Using Fundamental Analysis

Fundamental analysis is a very reliable method of investing in every financial asset class. Fundamental analysts focus on information and macroeconomic factors that are affecting the true value of financial security. This information may include both internal and external factors as mentioned below.

 

The Goals of Fundamental Analysis

The main goal of a fundamentalist is to trace and trade financial securities that are priced below their fair market value. Fundamental analysis is focusing on estimating the fair value of targeted financial security. Another important task for a fundamentalist is to identify and measure the potential risk of each investment decision. Risk identification is essential for managing your portfolio in an efficient and effective way. These are the main goals of fundamental analysis:

(1) Determine Fair Value of security (profit potential estimation)
(2) Identify and measure risk incorporated (loss potential estimation)

Fundamentals are based on internal and external factors affecting investment. For example, if you buy a US stock you must be aware of the company’s balance sheet but also be aware of US economic figures and especially about the corresponding industry figures.

 

Building a Fundamental Analysis Framework

Internal Fundamental Factors

Internal factors of fundamental analysis include facts and figures concerning a particular company. The most important internal factors are:

1) Earnings per Share – EPS
2) Projected Earning Growth – PEG
3) Dividends Paid
4) Sales per Share
5) Shareholders Equity
6) Debt exposure Analysis
7) Cash-Flow Analysis
8) Management experience and effectiveness (ROE and ROI ratios)
9) Strategic Analysis concerning new investment projects
10) Estimations about future Demand / Supply of the company's products/services

► More information regarding investment valuation

 

External Fundamental Factors

External factors include information concerning the global and local economy but also information about the related industry.

a) Macroeconomic Factors:

1) Level of interest rates
2) Market liquidity / Inflation
3) Industrial Production
4) Currency Exchange Rate
5) Political Stability and Strategic Analysis

b) Industry Factors:

6) Projected Growth Rate
7) Projected Demand / Supply
8) Current and future Investment projects
8) The SWOT analysis (strengths-weaknesses-opportunities-threats)
9) Strategic Analysis (using tools like Michael Porter's 5 forces model)

 

Technical Analysis Vs Fundamental Analysis

These two forces (Technical Analysis and Fundamental Analysis) are forming a complete framework of trading analysis in the financial markets.

The different nature of each of these forces is based on time. In short-term periods Technical Analysis is much more effective in contrast to long-term periods where fundamentals are far more important. Usually, traders who are using technical analysis to pick-up stocks do not care about fundamentals and vice versa Fundamentalists don't care about the predictions of Technical Analysis. Wise investors (or even traders) use them both.

 

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