What exactly is fundamental analysis? If you’re a technical trader, you may have wondered about fundamentals, but never looked into them.
Lots of serious market pros use fundamentals — portfolio managers, hedge fund investors, and investment bank professionals.
But what if you’re an everyday retail trader with a small account? Is it still worth doing your due diligence with fundamental analysis?
Read on to find out. This post breaks down what fundamental analysis is — and how it can help you based on your trading goals.
Table of Contents
- 1 What Is Fundamental Analysis and What Are Its Objectives?
- 2 Why Fundamental Analysis Is Important
- 3 What Is Fundamental Analysis Used For?
- 4 What Are the Types of Fundamental Analysis?
- 5 What’s the Difference Between Fundamental and Technical Analysis?
- 6 How Do You Calculate Fundamental Analysis?
- 7 Fundamental Analysis Indicators
- 8 5 Tips on How to Conduct Fundamental Analysis
- 9 Is It Possible to Perform a Fundamental Analysis of Cryptocurrency?
- 10 Can You Use Both Fundamental and Technical Analysis?
- 11 Best Fundamental Analysis Tools
- 12 The Pros and Cons of Fundamental Analysis
- 13 Real-Life Examples of Fundamental Analysis
- 14 Automation in Fundamental Analysis
- 15 Does Fundamental Analysis Work?
- 16 Conclusion
- 17 One Platform. One System. Every Tool
What Is Fundamental Analysis and What Are Its Objectives?
Fundamental analysis is the process of assessing a stock’s fair market value using macro and micro approaches.
Fundamental analysis looks at the economy as a whole. It compares stocks to others in the same sector. And it looks at a company’s various components.
The information gathered for fundamental analysis is public. That means anyone can use it. Institutional analysts and retail traders alike can gain access to relevant company data.
Fundamental analysis indicators can include revenues, earnings, book value, and return on equity … And it includes profit margins, future growth forecasts, and price-to-earnings ratios.
The goal of fundamental analysis is to assess how stocks might move in the future. Long-term investors want to know if they’re buying a stock with the potential for future growth. And if they’re getting it at a good price.
Stock analysts want to determine if a stock’s best days are behind it. If so, it could be a potential short. Or, if managing a client’s portfolio, they might rotate it out for a better value stock.
If an analyst thinks a stock is a good buy, they’ll label it “overweight.” This means they think the price will go up and it’s a good addition to clients’ portfolios. If they think it’s overpriced, they’ll recommend it as “underweight” and advise clients not to load up on it.
Analysts use the best fundamental analysis tools available to guide clients. Their goal is to maximize their profit potential.
What Is a Fundamental Approach?
A fundamental approach focuses on a stock’s intrinsic value — how much it’s worth based on its fundamental ability to perform. It’s not about how cool people think the company is.
There are a few ways to start fundamental analysis research. One’s not necessarily better — it’s a matter of preference.
- Top-down analysis starts with the broader economy. You analyze how the markets are doing, then narrow your focus to a specific sector, and finally, a chosen company.
- Bottom-up analysis is the reverse. It starts with a specific company, then branches out to projections for the industry, sector, and overall market.
Why Fundamental Analysis Is Important
Fundamental analysis tells you a company’s story. It goes beyond speculation to reveal a stock’s nuts and bolts.
If you don’t know a company’s business plan, objectives, or cash flows, it’s hard to know anything about it. You’re flying blind.
And if you don’t dig deep into its leaders’ backgrounds, it’s hard to guess where they might take the company next. Who knows if they can carry out their vision.
Fundamental analysis is like a roadmap or blueprint of the company’s foundation. You study it thoroughly and make an educated guess about where it’s headed.
What Is Fundamental Analysis Used For?
Fundamental analysis helps determine a stock’s value. Analysts who use it believe a stock’s price should reflect the company’s ability to earn profits.
They factor in the company’s inner workings, sector, as well as the economy at large.
Often, they hope to find overlooked stocks — value stocks. If the market sees their true value in time … it should price them accordingly.
They look for solid companies that can pass the test of time. No temporary hot sectors that day traders love here.
What Are the Types of Fundamental Analysis?
There are two main types of fundamental analysis. Let’s break it down.
Quantitative Fundamental Analysis
Quantitative fundamental analysis focuses on things you can measure. It’s concerned with facts and figures. Analyzing a company’s financial statements is an example.
Income statements, balance sheets, cash flow, and earnings reports all go into quantitative fundamental analysis. You may get different interpretations from the same information. But the facts and figures don’t change.
Qualitative Fundamental Analysis
Qualitative fundamental analysis focuses on factors that need interpreting. That requires experience.
Qualitative analysis looks at factors like a company’s business model and management, corporate governance structure, and the competitive landscape.
What’s the Difference Between Fundamental and Technical Analysis?
