Beginner’s Guide: Fundamental Analysis

Wed Jun 15, 2022, 11:56 am | by Azhar Khan | No comments

Fundamental and technical analysis are arguably the two main types of stock analysis, and great strategies to understand. We’ve already covered technical analysis in a previous blog post. This blog post will cover all you need to know if you’re wanting to get in on fundamental analysis strategies. While these two methods of stock analysis are often thought of as direct opposites of each other, many traders use both in their trading strategy—you don’t necessarily have to pick one or the other. 

Keep reading to find out how you can implement fundamental analysis into your trading strategy today!

Definition of Fundamental Analysis 

Fundamental analysis is one way to analyze securities, including stocks, bonds and derivatives. Fundamental analysis measures the intrinsic value of the ticker using factors such as macroeconomics, microeconomics, and financials. 

At the end of the day, fundamental analysts want to determine a price to compare with the current price to determine if the stock is under- or overvalued. Unlike technical analysts, this method of stock analysis does not use historical market data. Fundamental analysts will use factors such as competitive advantage, balance sheets, cash flow statements, and more. This type of data is known as quantitative data, one factor that is set as the foundation of fundamental analysis. 

Another factor fundamental analysts will look at is the qualitative data of a company. These factors include things like brand recognition, company executives—how well they’re managing the company, patents pending, and other factors that could directly affect the quantitative data of the company.

Fundamental analysts typically start with assessing the economic conditions, then move toward a specific stock.

Fundamental Analysis Quantitative Factors

As a fundamental analyst, it’s critical that you understand the underlying factors affecting the stock you’re analyzing. Without understanding what’s moving the stock, your predictions in price movement may be way off. Benzinga Pro allows you to view all of these financial statements in an easy to navigate and easily digestible platform. 

Earnings 

A good place to start when fundamentally analyzing a stock is to start with the company earnings. You want to know how much a company is making in profit, and what will they likely make in the next few quarters. Every publicly traded company reports earnings each quarter. More times than not, when earnings expectations are exceeded, it leads to a higher price, and when earnings miss, they can drive a price lower. Of course, there are always exceptions. 

You can also go deeper than just earnings, here are a few earnings ratios you’ll want to pay attention to:

  • Earnings per share (EPS) – How much of a company’s profit per share 
  • Projected earnings growth – The expected one-year earnings growth rate of the stock. P/E divided by the growth rate. 
  • Price-to-earnings ratio (P/E) – Current stock price/earnings per share 

Balance Sheet 

Investopedia defines a balance sheet as, “a financial statement that reports a company’s assets, liabilities and shareholder’ equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure.” 

  • Assets: What a company owns, such as cash on hand and inventory. 
  • Liability: What a company owes, including worker pay, taxes, rent, and more. 
  • Shareholder Equity: Total assets minus liabilities 

The balance sheet can show you a company’s current and long-term liabilities. Additionally, you can review the company’s equity which will inform you of how well a company is performing. Using the balance sheet gives you a high-level picture of the business, but should still be used with other financial statements.

Cashflow 

The cash flow statement specifies the amount of cash that goes in and out of a business. There are typically three types of cash flow reports: 

  • Operating Cash Flow – Cash generated from business operations
  • Cash from Investing – Cash invested in assets or acquisitions. 
  • Cash from Financing – Issued or borrowed cash 

Some analysts emphasize cash flow due to the fact it’s hard to manipulate. Ultimately, it’s useful to determine how much cash is in the bank for a company. Cashflow is also important so companies can pay dividends and operating costs (such as goods and services needed, wages, utilities, etc). 

The more cash positive, the more likely a company will survive a recession or hard economic times. The more debt a company has, the harder it will be to make acquisitions or protect itself during economic hardships. 

Income Statements

The income statement details a company’s revenue and expenses during a given period. It reports: 

  • Revenue 
  • Expenses 
  • Gains 
  • Losses 

Ultimately, it tells you whether or not the company profited or lost money in the given time period. These are usually released quarterly or annually. 

Fundamental Analysis Qualitative Factors 

There are four leading qualitative factors to consider when conducting a fundamental analysis. Qualitative factors aren’t just hard numbers like revenue or profit but can include things like quality of management, brand-name recognition, and more. There are four fundamentals to consider: 

  • Business Model: How is the company making money? 
  • Competitive Advantage: How unique is the company, and how many competitors does it have? Does it have a bigger brand name recognition? 
  • Management: What is the quality of leadership? Did the current leaders perform well at their previous positions? Are they buying/selling large amounts of shares? 
  • Corporate Governance: What are the responsibilities of the stakeholders? Do they have bylaws and regulations to follow? Do they have transparent communication? 

Other qualitative factors to consider include the industry, market share, regulation, customer satisfaction, pending lawsuits, and more. 

Fundamental Analysis v. Technical Analysis 

Fundamental and technical analysis are the two main types of stock analysis. One may fit your trading strategy better than the other, but you don’t have to pick just one. 

Technical analysts believe that a company’s intrinsic value is already incorporated into the stock’s price. Instead of looking at the fundamental data, they focus on analyzing historical data to determine where the price will move next. They will analyze charts and use indicators like MACD, moving averages, support/resistance levels, and more. 

Another key difference between the two is the time spans they’re analyzing. Fundamental analysts are more interested in finding insights about past performance because they believe this can help indicate current or future price movements. 

Technical analysts are interested in looking for patterns, which is why they focus more on information pertaining to short-time periods. Technical analysts believe that patterns repeat themselves, so if you see them in shorter time periods you’ll most likely see them again in the future.

Limitations of Fundamental Analysis

One limitation of fundamental analysis is that a stock may simply not trade at its intrinsic value. Whether it’s an internal or external catalyst, news, rumors, and economic conditions can affect what happens to a stock. 

Another limitation is that it is more time consuming than technical analysis to combine the data and come to a calculated price. Plus, much of the data fundamental analysis relies on is previous data instead of what is happening in the future. So, as new data and reports arrive, you may have to alter your strategy to keep up with recent data.. Additionally, you may need to hold onto a stock for a while before you get to the projected price, depending on the time you enter your position. 

One last criticism of fundamental analysis is that it can be biased based on your interpretation of the data and company. 

Final Thoughts 

Fundamental analysis is just one way to analyze a stock. In this method, analysts seek to find the intrinsic value of the stock by using the overall economic conditions and the company’s financials to determine a value.

This method looks at both quantitative and qualitative factors, including earnings, cash flow, management, and more. This strategy can be best implemented if you’re a trader wanting to hold longer positions. However, you can always alter this strategy to fit your unique trading plan.

You don’t have to pick one way to analyze a stock—you can use many factors, indicators, and catalysts to make informed trading decisions.

Disclaimer: Benzinga is a news organization and does not provide financial advice and does not issue stock recommendations or offers to buy stock or sell any security. Benzinga Pro is for informational purposes and should not be viewed as recommendations. Benzinga Pro will never tell you whether to buy or sell a stock. It will only inform your trading decisions. You can find our full disclaimer located here.