Discussion Topic: Fundamental Analysis
Today, we will discuss few very basic lessons of fundamental analysis. Here, you will get to know that what is fundamental analysis in stocks and forex trading? How it is done? And what are the advantages and disadvantages of fundamental analysis?
What is Fundamental Analysis? – Definition
Fundamental Analysis (FA) commonly refers to a group of methods used to analyze and evaluate every type of securities. Balance sheets, income statements, cash flow statements, and other publicly available documents are used to analyze the financial health of a company or the security in question.
Economic data such as unemployment rate, interest rates are also considered while doing fundamental analysis. The goal is to find out stocks/securities that are trading at a discounted price from their true (or “intrinsic”) value and thus may witness an increase in the stock price in future.
How Fundamental Analysis Works?
FA become essential when an investor wishes to invest in a business for the long term (let’s say 2 -10 years or more). At that time he/she has to understand the business from various perspectives. It becomes critical for an investor to eliminate the daily short-term noise in the stock/forex prices and focus on the underlying business performance or country's economy. Over the long term, the stock prices of a fundamentally strong company/currency tend to increase, thereby creating wealth for its investors.
For example, below are the primary factors to evaluate when conducting the fundamental analysis of a company:
- What is the company’s revenue?
- Are they making a profit?
- Is it growing?
- Are they paying off debts?
- What are their turnover rates?
- Does management take care of employees? etc.
What is the Difference Between Fundamental Analysis and Technical Analysis?
Since a few decades, there is a constant clash between the Fundamental Analysis and Technical Analysis. Often they are mistakenly presumed as a competitor to each other.
Many technical analysts say that there is no need to analyze the corporate and economic data to determine a company’s value, as the factors of TA says every market data is already reflected in the price [see the assumptions of technical analysis]. Instead, they focus on using various methods (indicators/price action) to predict where price will go in the future. They may consider price volatility to predict the strength and duration of a movement or may apply formulas such as MACD, Bollinger Bands, moving average etc to determine the price movement.
Similarly, many fundamental analysts say that the intrinsic value of the company is all that someone needs to know. For that, they may analyze EPS, P/E Ratio, balance sheets, cash flow statement etc.
The above theories lead to a misconception that fundamental and technical analysis is in competition and an investor must take one of them as a choice. But, we say that they both complement each other and should be taken care of jointly to maximize your return.
Tools Required For Financial Analysis
The minimum sets of tools that are required for fundamental analysis are extremely basic, and most of them are available for free. Being more specific, you would need the following:
- Annual report of the company: This is the single document that contains every little piece of information that you need for FA. The best part is that you can download the annual report free of cost from the company’s website.
- Industry related data: You will require industry data to see how the company is performing with respect to the industry's average or competitors. Basic data is available for free in the industry’s association website.
- Access to the news: Looking into the Daily News will help you stay updated on latest changes happening both in the industry and as well as in the company you are considering. You may start following a good business newspaper or services such as Google News, Google Alert etc.
- A Spreadsheet Application: You need to use a spreadsheet application like MS Excel or OpenOffice etc for doing fundamental calculations.
With just these four basic tools, you can start doing fundamental analysis at a highest possible level. In fact, even at the institutional level (FII & DII), the goal is to keep the research as simple as possible and as logical as possible.
Facts That You Need to Consider While Doing FA:
Below are all the facts and points that you will need to consider while doing the fundamental analysis. Though all of them are not equally important, still you need them to take an accurate decision.
Assets - Current
Assets - Fixed
Cash on hand
Discounted Cash Flow
Equity Risk Premium
Expenses Good Will
Gross Profit Margin
Liabilities - Current
Liabilities - Long-term
|Net Profit Margin|
R & D
Weighted Average Cost of Capital
Also, there are some ratios that need to be calculated while doing fundamental analysis:
Do not get confused with all these things; we will gradually discuss every individual thing.
We hope that you have enjoyed the above article explaining what is meant by fundamental analysis. Be with us to explore forex trading, stocks trading, and other money-making opportunities.
Leave us some comments if you have any questions or doubts about any of the aspects of the FA, we will definitely try to help you.