Fundamental Analysis Of Stocks
The two main methods that people use to pick stocks are fundamental
analysis and technical analysis. Fundamental analysis is the study of
the underlying data that affect a corporation. Technical analysis, on the
other hand, is the study of a stock's price.
Some of you may find that fundamental analysis is all you need in
order to be a successful investor. After all, understanding and applying
fundamental stock analysis helped make billionaire investor Warren
Buffett a very rich man. If you want to learn about the stock market, you must have at least a basic understanding of fundamental analysis. It is worth your time to study it.
Fundamental analysis
When you buy a stock on the basis of fundamental analysis, you are not
simply buying a piece of paper; rather, you are buying a piece of a corporation. If you're going to buy a stock, you should find out as much as
you can about the corporation. This is the essence of fundamental
analysis. You study the corporation to decide whether it is a worthwhile investment.
This includes looking at a number of factors, including the company's assets and liabilities, its earnings, the managers who are running the company, the competition, the kind of business the company is in, and the amount of debt it has. By using fundamental analysis, you should be able to pick out stocks that offer you the best chance for profits. You want to buy a stock whose price is reasonable when compared with its earnings-what fundamental analysts call "fair value."
You should know that fundamental analysis is one of the most popular methods of determining whether a stock is a good bargain or is better left alone. If you have done your homework and closely studied all aspects of a corporation, you should be rewarded with a higher stock price.
Nevertheless, fundamental analysis is merely a tool to help you
find and evaluate which stocks offer good value. Like anything related
to the stock market, this method is more art than science. Just because
you use fundamental analysis doesn't mean that you'll make a lot of
money in the market. The more methods you learn, however, the better.
This will also give you a chance to determine whether fundamental analysis is right for you.
The concepts behind fundamental analysis
Learn everything you can about the industry
The first thing an investor has to determine when engaging in fundamental analysis is what industry to look at. If we are in the middle of a
recession, when jobs are scarce and people are struggling to stay out of debt, you might look at recession-proof industries like food, oil, and
retail. Once the country is out of the doldrums and jobs are plentiful, you
take a look at industries like technology that could take the market higher.
Identify the leading company
Once you have identified the industry you want to invest in, you want
to choose companies that are stronger and more profitable than their
competition. Let's say you want to invest in the retail sector because
you believe (after careful research) that people will flock to discount
stores that can save them money. What stores come to mind? Wal- Mart? Home Depot? Exactly. Choose the stores that have name brand recognition and that advertise heavily. These companies are called industry leaders. If people are buying the company's products, the company's earnings will go up, which should cause the stock
price to rise. To find industry leaders, you want to look for companies
that have superior sales and earnings with little or no debt.
Talk to the managers
Many investors who use fundamental analysis believe in talking to the
CEO and company managers to get a feel for how the corporation is
being run. Ideally, when you speak to management, you can ask how
the business is doing, where it will be spending its money, and who its
competitors are; you can also get insights about the corporation. Questioning managers is something that many professional fund managers
do. They want to invest in companies with experienced, innovative
managers who have a vision for the future. They try to avoid companies
that have too much debt, are losing business to competitors, and have
other liabilities (like lawsuits) that can affect earnings.
As an individual investor, it is highly unlikely that you will be able
to sit down with the CEO or upper management to share a drink and a
game of golf and to try to find out exactly what is going on in the corporation. And even if you could, it is doubtful that the CEO would say
anything negative about the corporation. That is why management
interviews are somewhat controversial and why some professional
investors would rather study the balance sheet than talk with managers.
The balance sheet
A balance sheet is a report of the financial condition of a business, including items that only an accountant could love. And yet, to really understand the company you have invested in, you should study its balance sheet.
Unfortunately, most people buy stocks without taking the time to
read the balance sheet. Just remember this: You shouldn't waste thousands of dollars investing in a company unless you know a few facts about it, like how much the company earns, how much it spends, and how much it owes. When you have found out the truth about a company's earnings, expenses, and debt, you'll have a better idea of
whether you should buy its stock.
Let's take a quick look at some of the items on a balance sheet
(which by no means includes everything):
- Assets (what the company owns, such as cash, property, equipment, real estate, and accounts receivable)
- Liabilities (what the company owes, such as declared and unpaid dividends and accounts payable)
- Shareholders' equity, or net worth (assets minus liabilities)
Simply put, a balance sheet is a list of everything a company owns and everything it owes. This gives shareholders a snapshot of the company's finances. The best way to study a balance sheet is to compare it
to the balance sheets of other companies in the same industry. In addition, you should look at the balance sheet for previous years to get a
better idea of where the company has been and where it might be going.
As long as the company is not hiding debt or liabilities, the balance
sheet gives you a glimpse of its financial condition. However, reading a
balance sheet takes skill because some companies are clever at hiding
their expenses and debt while exaggerating their earnings.
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