We can say that fundamental analysis is the polar opposite
of technical analysis. Where technical analysts use indicators and technical
charts, fundamental analysts use micro- and macro-economic factors.
Fundamental analysts typically find a stock’s intrinsic
value. They also use different quantitative and qualitative factors. Most of
the time, fundamental analysis applies to the stock market, but you can also use it for other
securities such as currencies, derivatives, or bonds.
Let’s break fundamental analysis and see if this one’s the
best investing approach fit for you.
The Questions You Need to Ask
For stocks, fundamental analysis’ goal is to find the securities’
value. Fundamental analysts do this by studying the underlying factors that can
affect a company’s actual business and its long-term prospects.
In addition, you can do fundamental analysis on industries
and different economies as a whole. The following are the questions that you
need to ask if you want to perform a thorough fundamental analysis.
1.
Is the revenue growing?
2.
Is it earning profits?
3.
Can it beat its competitors in the future?
4.
Is the management cooking the books?
5.
Can it pay back its debts?
These are very important questions to answer. However, these
are just primers, and there plenty other questions that you can ask. The main
question that you are trying to answer here is: is this company’s stock a worthy investment?
What is “Intrinsic Value”?
When we say intrinsic value, we refer to the actual value of
an asset. When doing this, you have to consider many underlying factors,
aspects of business, and the overall perception of that stock’s value.
You have to remember that an asset’s intrinsic value may or
may not be the same with its current market value. In addition, the intrinsic
value is used generally in options pricing, indicating the amount of the option
in the money.
In effect, finding the intrinsic value of an asset is the
ultimate goal of fundamental analysis. This is because one day, one way or
another, the market will reflect that asset’s intrinsic value. When you figure
out the asset’s intrinsic value, you give yourself many opportunities.
You can try to hunt for assets that are undervalued, or
those that have current market prices that are lower than their intrinsic or
actual value. Once you find one, you can bet on it and go long. If your
assessment is accurate, you earn profits. You can go short if you think the assets' current market price is higher than its intrinsic value.
However, the main problem with fundamental analysis is that you
are faced with a couple of giant questions that cannot be definitively and
conclusively answered. First, you can’t be so sure if your determined intrinsic
value is correct. And then, you cannot know how much time it will take for the
markets to reflect that intrinsic value.
Quantitative and Quantitative Factors
When talking about fundamental analysis, quantitative
factors refer to those that are capable of being measured or expressed in
numbers. On the other hand, qualitative factors refer to the quality or characteristics
of a business or an asset.
Both qualitative and quantitative factors are important for
a fundamental analyst. The important thing to remember is that you should use
these two in conjunction with each other since both contribute to the final assessment
of an asset’s overall intrinsic value.
Read further: Active Management: Know the Basics
Conclusion
There’s a lot more to learn about fundamental analysis. However,
the most important thing to remember is that fundamental analysis is a big must
in the world of investing, even if other investors ditch it for technical
analysis. In fact, both kinds of analyses are helpful for investors who want to
outperform the market.
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