What is fundamental analysis?
Fundamental analysis is a method of determining the price value of an asset by analysing a company’s financial information. It is used to understand how a firm or company is doing. The same process is also used for fundamental analysis for stocks.
This financial information includes, for example, financial statements, balance sheets, the organisation’s strengths, its market and competition, its sales prospects, etc.
Fundamental analysis is about analysing and predicting the intrinsic value of an asset. The intrinsic value is the result of dividing the liquid assets by the number of stocks in circulation.
For example: the company ABC has US$ 1.000.000 of liquid patrimony and 100.000 stocks in circulation. If we make the division, the result is that the intrinsic value is US$10 per stock.
Fundamental analysis was created on the basis that the market is sometimes wrong in the valuation of an asset. It is used to determine when an asset is overvalued or undervalued. This is known through ratios, which are figures that represent different aspects of a company. We will look at them later, but they need to be interpreted when we need to make investment decisions.
Fundamental analysis is extremely important when we want to invest for the long term. In the short and medium term, the price of a stock will be guided more by technical analysis and market news. This is why, for short and medium term we usually look at some specific ratios, but for the long term we make a deep analysis of them. We will now look at the differences between technical analysis and fundamental analysis.
Fundamental analysis vs technical analysis
Technical analysis focuses on:
- Chart analysis.
- Price and volume.
- Used more in the short term.
- Looks for trends, support and resistance and patterns.
Fundamental analysis focuses on:
- Analysis of financial statements, accounting, economic reports, among others.
- Qualitative and quantitative aspects of a company: key figures.
- Used more for the long term.
- Looks for report expectations compared to current results, current news compared to previous news and events, etc.
This does not mean that you have to choose between one and the other. Ideally, if you are investing for the medium to long term, you should combine fundamental analysis (getting even deeper the longer the term) with technical analysis. In the short term, you can combine deep technical analysis with some fundamental analysis ratios. Neither excludes the other, you can use them in a complementary way.
Methods and tools for fundamental analysis
The variables that affect the value of a company can be microeconomic or macroeconomic. Microeconomic variables are those that affect only the company and macroeconomic variables affect any type of company. When valuing a company there are two types of methods:
This is an analysis from the general to the particular. It first studies the macroeconomic variables and then the microeconomic variables. Fundamental analysis examples:
- Study of the world economic situation
- Study of the most attractive countries for investment
- Within each of these, the sectors with the greatest potential are selected.
- Within these sectors, the companies that are most interesting to invest in are analysed.
This method goes from the particular to the general. It starts with microeconomic variables and then moves on to macroeconomic variables. Tools it uses:
- Companies with growth potential are chosen.
- Analyse the sector(s) in which these companies operate.
- Study the economic situation of the country or countries in which they operate.
- The global economic situation is analysed.
You can carry out your fundamental analysis with the method that suits you best or that you prefer depending on the type of investment you want to make.