Fundamental Analysis: A Detailed Case Study

 Fundamental Analysis: A Detailed Case Study

Fundamental analysis refers to an accounting and a financial strategy focused on identifying a specific business's key indicators. The aim is to assess its effectiveness by studying the financial statements.

Fundamental analyses aim to assess a specific security's intrinsic worth accurately. Its valuation approach analyzes various financial and economic factors and how they impact how the base entity. It could include financial metrics on assets, liabilities as well as earnings. They also consider the performance of management, the performance of competitors and macroeconomic indicators, such as unemployment rates, interest rates and GDP forecasts, analysts' forecasts, letters to investors, as well as press releases, announcements and other things.

The ultimate objective is to determine the value of a security and whether it is under or overvalued. To do that, it reviews every relevant information and then comes up with an amount that investors can use to compare the current value. It provides investors with an objective basis to determine whether or not to invest in an asset.

History of Fundamental Analysis

Benjamin Graham is considered a pioneer in the field of fundamental analysis. He's among many, if not the most influential and significant people throughout finance history.

In 1934, after the Great Depression, Benjamin Graham and David Dodd, both professors at the Columbia Business School, published the book " Security Analysis". The book advised investors against speculation in the market and encouraged investors to concentrate on the actual value of securities.

"Astute observers of corporate balance sheets are often the first to see business deterioration."

- Benjamin Graham, Security Analysis

It's probably not wrong to conclude that the most precise, comprehensive, and thorough answer to "What is fundamental analysis" is in this book.

The authors suggested the concept of a comprehensive fundamental analysis as a reliable method of estimating the actual worth of an asset. They suggested it be used as a base for determining the trend in the short term in the price of its future. It is important to note that Graham and Dodd should have concentrated on long-term predictions or tried to determine the actual price of an asset at a particular time.

More than 300 pages in the book are devoted to methods for analyzing financial statements. They cover accounts of income and balance sheets. The chapters cover essential accounting concepts and terms, such as amortization, depreciation, unique items, and unconsolidated subsidiaries.

The book was later an exceptionally frequently referenced and significant book in financial markets. A century after, Graham and Dodd's ideas are as precise and vital as ever.

The Development of Fundamental Analysis

After the publication of the "Security Analysis" book, fundamental analysis became the principal basis and the primary method for the valuation of assets. It was the case till the advent of digital technology took over the financial markets. Since then, the use of technical analysis, as well as other computational valuation methods become more common. Despite the development of new technology that changed the attention of investors to the fundamental analysis of their portfolios, it remains an integral component of investors' top tools.

Later revealed the fundamental analysis and crucial accounting issues covered in the book by Benjamin Graham. in several of our recent corporate scandals, such as the ones in the cases of Enron and Valeant Pharmaceuticals.

The foundation investment in value is its fundamental analysis. Warren Buffet is arguably the most successful investor of his time. He made his fortune following the rules that he believed in value investment.

"Other guys read Playboy, and I read annual reports."

- Warren Buffet

The fascinating thing is that even though Benjamin Graham was Buffet's mentor, he wasn't an influential investor. The reason for this was that Graham was fascinated by whether a business could produce enough income to overcome the issues that could initially reduce its price. Buffet expanded on this idea and made it more effective by focusing on the long-term scenario. From this, the expression "value investing" comes -- Buffet was looking to see if the current state of affairs and context surrounding a specific company would be of value shortly and assist it in beating its competition.

Fundamental and. Technical Analysis

Fundamental and technical analyses are the two fundamental principles of investment philosophy and the most popular school of thought in the theory of financial markets. They're both distinct and often conflict with each other. This is why there is a constant debate over fundamental and technical analysis.

Both analysis techniques are designed to assist investors in researching and forecasting the price that they will pay for an asset. However, they differ from one another in how their application along with the instruments they employ to conclude.

While fundamental analysis attempts to determine the value of an asset using data from official statistics, financial statements, and other sources, technical analysis bases forecasts on two main factors: the asset's price as well as the volume of trading. Analysts using graphs identify patterns and patterns that are created by the share's price as well as its trading volume and interpret them as signals to buy or sell.

Technical analysis, in reality, does not focus on the intrinsic value of an asset. It tries to simplify the notions in fundamental research by believing that the key indicators necessary to make an accurate forecast are included in the asset's price. To determine price fluctuations, technical analysts employ support and resistance indicators, momentum-based indicators moving averages, and trend lines.

