Knowledge Centre

Fundamental Analysis: The holistic way of studying a business

Updated on 25 July 2018

Widely used by analysts, the method of fundamental analysis comprises evaluating a security to scale its intrinsic value. This involves further examination of relative economic, financial factors in addition to qualitative and quantitative ones.

Fundamental analysts study everything that may influence the security's value. These factors may be macroeconomic like overall economy and its industry conditions, or microeconomic like financial conditions and individual company management or both. Fundamental analysis attempts to yield a quantitative value that investors can compare with the security's existing rate. This helps in finding out if the security is undervalued or overvalued.

Fundamental Analysis-In Depth

It’s only because of fundamental analysis that an analyst can determine a company’s health and performance. The analyst can produce an all inclusive report by checking key numbers and economic indicators.

Fundamental analysis is undertaken to recognize primarily strong companies or industries and weak ones investment decisions can be made for investor’s portfolio.

This way of analyzing security is touted to be the exact opposite of the method undertaken in technical analysis.

Basis of Fundamental Analysis you need to understand

In Fundamental analysis, real, public data is used to examine the security's value.

While analysts predominantly use it to evaluate stocks, it can also be used for all types of security. For instance, an investor can fundamentally analyze a bond's value by evaluating at surrounding economic factors like economy’s current state, interest rates, bond issuer information etc.

When evaluating stocks and equity instruments, this method uses information about profit margins, revenues, return on equity, earnings, future growth, etc to identify if a company is indeed valuable and has potential for future growth or not.

When valuing stocks, fundamental analysis undertakes financial statements in consideration.

In fundamental analysis, economic, industry and company analysis are paid attention to.

It is widely used by Investors in numerous portfolio management styles. Buy and Hold investors actively seek good companies based on this analysis to lower the risk as much as possible.

Using this analysis, value investors often levy importance on under-valued companies.

Good and bad companies are identified by checking how much the stock prices would fluctuate thus creating opportunities for benefit through this analysis.

Moreover, it is also said that through accurate fundamental analysis, a broker can make an informed decision without being swayed by popular market vote. Furthermore, managers can determine future growth rates.

The procedure of fundamental analysis

The process essentially begins with a financial statement analysis that involves examining financial ratios.

Analysts take a look at paid dividends, financing capital, cash flow (operating) and other new equity issues, etc. Further conclusions are made based on earnings estimates, growth rate projections, etc. Sufficient information is published widely by Reuters and it can be categorized as technical or fundamental in nature depending on validity.

Multiple valuation methods use income and cash determined growth rates, risk levels. A primary model is discounted cash flow model which gives analysts a present value of the forecast.

A factor that greatly influences the analysis is the company’s total debt which can be scaled via debt-to-equity ratio along with current ratio.

The price to earnings ratio is commonly used along with perpetual annuity model. Further growth estimates are measured and the entire analysis is concluded.