Brainy's
Share Market Toolbox



Fundamental analysis

When searching for investments,
there is a variety of analysis methods at our disposal.
Fundamental analysis is one of those methods.

Introduction

In rather broad but basic terms, fundamental analysis is the study of the financial information of a company in order to understand the company's true worth, or it's intrinsic value. But it can also include the study of anything which might impact on a company's performance, as outlined below.

Fundamental analysis can involve the study of company financial reports, as published at key times throughout the company's annual financial calendar. In the USA this happens on a quarterly basis; but in the Australian market it happens twice yearly, where public companies must report their 6-month financial results to the market within two months of their period-end date. For most public companies who have period-end dates at 31 December and 30 June each year, they need to report results by end February and end August respectively. Fundamental analysts tend to be very busy during these periods analysing the company results.

In the bigger picture, fundamental analysis of a company can also involve the study of the company's management and competitive advantages, as well as it's markets and competitors. In fact, it could include the study of anything which could impact on the viability and profitability of a company and it's performance, including geopolitical issues, sovereign risks and climatic and weather conditions.

The information below offers some suggestions for fundamental analysis methods, and comparison to alternatives.

More information

Useful information: Definitions for, and discussions on,
fundamental analysis:


Technical analysis

It is important to realise that hundreds of fundamental analysts will potentially have hundreds of different opinions about the precise intrinsic value of a company - and they cannot all be right.

Don't forget that price charts summarise the
underlying opinions and emotions of all the market participants.
Every chart tells a story, and it pays
to understand the stories in the price charts.

One analysis method for determining the fair value for a company's share price is the study of the historical performance of the share price (which summarises the opinions of all market participants). This is on the basis that share prices tend to factor in all known information and news, and that the price moves in waves from over-sold to over-bought positions as investors and traders buy and sell the shares based on their own belief of fair value.

One underlying principle with technical analysis is that "the trend is your friend", and therefore one investing strategy based on this belief is the trend following approach - to buy shares in an up-trending share price, and to sell when the trend weakens or has finished.

See more information about technical analysis.

Fundamental analysis options

There are many different ways that fundamental analysis can be performed, and there are many different fundamental analysis criteria that can be considered. Some people spend hours and hours poring over company financial information in order to arrive at something which they believe is the intrinsic value or fair value of the company's shares. Many people then make investment decisions based on this analysis. A whole room full of analysts or economists would potentially arrive at a range of answers.

From the huge range of fundamental analysis criteria, Robert Brain* utilises three key measures to select quality companies for one of his low-risk watchlists:

  • ROE - Return on Equity - a performance metric;
  • D/E - Debt to Equity Ratio - a financial risk metric; and
  • PEG ratio - PE Growth ratio - an anticipated forecast measure of growth.
For anyone who wants to limit the amount of time they spend on performing fundamental analysis, these three measures might be sufficient. For more details about how Robert uses these, and which threshold values he uses and the method for selecting stocks, see the detailed notes at right on Funda-technical Analysis.

Fundamental or technical?

Which analysis method should we use - fundamental or technical? Is one of them a waste of time? This question often arises, and there is no single correct answer.

Some people utilise fundamental analysis 100%, and are somewhat successful, while other people utilise technical analysis 100% and are somewhat successful. And there are other people who use a blend of both approaches and are all somewhat successful.

The right answer for each of us could be whichever method, or blend of the two, that we fell most comfortable with, and whichever we enjoy doing. It could be argued that some of the people who spend many hours undergoing their favourite analysis method are wasting time, because a smaller amount of time would produce very similar results. The important thing, though, is that they enjoy spending their time on their chosen analysis method.

See a more detailed discussion about balancing the time on research and investing.

Funda-technical analysis

This analysis method is a clever blend of both fundamental analysis and technical analysis, to optimise the benefits of fundamental analysis, and implement the realities and usefulness of technical analysis. 

Some people like to use fundamental analysis to eliminate the poor performing, or poorly managed, companies and then use technical analysis to time their entry and exit so as to maximise the chances of favourable share price performance.

See more details about Funda-technical analysis.

 

And whatever you do,
beware of the sharks in the ocean!

 Beware the sharks in the ocean.


* - Robert Brain is the author and web master
for this web site - see more information about Robert.

The information presented herein represents the opinions of the web page content owner, and
are not recommendations or endorsements of any product, method, strategy, etc.
For financial advice, a professional and licensed financial advisor should be engaged.


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Last revised: 1 October, 2014.