A common question people ask about a companys prospects is, what are
its fundamentals? This is a valid question, but what does it really
mean? It would behoove investors to fully understand what fundamental
analysis is in order to improve their investing skills.
Fundamental
analysis is a method for valuing the basics of a business. Basically it
is identifying the intrinsic or fundamental value of a company, and
buying or selling its stock based on that information. Investors
looking at the fundamentals of a stock would typically look at things
like earnings, cash flow, competitive position, and revenues. This is
in stark contrast to technical analysis, which deals with the trading
and price history of a stock in order to predict future price
movements. Very often, there is disdain from the diehard followers of
each method for the other. However, the two can be used to complement
each other effectively.
Famous investors like Warren Buffett
have made a name and fortune based on fundamental investing. Studying
his methodologies will teach you everything you need to know about
fundamental investing. He looks for companies that are stable, cash
producing businesses that are trading below their intrinsic value.
Buffett
looks at such measures as return on equity (ROE), debt levels,
competitive position, the potential for recurring revenue streams,
stability, and most importantly, valuation relative to its intrinsic
value. After digging through all of the fundamentals of a company, he
will buy if it is trading at least 25% lower than his calculated
intrinsic value.
Clearly, fundamental investing requires a lot
of work and research. One must be familiar and proficient with a myriad
of financial ratios as well as security valuation. However, this
diligence can be handsomely rewarded in the form of becoming a better
stock picker and identifying companies that are neglected by the stock
market. At the very least, becoming familiar with fundamental investing
will allow you to become a more educated investor, which always pays
dividends in the long run.
