Fundamental Analysis Guide: Definition & Overview
If you’re doing any business or accounting finance, there’s a good chance you’ve heard the term fundamental analysis. Fundamental analysis is a complex process that helps to determine a stock’s value. The value you determine is also known as the stock’s real, or “fair market” value. Are you encountering fundamental analysis in your life? Take a look at our guide to this investment strategy!
Here’s What We’ll Cover:
What Is Fundamental Analysis?
Fundamental analysis, abbreviated FA, is a comprehensive method used to determine a stock’s value. It is a method that’s very different from technical analysis. Technical analysis uses market data and price movements to make a determination. However, fundamental analysis looks at the big picture. Both methods are a way of determining if the current market price for a stock is fair.
What Does Fundamental Analysis Look At?
FA reviews things on a big picture scale. It looks at both macroeconomic factors and microeconomic factors equally. It also looks at outside factors that aren’t as easily reviewed as numbers may be. The two are very different from one another, but play a role in knowing if a company’s stock is undervalued or overvalued.
Quantitative factors are easy to determine. Quantitative simply means numbers. These are measurable in such a way that they can be seen on datasheets. Some of the most important quantitative measures surrounding a company are below:
The Big Three Financial Statements
There are three major financial statements that are considered quantitative. They provide a lot of numerical data in themselves and don’t require much else for review of a company’s worth.
- The Balance Sheet: The balance sheet provides a record of a company’s finances. It’s like a snapshot of everything they own. It includes their assets, liabilities, and equity. These can be used to find a number of key ratios that indicate how well a company is doing. They include the debt-equity ratio, the earnings ratio, and the overall financial ratio. The debt-equity is particularly helpful.
- The Income Statement: An income statement is a more in-depth look at a company’s success. It provides information about revenues, expenses, and profit over a period of time. An annualized income statement will give you all information for an entire year.
- Statement of Cash Flows: This is also known as the cash flow statement. These will focus on all inflowing and outflowing cash in a business. The three most common flows are cash from investing, cash from financing, and operating cash flow. Using a statement of cash flows tells you exactly where a business’s money is going to or coming from.
Qualitative factors associated with a business are harder to gauge. They deal less with solid numbers and more with the other parts of a business, like management and people. There are a few key factors that fundamental analysts will focus on when doing company analysis.
Their Business Model
A company’s business model tells you all about what they do and how they do it. Specifically, it tells you how they’re making their money, and tells you whether or not they’re viable in the current market.
Competitive advantage is a bit easier to review than other factors on this list. Competitive advantage here refers to a company’s ability to set itself apart from others. Large companies have already done this, and their brand name is enough of a competitive advantage to keep them relevant. A company with a good competitive advantage is a safer investment than an unknown company, in most cases.
Company management is one of the most important pieces of fundamental analysis. A company with strong leadership and management is bound to do better than a company without it. Management is one of the most heavily scrutinized factors according to fundamental analysts.
The last qualitative factor on the list is corporate governance. Corporate governance describes the relationship between the company and several parties. These parties are its management, directors, and stakeholders. Understanding these relationships help to determine if a company is run fairly and ethically. It also helps to determine whether or not the company respects its stakeholders and shareholders.
Fundamental analysis is one way of analyzing a company’s stock and its fair market value. It’s called fundamental analysis because it looks at all of the fundamentals. These include quantitative and qualitative factors. Both are equally important when trying to predict the investment opportunities of a company.
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