What is a Fundamental Analysis?

Published by Thomas Herold in Economics, Investments

'Fundamental Analysis' is explained in detail and with examples in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Fundamental analysis is a method for evaluating stocks and other instruments to learn the value of the shares based on two ideas. These are the factors that impact the actual business of a company in the here and now as well as its prospects for the future. Fundamental analysts most commonly consider individual stocks, but they can also use the method on the whole economy broadly or on individual industries more specifically. In its simplest form, this is the idea that individuals can determine the economic health of a financial issue or entity using information about the entity itself. The opposite idea to fundamental analysis is technical analysis.

Performing fundamental analysis involves looking at a number of different pieces of information on the given company. This information can be broken down into quantitative and qualitative components. Quantitative information analysis considers expenses, revenues, liabilities, assets, and other important financial elements that a company possesses. These numbers are tangible and demonstrate how the company share price should perform in the future based on how the company is doing now in the present. Financial analysts find most of this information in financial statements of the company they are considering.

The second component of Fundamental Analysis, qualitative analysis, is more difficult to define. Simply put, analysts determine qualitative measures from the quality of the company instead of its size and market share. This contemplates the parts of a company’s business that are more intangible and hard to measure. Among the things considered in qualitative analysis are the company executives and board members and their quality, the unique technologies a company possesses and its patents, and the recognition of its brand name. Analysts find some of this information in a company annual report presentation.

The goal of fundamental analysis is to answer a range of different questions that help to decide if a stock or industry is worthy of investment.

Some of these questions concern the following:
is the corporation increasing its revenue, will it be solid enough to beat competition not only today but tomorrow, can the company pay back its debts, and is the company earning a profit.

There are two main assumptions in which this type of analysis believes. Fundamental analysts are trying to measure intrinsic value. One of their main ideas is that the actual price of a stock on any given day does not equate to the true intrinsic value of the stock.

A second principal concept is that stock markets may not reflect the fundamental values for particular stocks now. These analysts believe that the markets will demonstrate fair intrinsic values over time. This time frame could be in coming days or even over years.

The entire goal in determining intrinsic value is to know at what price a stock should be fairly valued. Investors focus on this company in an effort to learn the intrinsic value so that they can buy the shares of the stock at a discount to this fair value. The idea is that given enough time, investments will make money when the market value of the stock rises to meet the fundamental fair value.

This study does not only look at the individual companies by themselves. It also considers the overall industry of which a company is a part. This is an important part of fundamental analysis.

When looking at an industry, fundamental analysts consider many different factors. They look at how many customers make up the industry base. The market share that a company possesses within the overall industry is also crucial information. Actual measurable growth of the industry reveals what the company’s future prospects are likely to approximate.

The number and strength of the competitors helps to explain what the company is up against within its own field. Finally, any governmental regulations on a given industry can massively impact the prospects and potential for any and all companies competing within the industry.

Fundamental analysis is criticized by two opposing ideas. Technical analysts argue that all of the information the fundamentals embody are already factored in to the value of the stock as it trades on a daily basis. Technical analysis states that this is a pointless exercise to go through, gather, and contemplate the various underlying components such as profit and loss or assets and liabilities.

The other main opponent to fundamental analysis is the efficient market hypothesis. The followers of this concept argue that individuals can not outperform the stock market over the long term regardless of how much information they gather and consider. They believe that the market itself already prices all stocks effectively on a constant and continuous basis. These proponents argue that the countless investors who participate in the markets all negate any advantage that fundamental or technical analysis would provide, so that no one is able to outperform the overall stock market over time.

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The term 'Fundamental Analysis' is included in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.