What are stock fundamentals?

Fundamental analysis of a stock involves evaluating its key metrics, such as cash flow and return on assets (ROA), to assess its value. This analysis is typically performed by analysts who examine data that is expected to affect the stock's price. Stock fundamentals refer to these key metrics that are used to evaluate a company.

How Stock Fundamentals Work

Fundamental analysis involves examining any data that is likely to impact the price or perceived value of a stock, apart from the stock's trading patterns. This means looking at the fundamental factors that can affect the value of the stock. The name "fundamental analysis" reflects the fact that this approach focuses on the underlying factors that determine the value of a stock, rather than its trading patterns.

• Cash flow
• Return on assets
• Conservative gearing
• History of profit retention for funding future growth
• The soundness of capital management for the maximization of shareholder earnings and returns

Fundamental analysts follow a systematic approach to evaluating stock performance by considering various factors that may impact a stock's value. These factors may include the industry as a whole, the company's competition, its management, its income and revenue, and its growth potential. The goal of fundamental analysis is to gain a comprehensive understanding of a company in order to make informed investment decisions.

Example of Stock Fundamentals

Fundamental analysts use publicly available data, often from a company's financial statements, to determine whether a stock is correctly or incorrectly priced by the market. All of the information used in this type of analysis is readily accessible to the public.

To help illustrate the concept, you can think of the stock market as a shopping mall, where stocks are the products being sold in various stores. Fundamental analysts focus on these products and disregard the opinions of other investors, who may be swayed by emotions and not have a clear understanding of the true value of the stocks. In this analogy, the analysts are the shoppers who are carefully evaluating the products for sale, while other investors are the general public who may not have as much knowledge about the stock's true value.

Fundamental analysts take a methodical approach to evaluating stocks, similar to how slow and careful shoppers might look for the best deals in a mall. They might pay more attention to stocks that other investors have overlooked, such as those in less popular industries or those that have fallen out of favor with the public. Just as shoppers might wait until the crowds have moved on from a particular store before examining the products more closely, fundamental analysts might wait until a stock has lost favor with the market before considering it for investment.

Fundamental analysts may attempt to determine the value of the PC if it were stripped down to its core components, such as the hard disk, memory cards, monitor, and keyboard. In the stock market, this is similar to calculating the book value or liquidation price of a company.

Analysts carefully evaluate the quality and durability of the PC, including reviewing the specifications, examining the manufacturer's warranty, and consulting consumer reports. In the same way, equity analysts assess a company's financial stability by reviewing its balance sheet.

Fundamental analysts may also analyze the performance of the PC in terms of characteristics such as processing power, memory, or image resolution. These are similar to forecast earnings and dividends that can be derived from a company's income statement.

Finally, fundamental analysts will use all of the collected data to determine the intrinsic value of the PC, which is its value independent of its current market price. If the market price is lower than the calculated intrinsic value, the fundamentalists will consider purchasing the PC. If not, they may decide to sell any PCs they already own or wait for the price to decrease before buying more.

Special Considerations

Conducting fundamental analysis requires a significant amount of effort, but this is part of what makes it attractive to some investors. By carefully examining a company's financial statements and evaluating its future potential, investors can gain a deeper understanding of whether the stock price is accurate.

By performing thorough fundamental analysis, conscientious investors may be able to identify inaccuracies in the market and generate profits. Additionally, focusing on a company's intrinsic, long-term value can help protect investors from the risks of short-term market fluctuations.

While fundamental analysis can indicate that a stock is undervalued, it does not guarantee that the stock will reach its intrinsic value in the near future. In reality, stock price movements may cause doubts about even the strongest investments, and even the most independent-minded investors may question the reliability of fundamental analysis. There is no foolproof method for determining intrinsic value.

During market booms, it may be tempting for investors to believe that they have a natural ability to select successful investments. However, during market downturns or times of uncertainty, luck alone is not sufficient for successful investing. Instead, investors must have a solid understanding of what they are doing.

Fundamental Analysis vs. Technical Analysis

Fundamental analysis and technical analysis are distinct approaches to stock analysis. While fundamental analysis evaluates a stock's intrinsic value, technical analysis focuses solely on the trading and price history of a stock, using trading signals and other analytical tools to determine its strength or weakness.

Technical analysts believe that a stock's past price and trading activity can provide insight into its future direction. The theory of technical analysis is based on the belief that price movements are not random, but rather that patterns and trends can be identified and tend to repeat over time.

To illustrate the difference between fundamental and technical analysis, consider the earlier analogy of shopping for PCs. While fundamental analysts focus on the intrinsic value of the PCs themselves, technical analysts ignore the PCs and instead watch the behavior of shoppers. If a technical analyst sees a large number of shoppers congregating in a computer store, they may try to buy as many PCs as possible, anticipating that the increased demand will drive up PC prices.

Conclusion

In conclusion, fundamental and technical analysis are two approaches to evaluating stocks. Fundamental analysis involves analyzing a company's financial statements and other factors to determine its intrinsic value, while technical analysis focuses on the trading and price history of a stock to identify patterns and trends that may predict its future performance. Both approaches have their strengths and limitations, and investors may choose to use one or both methods to inform their investment decisions.