Fundamental Analysis: Definition and Basic Guide for Beginners

Fundamental Analysis
Basic Investing Guide for Beginners

Fundamental Analysis
How Warren Buffet Discover His Stocks

Summarized Overview

You will learn the analysis basic concept, the assumptions, advantages and disadvantages, step by step guide on how to get started as well as some precautions while performing the analysis.

You'll also find information about the difference with technical analysis.

Definition and Basic Concept

Fundamental analysis is a practice that attempt to determine stocks’ valuation. This technique is focusing on the underlying factors that affect the company’s actual business performance and its potential growth.

Sometimes, it is referred to as security analysis. Benjamin Graham, Warren Buffet and Peter Lynch are the famous practitioners of this oldest and largest school of thought. To them, investing in stocks is like buying a business.

Assumptions of Fundamental Analysis

More often than not, the stock price does not reflect the real value of the stock itself. Market gyration and investors emotion will drive the price volatility. This result to either the stock price is overvalued or undervalued at that particular time.

In the long run, the stock price will reflect its fundamental value. This can be months, years or even decades. Nobody knows exactly when the market will reflect the stock’s true value, but its future prospect and potential growth is the best indication.

Advantages vs Disadvantages

Advantages

Fundamental analysis able to uncover the hidden gem in the stock market. This stock normally have valuable assets, strong balance sheet and stable earnings power.

It has the ability to predict long-term economic, demographic, technological and consumer trends as well. And once you bought this stock at discounted price, you will on the right track to wealth.

Disadvantages

Fundamental analyst doesn't care much of what is happening in the stock market. Due to this nature, investors might be overlooking some profits potential that exists in the stock market.

And since it is based on few assumptions, changes in potential growth can greatly affect the new stocks' valuation. You can use sensitivity analysis to decide a base-case valuation, a best-case valuation and a worst-case valuation, so that your analysis will not be so rigid.

Guide to Get Started with Security Analysis

Analyse Quantitatively

Analyst and annual reports have all the numerical figures than can be used to identify profitable stocks. You will discover how much profit the company is making, how does it perform compared to the previous year and how much cash it has in hand. At least, you have to look for its key financial ratios to have some picture on how the company is performing fundamentally.

And don’t forget to compare them with the industry average too; as you’ll know the stocks’ position when compare to its competitor. Then, you have to calculate intrinsic value and realize its fair price after you’d determine margin of safety.

Evaluate Qualitatively

Try to value some other intangible assets surrounding the businesses. This includes its brand recognition, patent and copyright value or its proprietary technology. This might not be as straightforward as quantitative methods, but it is not that difficult either.

Before betting any money into that stocks, understand its business model, identify its competitive edge, recognize its business lifecycle and acknowledge its business nature. All these are explained in “Guide in Analyzing Company”.

Precautions While Analyzing

Before buying any common stock, look at the balance sheet and the income statement to evaluate the stability and creditworthiness of the business, as well as its revenue and profits.

Compare the results with number of years to obtain a sense of continuity. Companies that show consistent and steady increases are more valuable than the one with erratic and highly fluctuate earnings.

Calculate the debt-to-equity ratio relationship to see if the business is too highly leveraged. Avoid companies that have more than two-third debt; best to have less than one-third debt.

Check the auditor’s statement to see that nothing untoward
is present and that the statement conforms to generally accepted accounting principles. Any explanatory comments are cause for further examination. This information is very helpful to confirm the reports statement, which can be easily manipulated.