Fundamental

analysis

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Fundamental analysis, in accounting and

finance, is the analysis of a business's
financial statements (usually to analyze
the business's assets, liabilities, and
earnings); health;[1] and 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.[2] These
terms are used to distinguish such
analysis from other types of investment
analysis, such as quantitative and
technical.

Fundamental analysis is performed on

historical and present data, but with the
goal of making financial forecasts. There
are several possible objectives:
 to conduct a company stock valuation
and predict its probable price evolution;
to make a projection on its business
performance;
to evaluate its management and make
internal business decisions and/or to
calculate its credit risk.
to find out the intrinsic value of the
share.[3]

The two analytical models

There are two basic methodologies
investors rely upon when the objective of
the analysis is to determine what stock to
buy and at what price, :
1. Fundamental analysis maintains that
markets may incorrectly price a
security in the short run but that the
"correct" price will eventually be
reached. Profits can be made by
purchasing the wrongly priced
security and then waiting for the
market to recognize its "mistake" and
reprice the security.
2. Technical analysis Technical analysts
look at trends and price levels and
believe that trend changes confirm
sentiment changes. Recognizable
price chart patterns may be found
due to investors' emotional
responses to price movements.
 Technical analysts mainly evaluate
historical trends and ranges to
predict future price movement.[4]

Investors can use one or both of these

complementary methods for stock
picking. For example, many fundamental
investors use technicals for deciding entry
and exit points. Similarly, a large
proportion of technical investors use
fundamentals to limit their universe of
possible stock to "good" companies.

The choice of stock analysis is determined

by the investor's belief in the different
paradigms for "how the stock market
works".For explanations of these
paradigms, see the discussions at
efficient-market hypothesis, random walk
hypothesis, capital asset pricing model,
Fed model Theory of Equity Valuation,
market-based valuation, and behavioral
finance.

Fundamental analysis includes:

1. Economic analysis
2. Industry analysis
3. Company analysis

The intrinsic value of the shares is

determined based upon these three
analyses. It is this value that is considered
the true value of the share. If the intrinsic
value is higher than the market price,
buying the share is recommended. If it is
equal to market price, it is recommended
to hold the share; and if it is less than the
market price, then one should sell the
shares.

Use by different portfolio

styles
Investors may also use fundamental
analysis within different portfolio
management styles.

Buy and hold investors believe that

latching on to good businesses allows
the investor's asset to grow with the
business. Fundamental analysis lets
them find "good" companies, so they
lower their risk and the probability of
wipe-out.
Value investors restrict their attention to
under-valued companies, believing that
"it's hard to fall out of a ditch". The
values they follow come from
fundamental analysis.
Managers may use fundamental
analysis to correctly value "good" and
"bad" companies.
Managers may also consider the
economic cycle in determining whether
conditions are "right" to buy
fundamentally suitable companies.
Contrarian investors hold that "in the
short run, the market is a voting
machine, not a weighing machine".[5]
Fundamental analysis allows an investor
to make his or her own decision on
value, while ignoring the opinions of the
market.
Managers may use fundamental
analysis to determine future growth
rates for buying high priced growth
stocks.
Managers may include fundamental
factors along with technical factors in
 computer models (quantitative
analysis).

Top-down and bottom-up

approaches
Investors using fundamental analysis can
use either a top-down or bottom-up
approach.

The top-down investor starts their

analysis with global economics,
including both international and national
economic indicators. These may include
GDP growth rates, inflation, interest
rates, exchange rates, productivity, and
energy prices. They subsequently
 narrow their search to regional/ industry
analysis of total sales, price levels, the
effects of competing products, foreign
competition, and entry or exit from the
industry. Only then do they refine their
search to the best business in the area
being studied.
The bottom-up investor starts with
specific businesses, regardless of their
industry/region, and proceeds in reverse
of the top-down approach.

