The fundamental stock analysis focuses on determining whether a stock’s market price goes below its intrinsic or fundamental value. The intrinsic value of a company is also referred to as its actual value. This is based on several underlying factors that have influenced it over time.
This method evaluates with the assumption that the current undervalued stock would be priced equal or greater than the company’s intrinsic value in the future. Therefore, investing in an under-valued stock will allow investors to gain profits once the stock reaches or increases beyond its actual value.
To date, certain laws have required trading companies to keep their financial information transparent, allowing analysts and investors to use those facts to conduct a fundamental analysis.
Factors to consider in Fundamental Analysis
Knowing what factors to check is the first step to properly conducting a fundamental analysis. Make sure to get your facts straight and your data as accurate as possible. This will increase your chances of arriving at the best outlook you can have on your investments.
Here are some factors to focus your research on:
Before everything else, consider whether the company you are planning to invest in is in a healthy financial condition. If the company does not get a good hold on its finances, chances are you would lose hold of your investment, too.
Revenues and Profits
These two are signs that a company is growing or gaining momentum, and same goes for a company’s stock price. It is also important to watch the company’s generated income. When it seems as if they are not earning enough to back the value of their stock, they are most likely overpriced. Also, if you happen to invest in a company that slowly generates revenues and profits, your stock will also end up growing slowly. So, keep your eye on these two and check them carefully.
Debts and Loans
Make sure the company is fully capable of paying back what they owe. Determine how long it would take them to pay their dues and most importantly, if they can. Find out if their cash flow generates enough spare to pay their debt or to improve or grow their company. Remember to choose a company that can guarantee your investments’ payback and security.
Economic Outlook and Market Opportunities
Find out about are the plans of the company for the future. Are they planning for any future expansions? Will they improve the quality of their products, delivery, or services?It is important to note whether the company has what it takes to be in the competitive scene. This will decide how your stocks will fare in the long-run. Do not let your money run loose on a company that does not know where it is heading.
These are some of, but not limited to, what analysts evaluate beforehand to decide whether it is worth to invest in a company’s stocks. This method is best used when investing is the main goal. Most analysts and investors use this method for generating long-term profits.
Two Major Assumptions
In fundamental analysis, investors and analysts focus on a company’s history and financial data in the long run. There will be focus on two major assumptions:
- Over time, the stock price will correct itself.
- You can gain profit by purchasing under-valued stocks, and then waiting until they are priced right.
This method of analysis looks backward and forward by properly evaluating investing pros and cons through a closer look at its finances. This is possible by interpreting financial statements and income sheets to identify and evaluate how the company uses and where it allocates their resources. The best way to do this is by calculating and using ratios to get the company’s intrinsic value and comparing that to its current price on the market.
When investors and analysts refer to fundamental analysis, they are usually talking about ratio analysis. Ratio analysis uses current and previous financial data of a company to evaluate its performance. It is also used to determine:
- whether the company is improving or not.
- if the company fares well in terms of the industry’s average.
- how does a company compare to another.
Most investors and analysts use two main ratios. The Price/Earnings and Price/Earnings-Growth ratios.
The Price/Earnings or P/E ratio is so widely used to the point that several stock charts provide this number for your convenience. This is because the price/earnings ratio or the P/E ratio is considered as the cornerstone for fundamental analysis.
This ratio determines how much an investor pays for a dollar of the company’s earnings and evaluates whether a stock is over or undervalued by dividing the price per stock by the EPS. To get the EPS, simply divide the profit with the outstanding stocks.
In calculating the P/E ratio, you need the company’s financial data to evaluate it and compare it with its previous trends or estimate future ones. When you make calculations using the past 12 months’ data, you will get the trailing P/E ratio. On the other hand, if you use the trend estimates, you will get an estimated future P/E ratio.
Between the two, it is better to use the trailing P/E since results based on calculating estimated values are not reliable and accurate.
The Price/Earnings-Growth or PEG ratio uses the stock’s capability to grow over time to determine its value on the market. A PEG which has a value less than 1 means that a stock is undervalued, and therefore a good investment. If the value is over 1, then the stock is overpriced.
The PEG ratio is calculated by dividing the P/E ratio by the earnings growth rate. This produces similar results as that of the P/E ratio but generates more accurate and comprehensive predictions.
Using this kind of analysis highlights the use past market data and trends to predict future stock prices. To technical analysts, diving into a company’s financial statements merits no importance. Instead, they focus on the stock’s value and where it is heading.
But do take note that this method relies on information on the stock’s supply and demand variability and is not effective in cases that involve external factors, such as; calamities, lawsuits, terrorist attacks, policy changes, and even the death of a CEO.
Three Major Assumptions
In technical analysis, investors and analysts focus on price movements and market psychology. The evaluation is done with three major assumptions:
- Price discounts everything. The idea that everything about the company is reflected in its stock’s price on the market.
- Price trends are not generated randomly. In this concept, analysts believe that the company’s stock trends have a pattern and most likely;
- Price trends will repeat itself.
This kind of analysis looks backward to determine whether a stock is worth buying and whether it will be profitable for trading. This is the reason it is used for short-term and fast-paced stock buying. With this method, traders buy stocks when they believe that they can be sold for a higher price in the immediate future.
If the fundamental analysis’ cornerstone lies with ratio analysis, technical analysis utilizes stock charts.
These charts which contain valuable data on a stock’s supply and demand allow analysts to make suggestions based on identified patterns and probable future values. It ranges from simple line charts and bar graphs that may be scaled by time or by the stock’s price ranges.
With charts, analysts mark areas depending on whether they are of support or resistance levels. Areas that are on support levels indicates prices which are below the current trading price while those marked as resistance areas are prices which are above the current price. This form chart patterns that are either reversals or continuations. Reversals are patterns which foresee a change of trend while continuations expect that the trend will continue once the pattern reaches its completion. This is based on the assumption that the price trends will eventually repeat itself.
Fundamental or Technical?
With the fundamental analysis, you ask yourself: How will the company’s history and financial situation affect their stock price in the future?
In technical analysis, the questions will be something akin to: According to the previous data on this company’s stocks, will I be able to sell them for a higher price soon?Or would you rather look at both?
Either of the two and even both together cannot give you the perfect evaluation, but it would help you decide.
In the end, the kind of analysis to use entirely depends on you.
Choosing the method to analyze stocks all depends on where your intuition and strategy leads you.
Some investors use both fundamental and technical analysis to properly evaluate potential investments while others prefer just one. Keep in mind that in the end, it will be you who decides whether to invest or not and the methods are only there to help you arrive at a decision.
Aside from using these two methods to the best of your abilities, it is also important to keep yourself updated on the national and international economic news and trends. Since neither of the two acknowledges one major factor in stock price: the economic condition of the country where the company you are evaluating is in. Knowing the state of the region where the company and stock exchange takes place is also important.
If you ever try your hand at investing, we hope that this helped.
Evaluate properly and invest wisely.