Fundamental Analysis: A Read-through

Fundamental Analysis: A Read-through

Definition of Fundamental Analysis

Fundamental analysis is a method of assessing the intrinsic value of a security by analyzing related economic and financial factors. Analysts using this approach brood over anything that can potentially make an effect on the value of a security. The study starts with squeezing macroeconomic factors, including the state of the economy and industry conditions down to microeconomic indicators, including the effectiveness of the management of the company.

The primary aim of this method is to yield an estimated number that an investor can compare to the current price of a security to check if it is overvalued or undervalued.

This specific approach is precisely the opposite of the method called Technical Analysis which deals with predicting price movement by analyzing historical market data zeroing in on volume and price.

How Fundamental Analysis works

Stock analysis is conducted to determine the value of a security (whether it goes over or under) when compared to another security. In the same way, fundamental analysis is conducted taking in the macroeconomics and microeconomics combined to single out a security that is either overvalued or undervalued by the market.

When analysts and researches conduct an analysis, they usually start from the broadest aspect which is the economic condition, then, narrow it down to the specific industry where the company operates, up to the specifics of the target company before coming up with an acceptable market value of the stock.

The most important material needed when conducting a fundamental analysis is the real public data to yield a realistic market value of a bond. This can be in the form of interest rates by central banks, economic growth rate, and all other significant economic indicators. For stocks, however, analysts gather figures of profit, growth, equity, profit margins, etc. 

Using the Fundamental Analysis approach to make investment decisions

Researches would recommend the most strategic move based on the results of the study using the Fundamental analysis. If it turns out that the intrinsic value of a stock is relatively above the current market price, the stock is considered “undervalued” and recommends the investor to make a “buy” move. On the other hand, if a below-the-market price intrinsic value of a stock is yielded, that stock is labeled as “overvalued,” and the analyst recommends the investor to make a “sell” move.

A sound move when making crucial buy and sell of stocks is formed through the thorough conduct of fundamental analysis: take a “short” position or sell your shares from underperforming companies and take a “long” place or buy shares from relatively god-performing companies. An investor buys when he expects a price increase of the stock and sells it when he expects the stock price to go down and repurchase it for a relatively lower price.  

Downsides of the Fundamental Analysis as an Approach

Since Fundamental analysis is the conversed version of Technical analysis, analysts using the technical method have thrown shades toward the Fundamental way and cited the following notions:

  • The fundamentals of the market are insignificant as trades are based on the stock movements of volume and price.
  • Trade momentum and time-to-time movements are the sole basis for going short or long in trade position

On a different level, believers of the Efficient Market Hypothesis school of thought oppose the idea of both approaches above, claiming that:

  • Both fundamental and technical analyses are inessential to the investor’s decision to take long or short positions when trading stocks.
  • The market sets the price of all stocks efficiently (hence, the name of the proposition) and traders cannot outperform the market by analyzing trends, and economic indicators, as well as price movements.

Fundamental Analysis in Action

To give readers a mental map of how fundamental analysis is done, let’s look at Google and its trademark as the leading search engine operator in the world. Researches should look closely at its earnings per share, dividend payout, among the quantitative factors of analysis to make a fundamental approach in analyzing Google as a company to invest in. 

But the study does not end there and goes beyond by acknowledging its brand and consumers’ outlook at the brand. A lot of other search engine tools are coming to existence, but not as many as billions of internet users know those other brands compared to Google.

Although fame not secure and measure a firm’s total worth, the patented brand puts weight and speaks volumes about the company’s current value and future growth amid the presence of competing companies out in cyberspace.