Fundamental Analysis is a metric of evaluating a stock’s intrinsic value of a business by looking at the fundamental or basic financial level. It uses key business ratios to examine the business’s financial health. In other words, it’s based on financial and economic factors.
The main aim of Fundamental Analysis in company valuation is to come up with a number that an investor can compare with the current security price to know if the security is overvalued or undervalued, whether privately traded or traded in Philippine Stock Exchange.
Also, Fundamental Analysis can help you know the status of the future company’s stock. This metric considers some factors, such as the interest rate, revenue, business production, as well as asset management.
Reasons for using Fundamental Analysis
Understanding the concept of fundamental analysis can help you make the right decision when trading in securities. It helps you to determine if a stock in the market is valued.
Analysts consider both micro and macro factors to know how stocks are trading- either lower or higher. Unpriced shares can be worth investing more money because they can turn higher earnings. This can be true when it comes to undervalued stock.
The secret that analysts use is to first look at the big picture of the company then narrow down to minor/small details. They carefully evaluate the state of the economy first and then consider the trading stock-both low and high. It’s through this research that the analyst knows the fair market value of a particular stock.
Take an example with an analyst who studies economic factors such as the performance of the bond issuer and interest rates to determine a bond’s value.
Assessing Company’s Performance
More importantly, Fundamental Analysis uses earnings, profit margins, revenues, expected growth, return on equity and other related tools to show a company’s value and performance. This method emphasizes looking at the financial statements over the past years or months.
Most investors use Fundamental analysis in evaluating securities. The sure indicator that you are using Fundamental Analysis is when you find yourself focusing on the big picture of a company, the state of the economy, the company’s financials, and industry.
Qualitative and quantitative Fundamental analysis
There exist some factors that determine what fundamentals to use in analyzing securities. This can call for examining any economic factor in a company. As we’ve mentioned earlier, most analysts use profits, losses, and revenues over a given time. They also compare the performance of the company as well as the current market share.
These fundamentals are categorized into two: a qualitative and quantitative analysis.
Qualitative Fundamental Analysis
It refers to the kind of data that relies on the character or quality of something, such as the reviews and ratings of customers and the way the company is managed. It’s simple to determine since it doesn’t include arithmetic or numbers.
In other words, it usually consists of impressions. Some good examples include: seeing how the key executives of that company are doing in social media, if the brand has many market shares or whether their patents are of high quality. Combining this kind of data with quantitative analysis ensures you understand the stock’s fair market value.
Quantitative Fundamental Analysis
On the other hand, quantitative fundamental analysis means that the data must be measured and presented numerically. This can be in the form of the number of revenues, production costs, and the number of sales.
This category transforms data into tangible/hard numbers. It’s from these numbers that you can tell how many sales were made in a year or quarter. Again, you can compare the company’s profits for one period with another. You can now understand why investors and analysts focus more on financial statements.
In summary, you’ve all the reasons to combine both qualitative and quantitative analysis since a company may record great financial statements but recently produced low-quality goods that led to poor customer satisfaction.
Factors to consider in Fundamental Analysis
This factor considers the main activity of the company, the growth potential, and where they rely on financially. Be sure to check their status of making money via multiple methods.
Honestly, an excellently managed company will continue making profits even when the economy is crawling. See if their executives are trustworthy and if they are experienced.
How is the company ran? Fairly? If it’s not run ethically, efficiently, and transparently, that’s a red sign.
Is the company investing in ideas to outdo its competitors? You have to choose a company with a competitive advantage since there’s always a high competition. For instance, see companies like Microsoft and Coca Cola.
These are factors that consider financial statements. It’s from these financial statements that companies disclose their financial performance. The key financial statements are balance sheets, income statements, and cash flow statements. They’re the ones that help investors and analysts make sound decisions.
This is a financial statement for showing the company’s assets, liabilities, and equity at a given time. It can be deduced using the formula:
Asset=Liability + Shareholders/Equity
Assets here refer to the resources owned or controlled by the company within a certain period. It consists of items such as cash, buildings, machinery, and inventory.
Liabilities indicate the amount the company must pay to debtors, while Equity represents the amount spent by the owners to fund the company.
This is another financial statement for measuring a company’s performance over a given period. It consists of items such as expenses, revenues, and profits that the business made within a given time.
Statement of cash flows
This is a financial statement that records the cash inflows and outflows within a specified period. Basically, cashflows focus on three financial-related activities which include operating cash flow, cash from financing and cash from investing.
Pros of Fundamental Analysis
Provide the right information. Securities need the right information to avoid making wrong decisions. Brings out the value of an asset. It’s from this value that you can make a long-term view of the security market.
Cons of fundamental analysis
Time-consuming. Yes, you’ve to analyze from multiple sources.It takes longer to arrive at the right decision. If you need to arrive at a quick decision, this can’t help you.