The fundamental analysis is a method for analyzing and evaluating different types of assets.
Fundamental analysis aims to calculate its fair price and compare it to the current market price.
This kind of analysis is most suited for evaluating stocks, although it is very useful for other types of financial classes, like bonds and forex, as well.
The fundamental analysis study all kinds of publicly available data.
This includes everything from macroeconomic factors, such as the state of the economy, to microeconomic factors, like the quality of the company’s management. It examines everything from external events that may influence the price of the asset to the financial reports of the companies.
The various fundamental factors can be grouped in two general categories – quantitative and qualitative.
Quantitative factors are the hard numbers derived from all kinds of indicators.
This includes the financial statements of companies. The most important of them are the balance sheet, the income statement and the cash flow statement.
Qualitative factors are less tangible.
They evaluate things like the business model of the company, the management, the quality of the relationship between managers and workers, or managers and shareholders. Qualitative analyses also assess competition, market share, regulations and business cycle.
The fundamental analysis is usually done from top to bottom (top-down analysis). This means that a broader view of the economy is taken first, by analyzing the entire market, then it is narrowed to the sector, the industry, and down to the very company (when analyzing shares).
A bottom-up analysis is also possible. It does the opposite. It starts from analyzing the company, then works its way up to consider all macroeconomic factors that have influence on the price.
The end goal is to arrive at a number that can be compared to the present price of the asset.
The resulting value is considered to be fair, because fundamental analysis gives an objective assessment of the factors that have influence on the asset.
This fair price is sometimes referred to as the “intrinsic” value of the asset.
If this intrinsic value is lower than the current market price, the asset is considered overpriced. It is reasonable to assume that the market price would fall. If the intrinsic value is higher than the current market price, it is considered underpriced and would be expected to rise.
Fundamental analysis finds these discrepancies in the prices and gives the opportunity to take advantage of them.
The price always catches up with the fundamentals in the long run.
The trick is, it may take a while.
