Fundamental analysis

What is Fundamental Analysis

Fundamental analysis is a method of evaluating a security in an attempt to assess its

intrinsic value, by examining related economic, financial, and other qualitative and
quantitative factors. Fundamental analysts study anything that can affect the security's
value, including macroeconomic factors (e.g. economy and industry conditions) and
microeconomic factors (e.g. financial conditions and company management). The end
goal of fundamental analysis is to produce a quantitative value that an investor can
compare with a security's current price, thus indicating whether the security is
undervalued or overvalued.

Understanding Fundamental Vs. Technical Analysis

Fundamental analysis determines the health and performance of an underlying

company by looking at key numbers and economic indicators. The purpose is to identify
fundamentally strong companies or industries and fundamentally weak companies or
industries. Investors go long (purchasing with the expectation that the stock will rise in
value) on the companies that are strong, and short (selling shares that you believe will
drop in value with the expectation of repurchasing when at a lower price) the companies
that are weak. This method of security analysis is considered to be the opposite of
technical analysis, which forecasts the direction of prices through the analysis of
historical market data, such as price and volume.

The Basics of Fundamental Analysis

Fundamental analysis uses real, public data in the evaluation a security's value.
Although most analysts use fundamental analysis to value stocks, this method of
valuation can be used for just about any type of security. For example, an investor can
perform fundamental analysis on a bond's value by looking at economic factors, such as
interest rates and the overall state of the economy. He can also look at information
about the bond issuer, such as potential changes in credit ratings.

For stocks and equity instruments, fundamental analysis uses revenues, earnings,
future growth, return on equity, profit margins, and other data to determine a company's
underlying value and potential for future growth. In terms of stocks, fundamental
analysis focuses on the financial statements of the company being evaluated. One of
the most famous and successful fundamental analysts is the so-called "Oracle of
Omaha," Warren Buffett, who is well known for successfully employing fundamental
analysis to pick securities.
An Example of Fundamental Analysis

Even the market as a whole can be evaluated using fundamental analysis. For example,
analysts looked at fundamental indicators of the S&P 500 from July 4 to July 8, 2016.
During this time, the S&P rose to 2129.90 after the release of a positive jobs' report in
the United States. In fact, the market just missed a new record high, coming in just
under the May 2015 high of 2132.80. The economic surprise of an additional 287,000
jobs for the month of June specifically increased the value of the stock market on July 8,
2016.

Fundamentals

Fundamentals consist of the basic qualitative and quantitative information that underlie
a company or other organization's financial and economic position.

Ratio Analysis

A ratio analysis is a quantitative analysis of information contained in a company’s

financial statements.

Quantitative Analysis (QA)

Quantitative analysis (QA) is a technique that seeks to understand behavior by using

mathematical and statistical modeling, measurement, and research.

Risk Analysis

Risk analysis is the process of assessing the likelihood of an adverse event occurring
within the corporate, government, or environmental sector.

Qualitative Analysis

Qualitative analysis is a securities analysis that uses subjective judgment based on non
quantifiable information, such as management expertise, industry cycles, and labor
relations.

Financial Analysis

Financial analysis is the process of assessing specific entities to determine their

suitability for investment.
Meaning of Fundamental analysis
Fundamental analysis is really a logical and systematic approach to estimating the
future dividends and share price. It is based on the premise that share price is
determined a number of fundamental factors relating to the economy, industry and
company. Since the economic fundamentals, Industry fundamentals and company
fundamentals have to be considered while analyzing a security for investment purpose.
Fundamental analysis is , in other words, a detailed analysis of the fundamental factors
the performance of the company.
Each share is assumed that to have an economic worth based on its present and future
earning capacity. This is called its intrinsic value or fundamental value. The purpose of
fundamental analysis is to evaluate the present and future earning capacity of a share
based on economy , Industry and company fundamentals and thereby assess the
intrinsic value of the share. The investor can then compare the intrinsic value of the
share with the prevailing market price to arrive at an investment decision. If the market
price of the share is lower than its intrinsic value, the investor would decide to buy the
share as its underpriced. The price of such share is expected to move up in future to
match with its intrinsic value.

On the contrary, when the market price of the share is higher than its intrinsic value, it is
perceived to be overpriced. The market price of such a share . fundamental analysis
thus provides an analytical framework for rational investment decision-making. This
analytical framework is known as EIC framework, or economic-industry –company
analysis.

Fundamental analysis insists that no one should purchase or sell a share on the basis
of tips and rumors. The fundamental approach calls upon the investor to make his buy
or sell decision on the basis of a detailed analysis of the information about the company,
the industry to which the company belongs, and the economy. This results in informed
investing. For this, a fundamentalist makes use of the EIC framework of analysis.

Economy-Industry-Company analysis framework

The analysis of economy, Industry and company fundamentals constitute the main
activity in the fundamental approach to security analysis. These can be viewed as
different stages in the investment decision-making process and be depicted graphically
with three concentric circles .
The logic of this three tier analysis is that the company performance depends not only
on its own efforts, But also on the general industry and economy factors. A company
belongs to an industry and the industry operates within the economy . As such, industry
and economy factors affect the performance of the company . The multitude of factors
affecting the performance of a company can be broadly classified as:

1. Economy-wide factors such as growth rate of the economy, inflation rate, foreign
exchange rate, etc. which affect all companies.
2. Industry –wide factors such as demand-supply gap in the industry, the emergence of
substitute products, changes in government policy relating to the industry ,etc. These
factors affect only those companies belonging to a specific industry.
3. Company-specific factors such as the age its plant , the quality of management , brand
image of its products, its labour-management relations, etc. These factors are likely to
make a company’s performance quite different from that of its competitors in the same
industry.

Fundamental analysis thus involves three steps:

 Economy analysis
 Industry analysis
 Company analysis

Let us see what each of these analyses implies.

Economic Analysis :-
Economic analysis involves assessing or examining topics or issues from an
economist’s perspective. Economic analysis is the study of economic systems. It may
also be a study of a production process or an industry. The analysis aims to determine
how effectively the economy or something within it is operating. For example, an
economic analysis of a company focuses mainly on how much profit it is making.

Economists say that economic analysis is a systematic approach to find out what the
optimum use of scarce resources is.

Economic analysis involves comparing at least two alternatives in achieving, for

example, a certain goal under specific constraints and assumptions.

Economic analyses factor in the opportunity costs that people or companies employ.
They measure, in monetary terms, what the benefits of a project are to the economy or
community.
The performance of a company depends on the performance of the economy. If the
economy is booming, incomes rise, demand for goods increases, and hence the
industries and companies in general tend to be prosperous . on the other hand, if the
economy is in recession , the performance of companies will be generally bad.

Investors are concerned with those variables in the economy which affect the
performance of the company in which they intend to invest