Fundamental analysis is an important concept in investing. In fact, all types of investing has to undergo studying some fundamentals. The subject of fundamental analysis is also very vast. However, the most important part of fundamental analysis involves inquiring the financial statements. This involves looking at revenue, expenses, assets, liabilities and all the other financial aspects of a company. Fundamental analysts look at these pieces of information to gain an insight into a company’s future performance.
Fundamental analysis consists of a systematic series of steps to examine the investment environment of a company and then identify opportunities. Some of these are:
- Macroeconomic analysis – which involves analysing capital flows, interest rate cycles, currencies, commodities, indices etc.
- Industry analysis – which involves the analysis of the industry and the companies that are a part of the sector
- Situational analysis of a company
- Financial analysis of the company
Fundamental analysis is a stock valuation methodology that uses financial and economic analysis to picture the movement of stock prices. The fundamental data includes the company’s financial reports and non-financial information such as estimates of its growth, demand for products sold by the company, industry comparisons, economy-wide changes, changes in government policies etc.
The outcome of fundamental analysis is a value of the stock of the company called as Intrinsic value. This is often called a price target in jargons of fundamental analysis.
According to a fundamental investor, the market price of a stock tends to revert towards its intrinsic value.
If the intrinsic value of a stock is above the current market price, the investor would purchase the stock because he believes that the stock price would rise and move towards its intrinsic value.
If the intrinsic value of a stock is below the market price, the investor would sell the stock because he believes that the stock price is going to fall and come closer to its intrinsic value.
To find the intrinsic value of a company, the fundamental analyst initially takes a top-down view of the economic environment; the current and future overall health of the economy as a whole. After the analysis of the macro-economy, the next step is to analyse the industry environment which the firm is operating in. One should analyse all the factors that give the firm a competitive advantage in its sector, such as, management experience, history of performance, growth potential, low cost of production, brand name etc.