Investing in stocks is definitely one of the most profitable ways you can invest your money. But you can also lose money on this if you don't know what you're doing.
That is why it is wise to increase your understanding of company analysis to reduce risk. And this is exactly what this article aims to tackle.
In this article you will learn about fundamental analysis and how to apply this type of analysis when analyzing companies.
Understanding the differences between your company's value and its share price on the stock exchange - and knowing how to find this out - is crucial for you to make safe, well-considered investment decisions that give you positive returns over time.
What is fundamental analysis?
Fundamental analysis is a method of assessing the value of a stock by examining the company's fundamental characteristics.
These fundamental characteristics can include key figures such as:
- Earnings (both top-and bottom line)
- Growth potential
- Cash Flow Statement
- Equity
- Debt
The purpose of fundamental analysis is for you to understand what drives the price of a stock and to assess whether it is undervalued or overvalued compared to the company's fundamental value.
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The difference between price and value
Price is what you pay. Value is what you get.
-Warren Buffett
The quote above is a very famous quote uttered by investor legend Warren Buffett.
By this he means that the share price does not always reflect the company's real value - for better or for worse.
Price is what you pay for a stock on the stock exchange, while value is what the stock is actually worth based on the company's fundamentals.
A stock can be overvalued if the price is higher than the fundamental value, or undervalued if the price is lower than the fundamental value.
In extremely frothy periods, for example, companies that do not make much money can be overpriced on the stock exchange based on future earnings potential - even if the company's actual fundamental characteristics cannot justify this.
If the good times were to turn, it is precisely such companies that could be severely punished, since they cannot defend the high pricing without the necessary fundamental characteristics in place.
It is therefore important that you are able to distinguish between price and value when it comes to equity investment.
Fundamental analysis vs technical analysis
There are two main methods of analyzing stocks:
- Fundamental analysis
- Technical analysis
Where fundamental analysis focuses on the company's fundamental characteristics, technical analysis focuses on price trend and volume in chart to predict future price movements.
Many professional investors use a combination of both methods to make the most informed investment decisions possible.
Read also: shares for beginners: a great guide to investing in shares and fund
Quantitative and qualitative analysis
There are two main types of fundamental analysis: quantitative and qualitative analysis.
Quantitative analysis
Quantitative analysis is a method for measuring the company's financial data, such as earnings, equity and debt.
This gives the investor a picture of the company's financial situation and ability to generate income and profits.
In quantitative analysis, we like to look at the company's:
- Key figures in financial statement
- Annual and quarterly reports
- Balance sheet
- Cash Flow Statement
If you want to read more about how to find a company's value, you can read this article .
Qualitative analysis
Where quantitative analysis is about looking at the hard numbers, qualitative analysis is a method of assessing the company's non-financial characteristics, and factors outside the company that can influence earnings and growth.
By looking at the qualitative picture, you can create a thesis of the company's long-term potential and ability to handle challenges and exploit opportunities.
In qualitative analysis, we typically consider the company's:
- Management
- Strategy
- Competitive advantage
- The industry they operate in
It is important to note that neither of the two methods is one hundred percent perfect. Events can always occur that the company cannot control, and which can negatively affect the market value.
A certain pandemic, for example.
However, by using a combination of fundamental analysis and technical analysis, the investor can reduce risk and increase the chances of profitable investments.
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For you who are serious about stock analysis. Get access to all important key figures in a company's accounts and KPIs. You get a 30% discount via me.
So how do you use fundamental analysis in stock investing?
First of all - it is important to examine the company's fundamental characteristics and compare them with competitors in the same industry. How do you use fundamental analysis in stock investing?
You can then proceed quantitatively and compare the company's share price with the estimated fundamental value to assess whether the share is undervalued or overvalued.
Some of the calculations you can use are:
- Free Cash Flow Yield
- Discounted cashflow method
- NCAV method
You can read and learn more about these three valuation methods, as well as how to apply the formulas here.
Key points about fundamental analysis
- Fundamental analysis is a method of assessing the value of a share by examining the company's fundamental characteristics
- There are two main types of fundamental analysis: quantitative and qualitative analysis
- In qualitative analysis, you look at the company's competitive advantage, management, company strategy and the industry as a whole
- In quantitative analysis, you look at the company's accounting figures such as earnings, debt, cash flow and equity
- By using a combination of fundamental analysis and technical analysis, you can theoretically reduce risk and increase the chances of profitable investments
My recommended tools for fundamental analysis
Below you will see two investment tools that I use daily and that have saved me a huge amount of time and made me a better investor faster than I could have done without.
I recommend you check them out for yourself and get ahead of other investors today:
I recommend Finchat.io to you who are serious about investing in individual shares, who want detailed information on companies' key figures. You also get access to an AI chat dedicated to finance. Even professional investors use FinChat, and if you're a graph lover, this is for you.
Simply Wall St is for you who want to be served a simple overview of a company, in addition to getting their 'intrinsic value' via the cash flow method. It gives you a clue as to whether you are buying an underpriced or overpriced share - in a simple visual way.