Investors make investment decisions based on the intrinsic worth of an investment. Generally, choose fundamental analysis as their primary method of research. On the other hand, day traders, speculators, arbitrage traders or short-term investors prefer to use technical analysis. It offers them a swift and accurate forecast of prices in which they are interested. Market participants attempt to mix both methods to forecast long-term prospects accurately.

Types of Fundamental Analysis

There are two kinds of fundamental analysis: bottom-up and top-down. For a better understanding, consider the top-down method as the one that is global and the bottom-up approach as the local approach.

Top-Down Approach

It focuses on macro variables like the economic situation and the forecast for GDP growth, unemployment and interest rates. In taking all of these aspects into consideration, the investor is attempting to formulate predictions about the larger perspective - the economy's direction and general market developments. When you've done that, you'll be aware of the industries that will prosper as well as those that aren't investment-worthy opportunities. Then, you can go one step further and analyze a company level to find stocks with high potential.

The intention is to narrow the investment window by starting with the overall picture before the shift to specific stocks.

Bottom-Up Approach

The bottom-up method reverses the pyramid and begins to analyze the state of the economy from the micro-level. Investors who use this approach think that the economy's overall condition might reflect something other than the performance of specific stocks. They believe that some stocks have excellent investment potential even though they are part of a slowing industry or sector.

Fundamental analysts from the bottom look at the company's earnings and balance sheets, financial statements, news announcements letters to investors, estimates of demand and supply of the goods and services offered by the business, and other sources of information specific to the company.

Fundamental analysis in both forms comes with advantages and disadvantages. For instance, top-down analysts tend to identify the best-performing industries and sectors. This way, they can limit available opportunities and swiftly change their focus to particular businesses. Bottom-up analysts, on the other hand, gain a better understanding of the specific company and its operation.

There is no way to say that one method is superior to the other. Fundamental analysis of both types is suitable for various situations and appeals to different kinds of investors. The top-down strategy, for instance, is the preferred choice for beginners or those who need more time to conduct financial calculations on a micro level. Bottom-up is, however, the preferred choice of investors looking for stocks with high potential that can outperform the market, even during difficult times.

Other Methodologies

Before discussing the best way to conduct fundamental analysis, we must be aware that specific experts pick out other fundamental analysis methods. In the book "A Complete Guide to the Futures Market: Technical Analysis, Trading Systems, Fundamental Analysis, Options, Spreads, and Trading Principles" ( link), Jack Schwager and Mark Etzkorn dissect this "old-hand" approach. Based on their research, the method is utilized for analysts acquainted with the markets they are investing in (the authors describe them as possessing "a virtual sixth sense concerning price fluctuations").

Balance tables are a different method that the author suggests. They provide a comparison of the current season's supply and changes from previous seasons. They also discuss the analogous season in which analysts look at previous seasons with similar characteristics to the current season to develop a plan for forecasting price changes. Schwager and Etzkorn discuss regression as a technique that generates forecasts using the analyzed data.

As a basis for fundamental analysis, you must be aware of the bottom-up and top-down strategies. If, at the time, you decide to improve your skills, take the time to improve them by using other methods that the authors suggest.

How to do Fundamental Analysis

We must give the complete answer to how to perform fundamental analysis with more than one guide. There are thousands of pages written by prominent investors and industry leaders such as Warren Buffet, Benjamin Graham and others. That goes deep into the fundamental principles of analysis and the best way to use them to enhance the performance of your investments.

We'll illustrate a practical application of both bottom-up and top-down investing strategies. In this article, we will provide helpful tips for conducting a fundamental analysis using the bottom-up and top-down methods:

How to do Fundamental Analysis via the Top-Down Approach

As we've said before, the top-down approach is focused on the bigger perspective. It is necessary to consider macroeconomic variables to determine the direction of a specific sector or business. In the end, based on the assumption that stocks in high-performing industries are also doing well, We can examine the micro-level to identify specific options.

Macroeconomic Indicators

It is essential to determine as many macroeconomic variables as possible. It will help us expand our horizons to a variety of industries later. It is a good idea to gather information to estimate GDP . The US, global markets, the forecast for interest rates, yields and prices of bonds and inflation rates, commodities, and so on.

