Definition: We define fundamental analysis as the evaluation of a security or any given tradeable asset to determine its inherent value and a suitable selling price for it based on the inherent value.
This evaluation is carried out by looking at the fundamentals of the security, such as the issuer behind it, the strength of the management, its financial reporting, the sector the issuer operates in the economy, as well as the general economy at any given time.
Fundamental analysis is a research technique employed by investors when trying to assess a particular security issued by a company to arrive at a fair value for the security. It is a research method commonly used in researching stocks more than other types of security.
This is basically, what fundamental analysis underscores in the investment world. It defers essentially from technical analysis, which on the contrary looks at trading activities, such as price movement and volumes of trade. It tracks and investigates how the price of a given tradeable asset moves, whether up or down and the size of deals associated with each movement.
Basic Facts
- Fundamental analysis is one of two major evaluation techniques used by investors in the security market. The second technique is technical analysis. However, they are both different in application.
- While technical analysis looks at the direction of the price movement of a security in the past and what quantity of the security were sold and bought each time the price moved, fundamental analysis on the other hand tries to determine if the current selling price represents the true value of the security.
- Therefore, fundamental analysis is the evaluation of security to determine if it is currently trading at a proportionate price to its actual value when all the fundamental factors of the security are considered on merit.
- The price derived from a fundamental analysis evaluation of a security is referred to as the fair price for the security irrespective of how much it currently trades in the market.
- Fair market price of a security is arrived at by looking at the fundamentals of the company that issued the security, which includes data both from the company and outside the company.
- Result from fundamental analysis helps investors take an informed investment decision regarding the best trading opportunity the security provides to the investor – whether to buy, hold or sell.
Background
Investment decision is not made on emotions. It is made on facts and figures extracted from available data about the security. Professionals involved in this decision making are analysts who understand how to extract and apply both technical and fundamental essentials from these securities. In carrying out these analyses these professionals, use various options, formulas and charts to interpret trends and make projections with them.
Fundamental analysis is a major research method amongst other options available to investors to analyze and reach investment decisions. It interrogates fundamentals factors about a security by looking at data from the company to determine its financial health and the strength of its future projections if any.
It also looks at the capacity of the company`s existing management and available financial statements. By looking at the financial reporting an analyst considers the company`s earnings, liabilities and outgoings, which could give an insight on the possibility of dividend payout.
Another factor that contributes in a fundamental analysis is what future plans the company has in the line of business – are there projects, products, contracts, services and any other ventures the company has in the pipeline that could increase its earnings, profitability and market share?
With the above in mind, an analyst will also look at the nature of business, the sector or industry of operation the company is engaged in. This is considered alongside the general economy to understand the future prospect of the company. What an investor is investing in, is not just the company as it stands in the present, but also how it pans out in the future.
Another analytical vehicle available for investment decisions used by investors is technical analysis, which we have already briefly discussed above. Investors who use technical analysis assume that credible fundamental analysis have already been done on these securities in the past to determine the prices associated with the previous volumes of trade.
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