Fundamental analysis (FA) is a method of measuring a security’s intrinsic value by examining related economic and financial factors. Fundamental analysts’ study anything that can affect the security’s value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company’s management.
The end goal is to arrive at a number that an investor can compare with a security’s current price in order to see whether the security is undervalued or overvalued. This method of stock analysis is considered to be in contrast to technical analysis, which forecasts the direction of prices through an analysis of historical market data such as price and volume.
- Fundamental analysis is a method of determining a stock’s real or “fair market” value.
- Fundamental analysts search for stocks that are currently trading at prices that are higher or lower than their real value.
- If the fair market value is higher than the market price, the stock is deemed to be undervalued and a buy recommendation is given.
- In contrast, technical analysts ignore the fundamentals in favour of studying the historical price trends of the stock.
Understanding Fundamental Analysis
All stock analysis tries to determine whether a security is correctly valued within the broader market. Fundamental analysis is usually done from a macro to micro perspective in order to identify securities that are not correctly priced by the market.
Analysts typically study, in order, the overall state of the economy and then the strength of the specific industry before concentrating on individual company performance to arrive at a fair market value for the stock.
Fundamental analysis uses public data to evaluate the value of a stock or any other type of security. For example, an investor can perform fundamental analysis on a bond’s value by looking at economic factors such as interest rates and the overall state of the economy, then
studying information about the bond issuer, such as potential changes in its credit rating.
For stocks, fundamental analysis uses revenues, earnings, future growth, return on equity,
profit margins, and other data to determine a company’s underlying value and potential for future growth. All of this data is available in a company’s financial statements (more on that below).