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General information on Fundamental Analysis

For those of you who still insist on fundamental analysis…

“When you measure what you are speaking about, and express it in numbers, you know something about it; but when you cannot measure it, when you cannot express it in numbers, your knowledge is of a meagre and unsatisfactory kind; it may be the beginnings of knowledge, but you have scarcely, in your thoughts, advanced to the stage of science.”

William Thomson, Lord Kelvin

When you go into a business, you would want to know everything about the business, in order to better manage it. When you invest in a company’s shares, you would want to have information about the company, in order to better satisfy yourself that it will provide your target returns.

You do not want anything elaborate, just the fundamentals — the kind of information that gives an idea of profit performance, consistency, dividends history, property and debts, and other dollars-and-cents information. This is the kind of information you would consider in your fundamental analysis of a company.

Despite what it may sometimes seem, there is very little in the world of finance that is so complex that you would not understand it. The fundamentals are exactly what their name implies: uncomplicated, basic … fundamental. The only thing that complicates financial information is jargon, overly complex statistical analysis that results in mental paralysis, and complex formulas that don’t convey information any better than straight talk.

At the very least, fundamental analysis provide us with a means of comparison, a way to compare apples and oranges. Until we are able to compare one thing to another, we cannot make our independent judgements. Until we have the chance to evaluate two or more alternatives, we will not know where our preferences lie. That is simply the nature of things, of how we are designed. This is as true in the stock market as it is everywhere else.

Tests of the fundamentals are a set of consistent applications of performance standards to several companies. They are not magic formulas that tell us to go this way or that; but after applying these fundamental tests, we hope the results can guide us in our decision process to select one stock over another, that is, to decide whether to buy, hold, or sell a stock.

Fundamental analysis is a research method that evaluates the business of the company: supply and demand, industry strength, management ability, and other intrinsic matters affecting a stock’s market value and growth potential. All of these will impact the company’s financial performance, so basic financial information is the starting point of fundamental analysis. Certainly some aspects of price movement in the stock market are beyond logic, and baffling to anyone with a logical mind. The fundamentals – those intrinsic facts about a company – can be used to forecast financial performance and, to some degree, stock price movements.

Fundamental analysis is divided into two categories: quantitative and qualitative. Quantitative analysis examines those aspects that can be measured or expressed in numerical terms; whereas, qualitative analysis relates to the character of something, as opposed to its size or quantity. Quantitative data are summarised in the financial statements. Qualitative fundamentals are the less tangible aspects such as the quality of the company’s management, brand-name recognition, and its intellectual properties.

The bulk of fundamental analysis involves the quantitative part, researching the various financial statements. Fundamentalists review all aspects of a company including revenue, expenses, assets, liabilities and any other financial information of a company. The reasoning behind such review is to gain insight from a company’s past performance and consider how that might affect future performance. But fundamental analysis goes beyond merely analyzing the numbers; rather it includes an evaluation of intangible aspects of the company, such as management, operations, product ideas that are still being developed, its competitive position in the industry, physical and intellectual resources it is able to muster, and many others.

Both facets of fundamental analysis discern the intrinsic value of the company. The concept of intrinsic value is that a company’s stock price prevailing on the stock market does not fully reflect a stock’s real value: the price could be above that value (in which case it is over-priced) or below (thus under-priced). The wise investor wants to buy stocks that are trading at prices below their intrinsic value.

The direct opposite of fundamental analysis is technical analysis. Technical analysis bases investment decisions solely on the price and volume movements. Technical analysts use charts, graphs, and other online trading systems, to trade on the momentum of a stock. The technical analyst’s primary premise is that the market discounts everything. Thus, all news and information about a company are already factored into the company’s stock. Therefore, a stock’s price movements give more insight than the underlying fundamental factors of the business itself.

Over and above technical analysis being viewed by many serious investors as less cumbersome than fundamental analysis, technical analysis also allows for early identification of trend reversal thereby allowing them to take appropriate action quickly. This is important in the modern markets, where timing is everything.

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