught off guard. However, analysts on Wall Street risk losing their jobs if they are frequently caught unawares. That’s why experts conduct in-depth analyses to find the sweet spot (just right) for a stock’s worth. For the same reason, your own core research relies heavily on their analysis.
To get a good idea of how much a company is worth, analysts employ models and formulas like the dividend discount model (DCM) and discounted cash flow (DCF). The models are simple in and of itself; they both “discount” a company’s future earnings to their current value and estimate all of that money. The challenge lies in projecting those dividends and/or cash flows into the future. You guessed it: fundamental analysis is the bedrock upon which their complex proprietary models rest. The good news is that you can pick up a lot of the analysts’ knowledge without having a doctorate in finance. They leave clues about a stock’s value, and if you know what to look for, you may follow those.
Four sources of fundamental analysis
Finding the spots where fish bite is the key to catching them. Find out where the Wall Street types hang out if you want to discover the fundamental analysis-based opinion of analysts regarding a stock. Nothing happens offline anymore. You can find the opinions of analysts in these four locations:
- Your brokerage firm. Brokerage firms usually provide free market and stock-specific analyst analysis on their websites for investors. If you are unsure of where to look, consult the brokerage. They will be able to point you in the correct path.
- Financial media. Analysts often get quoted in business newspapers and appear on financial TV networks. In particular, check the news around earnings time. That’s when the analysts usually give their two cents on the quality of a company’s quarter and what might happen next.
- Company earnings calls. If you want to spend more time figuring out where analysts stand, try listening online to a company’s most recent quarterly earnings call (they’re available in the Investor Relations section of any public company’s site). These calls provide leaders’ thoughts on demand, future plans, industry trends, and competition, followed by a Q&A between analysts and company leaders.
- Other research. Checking almost any financial site will show you analysts’ average earnings and revenue predictions for the company’s next quarter. Try searching on the stock’s ticker symbol.
Fundamentals to track
Analysts may use sophisticated formulas to reach those estimates, but it’s all based on fundamentals you can understand. These fundamentals are also at your fingertips and can provide great clues. Here are some to track:
- Past earnings results. Comb through the last few earnings reports or listen to the company’s call. Which products enjoy the most growth potential, and will they help the bottom line? What new products loom?
- Price-to-earnings ratio. The P/E ratio is the stock price (P) divided by the most recent annual earnings per share (E). A P/E is the closest thing to a price tag on a stock, giving you a sense of whether the stock trades high or low relative to the market and competitors.
- Competitive factors. How wide is the “moat” around products? Alphabet (the parent of Google) has few online search competitors, providing it a huge advantage.
- Company leadership. Does the C-suite have a track record of successful product launches, fending off competition, making accurate financial forecasts, and cutting costs? What about recent leadership changes that could shift fortunes?
- Macroeconomics. A company’s EPS estimate may need to be updated due to external factors such as political leadership changes, Federal Reserve interest rate changes, recessions, and natural disasters.
Focusing on a single industry can help you become a better fundamental analyst over time. Because of this, some investors specialize on just one area. Focusing on one thing at a time will help you become an expert forecaster, just like the pros.
Be wary of getting overly comfortable with any one investment vehicle and putting all your money into it. If you’re constructing a portfolio with the long term in mind.A well-balanced portfolio still benefits from diversification.