Procedures
The analysis of a business's health starts
with a financial statement analysis that
includes financial ratios. It looks at
dividends paid, operating cash flow, new
equity issues and capital financing. The
earnings estimates and growth rate
projections published widely by Thomson
Reuters and others can be considered
either "fundamental" (they are facts) or
"technical" (they are investor sentiment)
based on perception of their validity.

Determined growth rates (of income and

cash) and risk levels (to determine the
discount rate) are used in various
valuation models. The foremost is the
discounted cash flow model, which
calculates the present value of the future:
 dividends received by the investor, along
with the eventual sale price; (Gordon
model)
earnings of the company;
or cash flows of the company.

The amount of debt a company possesses

is also a major consideration in
determining its health. It can be quickly
assessed using the debt-to-equity ratio
and the current ratio (current
assets/current liabilities).

The simple model commonly used is the

P/E ratio (price-to-earnings ratio). Implicit
in this model of a perpetual annuity (time
value of money) is that the "flip" of the P/E
is the discount rate appropriate to the risk
of the business. The multiple accepted is
adjusted for expected growth (which is not
built into the model).

Growth estimates are incorporated into

the PEG ratio. Its validity depends on the
length of time analysts believe the growth
will continue. IGAR models can be used to
impute expected changes in growth from
current P/E and historical growth rates for
the stocks relative to a comparison index.

Computer modelling of stock prices has

now replaced much of the subjective
interpretation of fundamental data (along
with technical data) in the industry. Since
about the year 2000, a new job role has
been invented with computers now able to
crunch vast amounts of data . At some
funds (Quant Funds) managers' decisions
have been replaced by proprietary
mathematical models.

Automation
The process of fundamental analysis has
significantly dropped in difficulty over the
past 10 years. Ever since computers
became a household product, people have
built software designed to make the
investor's life easier. Fundamental analysis
is one of the most time consuming forms
of analysis. Furthermore, with the fast-
paced trading style of the 21st century,
where markets are dominated by HFT
firms and day traders, it is difficult to keep
up with the market in a timely fashion. One
way to go about cutting down analysis
time, is to subscribe to either free or paid
screening services. Screening services will
allow you to search the entire market for
stocks that match the quantitative fields
you are looking for. These types of
software then automatically give you
results, hence cutting down on time spent
sifting through SEC filings.
Reference - Fundamental Analysis
Software for more information on
fundamental analysis software.

Criticisms
Economists such as Burton Malkiel
suggest that neither fundamental
analysis nor technical analysis is useful
in outperforming the markets.[6] This is
especially true of low liquidity markets
or securities.[7]

See also
Lists of valuation topics
Security analysis
 Piotroski F-Score
Stock selection criterion
John Burr Williams#Theory
Mosaic theory
Chepakovich valuation model
Fundamental Analysis Software
Financial forecast

References
1. "Technical Analysis vs. Fundamental
Analysis" . Market Technicians
Association. Retrieved 6 March 2015.
2. "An Introduction to Fundamental
Analysis and the US Economy" .
 InformedTrades.com. 2008-02-14.
Retrieved 2009-07-27.
3. "Fundamental and Technical analysis |
Fundamentals of Accounting" . 2016-
07-07. Retrieved 2016-07-07.
4. Murphy, John J. (1999). Technical
analysis of the financial markets : a
comprehensive guide to trading
methods and applications (2nd ed.).
New York [u.a.]: New York Institute of
Finance. ISBN 0735200661.
5. Graham, Benjamin; Dodd, David
(December 10, 2004). Security
Analysis. McGraw-Hill. ISBN 978-0-07-
144820-8.
 6. "Financial Concepts: Random Walk
Theory" . Investopedia.
7. Dzanic, Enis (2013-05-10). "Correlation
of Change in Fundamental Indicators
and Stock Price Movements on
Sarajevo Stock Exchange" . Rochester,
NY.

External links
MIT Financial-Management course
notes
Fundamental Analysis Works

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Last edited on 16 August 2019, at 03:54

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