For instance, if we consider the interest rate indicator, a great area to study is the financial sector. The primary source of income for banks is derived from the interest rates they charge on loan products, and we can monitor the change between an index of the financial market (for an example, see below). ) we employ that index, the Financial Select Sector SPDR ETF (XLF), as well as the ten-year Treasury, yield to reference changes in interest rates.

The graph illustrates what appears to be a direct connection between the two instruments. As interest rates rise, banks' stocks are likely to perform very well. It's important to note that this only sometimes happens, and any analysis should be supplemented by other factors, such as the general economy's performance. If, for instance, the economy isn't doing as well while interest rates rise and banks' stock prices are falling, it could also impact them.

Similarly, we can also use interest rates as a critical aspect of analyzing home construction and construction material manufacturing firms. When the interest rate is low, home construction mortgages become less expensive. It can lead to increased demand and an increase in the construction industry.

Commodity Examples

About the price of commodities, An easy way to look at the price of commodities is to examine the price of oil and companies that are involved in oil production. The correlation is positive, and the upward trend of prices of oil will almost always reveal to you the price of shares of companies that are related to oil. In the case below, we will compare the prices for the Crude oil Futures agreements (CL) and the price of shares for the Exxon Mobil Corporation (XOM). It is clear is a rise in the price of shares in the company always accompanies any spike in the cost of the commodity.

The top-down method could be used for a specific country or region stocks, taking into consideration the projected local GDP, the unemployment level, the economy's health, and many other variables.

How to do Fundamental Analysis via the Bottom-Up Approach

When investors use the bottom-up approach that they don't consider the general market conditions and macroeconomic factors initially, they only focus on specific fundamentals of the stock, which aid in assessing other companies in the same sector.

What are the fundamentals of stocks? They can be classified into two groups, namely qualitative and quantitative. The distinction is that the former is measured numerically while the latter is determined using abstract variables such as character or quality. Let's examine both.

Qualitative Fundamentals

Qualitative fundamentals are more tangible, and the size, quantity or volume value only sometimes quantifies them. Here are the most well-known qualitative elements:

Competitive advantages and business model

The fundamental aspect defines the company's work and how it differentiates itself from the rest of the market. It's a personal thing that isn't measured in any number of metrics. Naturally, businesses that have compelling competitive advantages are the most sought-after by investors.

Management

As per the vast majority of analyst opinions, this is the most crucial. The management team and their style are detrimental to the performance of a specific company's shares. There are plenty of instances of how poorly run companies fail to live up to their potential and end up failing. To understand the management style of a specific company, it's always an excellent idea to study the personal histories of team members and learn what they did in previous positions.

The power of a brand

Any investor can be confident about the strength of brands like Nike, which created a community of loyal customers. It is essential when making predictions on how a specific company, in the face of crisis, has a less robust economy, fierce competition and so on. and its growth in sales. Businesses with strong brands can overcome external risk factors and even advance in difficult times.

Could consider various qualitative variables be. It includes the overall growth in the industry, the regulatory framework within the particular industry, the competitive landscape and the way it operates, the customer base, patents, proprietary technology market dominance, and many more.

Quantitative Fundamentals

Consider them as numbers that are hard to calculate or the measurable traits of a particular business. When determining the value intrinsic to an investment, the bottom-up approach uses several methods, including growth ratios, financial ratios, and many others. These are the most widely used tools:

Earnings-per-Share (EPS)

The EPS ratio shows the level of profitability of a particular company. It reveals the amount of profit allocated per share. A higher EPS ratio indicates that the business is more efficient and profitable, making it an investment opportunity.

Price-to-Earnings (P/E)

The ratio is a measure of the number of corporate payouts about the value of the stock. Imagine it as the pay for an in-position. It tells us whether the stock pays well about the amount it costs (its cost). Investment opportunities that are good come with lower P/E.

Too high or low P/E indicates that the stock is either undervalued or overvalued and is likely to be corrected shortly.

Price-to-Book (P/B)

The P/B ratio tells you the amount of stock worth compared to the company's book values. A ratio that is higher than 1 means the market will grow faster than the book value. If you calculate the ratio of this type, do not be amazed when you see numbers that exceed 100 or greater. It is common for stocks that are growing.

Return on Equity (ROE)

ROE is one of the most well-known and commonly used fundamental indicators. It can show the efficiency of a business when using the equity of shareholders. A greater ROE signifies that the company has more efficiency.

