Having a basic knowledge of fundamental analysis will give you a better foundation for your investment decisions. Understand why you should use it when investing. You will learn how to find relevant information in earning reports from the listed companies.
Fundamental analysis is critical component in stock analysis. It is quite accessible, extremely valuable and you actually don’t need a finance degree to get a basic understanding of it. The problem of fundamental analysis is however that it can very easily get quite complicated, but it doesn’t have to be.
What is a Fundamental Analysis?
A fundamental analysis is all about getting an understanding of a company, the health of its business and its future prospects. It includes reading and analyzing annual reports and financial statements to get an understanding of the company’s comparative advantages, competitors and its market environment.
Why use fundamental analysis?
Fundamental analysis is built on the idea that the stock market may price a company wrong from time to time. Profits can be made by finding under priced stocks and waiting for the market to adjust the valuation of the company. By analyzing the financial reports from companies you will get an understanding of the value of different companies and understand the pricing in the stock market.
After analyzing these factors you have a better understanding of whether the price of the stock is undervalued or overvalued at the current market price. Fundamental analysis can also be performed on a sectors basis and in the economy as a whole.
The true value of a stock?
For a fundamental analyst, the market price of a stock tends to move towards its ‘intrinsic value’, which is the ‘true value’ of a company as calculated by its fundamentals. If the market value does not match the true value of the company, there is an investment opportunity.
Example of this is that if the current market price of a stock is lower than the intrinsic price, the investor should purchase the stock because he expects the stock price to rise and move towards its true value. Alternatively, if the current market price is above the intrinsic price, the stock is considered overbought and the investor sells the stock because he knows that the stock price will fall and move closer to its intrinsic value.