Fundamental analysis and technical analysis have different objectives. And they look at different aspects of a company.
Fundamental analysis dives deep into a company’s business model. Analysts read through financial statements, industry forecasts, and economic articles. This helps them assess how a particular company might perform … They also look at the company’s market sector and the broader economy.
Company leadership can impact a company’s perceived value. Has a chief executive led previous companies to success? Maybe that’s a sign that the new company will do well.
Increasing volume can mean fast price moves, favoring longs or shorts, depending on the trend.
Who focuses on technical analysis? Usually day or swing traders like me and many SteadyTrade Team members. Technical analysis helps you break down short-term price fluctuations.
The momentum comes from people reacting to company news or hype. It could be a change in leadership, or a biotech company getting regulatory approval for a product.
At the end of the day, both types of analysis are important. They’re different approaches to predicting future stock prices.
How Do You Calculate Fundamental Analysis?
Fundamental analysis is a thorough and time-consuming process.
It’s great to start with quantitative data — the things about a company you can measure. Then, analyze its financial statements over a span of several months or years.
You’re looking for rising year-over-year profits and healthy balance sheets. What does the company spend the most money on? Does its spending generate more revenue over time?
Next, do some qualitative analysis. You’ll need to use your instincts more here. Look at the impression the company makes…
For example, are the managers known for their successes? Are they new to the industry? What kind of reviews do users write?
Be sure to look beyond the hype. Especially with newer companies. Check under the hood before committing your hard-earned dollars.
Fundamental Analysis Indicators
There’s a range of fundamental analysis indicators. Below are some of the most common.
- Price-to-earnings ratio (P/E): This ratio compares the current price of a company to its earnings per share.
- Earnings per share (EPS): This is a measure of how much company profit gets distributed per share.
- Price-to- earnings growth ratio (PEG): This tool is used to measure a company’s stock price relative to its earnings growth rate.
- Price-to-book ratio (P/B): This ratio compares a stock’s market price to its book value.
- Return on equity: This is the company’s net income divided by shareholder equity.
5 Tips on How to Conduct Fundamental Analysis
OK, enough theory, right? Let’s break fundamental analysis down into 5 tips…
Find Reputable Sources
Make sure you can trust your data sources. Most companies make their financial statements public. You can also get a prospectus through most brokers. The U.S. Securities and Exchange Commission (SEC) is also a great resource.
Read the News
You want to know how the public views the company. Corporate marketing materials won’t provide the clearest picture. Find reviews and articles from established publications and websites, and look at social media. A tool like StocksToTrade can help you find the news and filings for a company on one platform.
Perform Background Checks
Not legal ones … Do research on the company’s leadership. Find out where they worked before. What decisions did they make on behalf of the company? What were the results?
Focus on Undervalued Stocks
The key to fundamental analysis is finding stocks that have the potential to outperform. Take, for example, value stocks. These companies tend to have great reputations … They’ve been around a while and plan to be around even longer.
You want to be sure that the reason for a price decline is a short-term thing, and that you’re getting a great deal.
Trust Your Gut
At the end of the day, it’s your call. You have to develop an instinct for trading and picking stocks.
Is It Possible to Perform a Fundamental Analysis of Cryptocurrency?
It would be difficult. Fundamental analysis relies on things like earnings and business plans, the competitive advantage of a company, and its corporate structure.
Cryptocurrency isn’t governed by a board or executives. It’s decentralized. When it first came out, it traded erratically. Even technical analysis would’ve been hard to use.
After bitcoin broke out past $20,000, things changed. Crypto started to follow some basic technical indicators.
If you want to find the best stocks to follow when cryptocurrencies are trending, tune into my LIVE Pre-Market Prep sessions. I’m there for you every trading day at 8:30 a.m. Eastern.
Can You Use Both Fundamental and Technical Analysis?
Absolutely. It all depends on your trading strategy and personal preference. Some people are purists. They only want to use one system and ignore the rest.
I can’t blame them. Sometimes we put our hands in too many buckets. That can confuse our intuition when we need it most. Investing takes both knowledge and sharp instincts.
How to Combine Fundamental and Technical Analysis
Fundamental analysis is generally used for longer-term strategies or investing. You have to dig deep into the fundamental building blocks of a company. And you have to take a big-picture approach. Imagine where the economy will be several years down the line.
Technical analysis uses historical price data and volume analysis. It estimates where the stock’s price will go, usually based on shorter-term momentum swings.
You can use both methods for different reasons. First, do your due diligence on a company through fundamental analysis. Put it on your watchlist. Then use technical analysis to estimate when the best time to buy will come around.
Best Fundamental Analysis Tools
Finviz is a popular platform that allows traders to search stock charts through a wide range of metrics. It can be a great starter tool for market newbies.
