Definition
Fundamental analysis, in accounting and finance, is the analysis of a business’s financial statements; health; and its competitors and markets. It also considers the overall state of the economy and factors including interest rates, production, earnings, employment, GDP, housing, manufacturing and management. There are two basic approaches that can be used: bottom up analysis and top down analysis. These terms are used to distinguish such analysis from other types of investment analysis, such as quantitative and technical.
Fundamental Analysis
Fundamental Analysis is a way of getting to understand the position of a company in the market, in order to take the decision of buying or selling its shares.
What exactly is fundamental analysis?
The definition of “fundamental analysis” can be defined as – analysis that is important for doing something. In this particular case, this term points towards valuating the stock and bonds of a company, and finding out whether they are worth buying/keeping or not.
During this analysis, the investor goes through a detailed inspection – a due diligence – of a company which involves studying its balance sheets, contemplating its cash flows, and analyzing its income statement. This allows the investor to paint a clearer picture of the company’s present and future position in the market, thus helping with the decision of trading its shares.
Different aspects of fundamental analysis
During fundamental analysis, the investor goes through the complete financial statements of a company. In addition to that, he also goes beyond paper work, and sees how the company processes in order to better understand if its stocks are overpriced or underpriced. For instance, different graphs and ratios are used by the investor to compare the company’s performance with a similar industrial player.
What to look for during a fundamental analysis?
Going through the financial statements is one of the basic things you could add to your due-diligence. Following are some things you must go through while analyzing these books.
Balance sheet
When going through a balance sheet, you should see if the debts or liabilities of the company are greater than its assets. This will give you a better picture of whether the company is on the right track or not. Furthermore, the investment of shareholders in the company also lets you know if people are inclined towards its shares or not.
Income statement
The Income statement of a company will add to the information gathered from the balance sheet helping you to see the bigger picture. This document tells you the different expenses of the company in addition to its revenues. Subtracting them from each other, they also give you the net income of that company, which can be compared to the figures of other firms or with the previous years of the same company
Cash flow statement
The cash flow statement offers great insight to the debt taken by the company or the investments made by it. The cash flow statement is one of the most detailed documents of the company when it comes to the generation of revenue. It is also said to be one of the most authentic documents because it cannot be manipulated easily.
These documents along with several additional techniques, leads you towards fundamental analysis that shows the real value of a certain stock price. Based on this analysis, you can take a fair decision of selecting a share or letting go of it.
Further Reading
- Importance of technical and fundamental analysis in the European foreign exchange market – onlinelibrary.wiley.com [PDF]
- Abnormal returns to a fundamental analysis strategy – www.jstor.org [PDF]
- Fundamental analysis and subsequent stock returns – www.sciencedirect.com [PDF]
- Cost behavior and fundamental analysis of SG&A costs – journals.sagepub.com [PDF]
- Short-sellers, fundamental analysis, and stock returns – www.sciencedirect.com [PDF]
- Strategy of stock valuation by fundamental analysis – www.econstor.eu [PDF]
- A fundamental analysis of Korean stock returns – www.tandfonline.com [PDF]
- The use of technical analysis in the foreign exchange market – www.sciencedirect.com [PDF]
- The profitability and performance measurement of US regional banks using the predictive focus of the “fundamental analysis research” – www.emerald.com [PDF]