Beta (b)

The Beta is an important indicator to look at for the connection of a specific stock with the industry's movements. For Beta value calculation, it is necessary to compare the price to the benchmark, usually an index. The value of the Beta varies between 1 and -1 but, in some instances, might be higher than that.

• Covariance is the return of the stock on the market
• Variance is the way that the market performs in comparison to its mean

If b is less than zero, the stock is in reverse correlation to the benchmark. The lower value has a more excellent negative correlation. Lower Beta implies lower volatility and higher profits. If b is greater than 0 is true, then the share price corresponds to the benchmark. A greater Beta isn't just more correlation; it also means more probability of profit and higher volatility.

Projected Earnings Growth (PEG)

The indicator's purpose is to allow you to determine the amount you'll be paying per unit of anticipated growth in earnings. In this case, even stocks with a high P/E and a high PEG could be regarded as excellent investment options.

The PEG ratio increases the ratio of P/E by including an additional parameter, such as EPS growth. Doing this makes it more comprehensive and allows for more precise projections. The PEG reflects the true worth of a company and helps investors identify undervalued and overvalued assets.

Dividend Yield and Dividend Payout Ratio

Value investors such as Warren Buffet or investors who prefer dividend income can use this indicator as their primary instrument to determine the potential of an investment opportunity. The indicator shows the percentage of the return the company gives its shareholder's dividends.

To add a new dimension to dividend estimates, investors must also look at the indicator of the Dividend Payout Ratio. The values calculated, even though unclear, cannot be interpreted with a simple understanding. It is essential to analyze them concerning other data or metrics.

Let's assume that DPR is calculated as 20 per cent. This figure isn't a little. For instance, growing businesses tend to keep a large portion of their earnings and invest them in their expansion. That means they pay minimal or no dividends. However, businesses that pay more dividends could be older businesses with little growth potential.

There is a myriad of fundamental analysis metrics that you can use, and covering all of them could make this guide an instructional manual. We're introducing you to the whole analysis field and its main tools. It will allow you to explore the world of investing and expand the knowledge you have acquired.

Fundamental Analysis Tips and Tools

At this point, we need to know what analytical analysis is and how it operates in real life. It's time to concentrate on basic analysis techniques and tools to streamline the process.

As we all know, the primary requirement for good fundamental analysis is access to official corporate information. For example, public companies release their financial statements and notes to shareholders on their websites. Private companies, however, don't have to, so it's difficult to find any information regarding them. To get around this issue, You can use tools such as Powrbot to help you find details about the corporate entity without cost.

Suppose you look for features for charting and visualizing how a specific market over time TradingView can do the job for you. If you better understand the market, you could also investigate the array of included technical indicators.

SimplyWallStreet is another fantastic tool to help you understand the math behind stock valuation. The software calculates ratios and other metrics and displays the results as easy-to-read information graphics and charts. The program makes fundamental analysis accessible and understandable to those new to the field.

If you're looking for an application with all the elements required to conduct a thorough fundamental analysis, consider giving Finviz a chance. It's a screener for stocks and heat map makers, a news compiler and much more. It can calculate the connection between various types of assets or stocks. It assists you in being informed about events that are likely to change the value. It is also possible to make use of it for studies.

Platforms

The section on tips and tools of this guide would only be complete with mention of trading platforms. A majority of the top brokers offer well-designed and functional platforms. They are typically accessible for free and are suitable for primary, technical as well as quantitative analyses. One example of this can be TD Ameritrade and its Thinkorswim platform.

Remember that you can create fundamental analysis from scratch. Particularly not when you're beginning your journey into trading. There is a lot of research on the internet that could be a good starting point. It is a good idea to look over an overview of the various industries to understand how these sectors operate. Learning this will show you how the market reacts to the stock of the companies that operate in those areas. The SeekingAlpha website, for instance, is a good starting point and is an excellent source for research and analyses of the industry. You can also utilize Twitter to follow top fundamental analysts to keep up-to-date with their advice and the latest stock predictions.

To Conclude

Fundamental analysis is a crucial component of the current reality of the financial market. Today, the days of romantic long-term investment appear to be over. Today, most investors are searching for quick-term gains and strategies to profit from potential opportunities in momentum trading. Fundamental analysis continues to play an important part when it comes to the strategy of successful investors. Learning the art of fundamental research is well worth the effort, even if it requires more time. If you need more clarification, check out Warren Buffet's net worth.