The SEC’s Electronic Data Gathering, Analysis, and Retrieval system (EDGAR) provides free public access to important company information.
You can find documents including prospectuses, periodic reports, and earnings announcements. It’s definitely one of the best fundamental analysis tools out there.
A great tool for day traders and swing traders alike is StocksToTrade. Its newest add-on feature, Breaking News Chat, helps you stay on top of the news that matters most. Two market pros alert members to the news that moves stocks. Get your 14-day trial for $17 here!
The Pros and Cons of Fundamental Analysis
Fundamental analysis can help you understand a company’s foundation. When you pore over a company’s financials, you get a clear picture of where its revenue comes from.
From there, you can make educated guesses about the company’s potential. Can it maintain that revenue and grow it?
Is there a threat to a key ingredient in their supply chain? A crisis — like a ship getting stuck and blocking the Suez Canal — can throw supply chains into disarray.
Will the company’s product become essential to a new lifestyle? A lifestyle that’s here to stay?
Here’s an example … Target Corp.’s (NYSE: TGT) retail and online shopping options provide flexibility. Customers have gotten used to convenience. Do you think they’ll go back to mom-and-pop shops? I doubt it.
Fundamental analysis alone can’t predict short-term price swings. Fundamental analysts tend to be buy-and-holders. They don’t buy and sell stocks based on press releases.
As an investor, your money is subject to the risks of being in the market longer. As a trader, you can move in and out of markets at ideal times. You don’t weather the storms. You don’t watch your balances go down and give yourself pep talks about how much you believe in your stocks.
Fundamental analysts don’t ride the waves of volatility. They swim underneath them and wait for calmer waters before coming up for air.
Real-Life Examples of Fundamental Analysis
- Portfolio managers can use fundamental analysis to support different goals.
- Buy-and-hold investors use fundamental analysis to find stocks with strong foundations.
- Value investors use it to find undervalued stocks.
- Contrarian investors use fundamental analysis to form their own opinions. They want to decide the true value of a company and ignore the whims of the market.
Automation in Fundamental Analysis
Fundamental analysis is a lot of work. It takes time and patience to do the in-depth research needed to draw solid conclusions.
Markets move fast. Especially now that there are more traders in the game than ever before. Not only that … There are institutions dedicated to high-frequency trading (HFT).
It takes a lot to stay ahead. That’s why software algorithms conduct a lot of fundamental analysis. Computer programs create equations after processing all the data.
If it takes too long, and you have better things to do … Leave it to the robot brains!
That’s what Breaking News Chat does for us. It’s the software feature that allows our market pros to alert you to the news that can really move stocks.
Fundamental Analysis Books
There are a ton of fundamental analysis books out there. If you’re serious about becoming a fundamental investor, it’s great to read up first. Here are a few good ones…
“Fundamental Analysis For Dummies” by Matthew Krantz
The “For Dummies” series is a classic for a reason. It provides a solid framework for beginners to grasp new concepts. This book breaks down the ABCs of fundamental investing. It’s a great starter book for any new skill set. And a reference manual to keep in your library.
“How to Make Money in Stocks: A Winning System in Good Times and Bad” by William J. O’Neil
This book provides a thorough guide for analyzing stocks. It starts with a good foundation for fundamental analysis. Then it hones in on which fundamentals to focus on to find outlier stocks.
Its goal is to help you find the gems outperforming the market. Many serious investors keep this book in their libraries.
“The Intelligent Investor” by Benjamin Graham
This is one of the most popular books on fundamental analysis. It also focuses on value investing. Many investors consider it the bible of the investing world. It’s a must-read for investors. Warren Buffett once called it the “best book on investing.”
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Does Fundamental Analysis Work?
It depends on who you ask. If you ask a value investor, they’re likely to say yes. It’s a smart way to ignore the hype and focus on what a company is capable of achieving.
But those who believe in the efficient market hypothesis (EMH) would disagree. They believe all available information is already priced into the market. That is, it’s reflected in the current stock price.
Those who believe in the EMH don’t think it’s possible to beat the market, and they don’t spend their time trying to.
If you’re looking for a trading strategy that works for you, it helps to have a team on your side. The SteadyTrade Team can show you the ropes. You’ll get hands-on mentorship, twice-daily live webinars, and access to a great community of dedicated traders. Sign up for the SteadyTrade Team here!
No matter how you trade, it’s important to have a basic knowledge of fundamental analysis.
It’s one of the main ways that long-term investors choose stocks. And it definitely affects sector rotation — when one sector becomes more popular than another.
When you see how large-cap stocks perform, you can look for small-cap stocks that move in sympathy with them.
The more you know, the stronger your trading instincts will be. That’s how you learn to trade through every kind of market.
What do you think? Has fundamental analysis helped you understand the markets? Sound off in the comments!