Fundamental stock analysis

Fundamental stock analysis

What is fundamental analysis?

Fundamental stock analysis is the process of analysing some of the core financial data of a company. Fundamental analysis should form the basis of any smart stock investing strategy. When combined with a variety of other tools and strategies it is a very powerful way of increasing the chances of making a successful stock pick.

Essentially fundamental analysis is the process of analysing the financial statements (income statements, balance sheet, cash flow forcasts etc) and comparing them to both past performance and the performance of the company's competitors. The technique relies upon the market theory that states that financial markets often mis price stocks in the short term. This is mainly due to the slow or irregular flow of information. In the medium to long term, all the available information (in this case fundamental information) is absorbed by the market until the fair or true price of the stock is reached. Fundamental analysis looks to spot information in the accounts of a company that the market may have overlooked or not yet reflected in the stock price.

Technical Analysis

The opposite of fundamental analysis is Technical Analysis. Technical analysis argues the opposite to fundamental analysis in that it states that all available information about a company is already reflected in it's stock price. Instead the anbalysis focusses on trends or past price behaviour. The true value of a company is of no interest to a technical analyst. Instead they try to guage past stock price movements and extrapolate forward into the future.

Ratio analysis

Ratio analysis is one of the easiest and largest areas of fundamental analaysis. By studying the ratio areas mentioned below you can quickly begin to piece together an overall picture of the financial health of a company out of the annual accounts.

-Liquidity Ratios
-Debt Ratios
-Turnover Ratios
-Profitability Ratios
-Dividend Ratios

Despite their usefulness there are some limitations of ratio analysis. The main one is that in isolation they can skew the picture. To get the best use from them you need to compare the ratios to historic data and/or competitors ratios. Also they need to be considered alongside all your other analysis of a company thus eliminating any potential false information. In addition ratios can sometimes be limited or skewed by accounting standards. Different methods used by different companies can produce very different results so be sure to check you data very carefully.