Fundamental analysis is a method that is used to measure a security’s intrinsic value by examining and analyzing related economic and financial factors. These can include macroeconomic factors such as the state of the economy and current industry conditions to microeconomic factors like how effectively a company is managed.
The purpose of fundamental analysis is to determine a number that investors can compare with a security’s current price to inform them whether it is overpriced or underpriced. Fundamental analysis is considered to contrast technical analysis which focusses on historical market data including price and volume.
How fundamental analysis works
Experienced fundamental analysts can identify buy or sell signals, calculate a security’s intrinsic value and assess factors that could impact the value of an asset.
Even at the most basic level, a fundamental analysis strategy will include the following primary factors to assess the security:
The structure and revenue of the company
Growth of revenue in recent years
Profit made by the company
The debt structure of the company
The company’s rate of turnover
Employee management and managements approach to employees
Fundamental analysis can help investors determine whether to buy or sell an asset by looking at public data.
Types of fundamental analysis
The fundamental variables used in fundamental analysis can be categorized in two ways: quantitative and qualitative.
Quantitative fundamentals are typically any variables that can be measured or expressed in numbers. This type of fundamentals is useful if you are comparing securities in the same asset class or industry. Examples of qualitative fundamentals include price to earnings ratio, revenue and current liabilities – all of which can be found in a company’s financial statements.
Qualitative fundamentals are anything that cannot be measured or expressed in numbers. These can include trends, a country’s media presence or a company’s board of directors. These factors are driven by opinion and can be harder to compare.
Although each requires a different approach, both are equally as important to complete a full analysis of a company’s share price.
The approach fundamental analysts can be either top-down or bottom-up. The top-down approach concentrates on the qualitative fundamentals first and then digs deeper into the numbers, whereas a bottom-up approach looks at the quantitative fundamentals first and then at the macroeconomic and microeconomic factors.
Advantages of fundamental analysis
The advantages of fundamental analysis include:
Fundamental analysis looks at both the financial performance of a company as well as other factors that could affect the value of its share gives a comprehensive and detailed analysis, enabling investors to make informed decisions.
This type of analysis can identify long-term opportunities for investors as it considers multiple areas that can impact the stocks and securities value.
Can highlight early warnings
Undertaking fundamental analysis can highlight early warnings and provide insights into the effect of fiscal and monetary policy and the direction of global markets.
Disadvantages of fundamental analysis
The disadvantages of fundamental analysis include:
Can be time-consuming
The process of conducting fundamental analysis can be time-consuming. As a detailed method of analysis, it involves a variety of approaches that can take more time than other analytical methods.
Following on from the previous point, the amount of time fundamental analysis takes could lead to missed opportunities where an investor needs to make a quick investment decision. In these instances, investors should look at alternative analysis methods.
As this method of analysis considers all the micro and macro factors together and analyzes them simultaneously, it can become complicated and subjective. Placing a numerical value against different factors will usually be a combination of experience and personal biases.