Fundamental analysis is the study of the fundamental factors that impact the workings of the economy, industries, or organisations. In the case of the national economy, the fundamental analysis focuses on economic information to evaluate the current and projected growth of the economy. On an industrial scale, there is an analysis of demand and supply for the goods offered. Lastly, on an organisational scale, this analysis might entail the study of financial management, data, and business competition.
Most fundamental analysts use data to evaluate the value of a security. For instance, a trader can conduct fundamental analysis on a shares’ value by reviewing economical constituents, such as interest rates and the overall situation of the economy. They can also view the data about the share issuer to understand the potential fluctuations in their credit ratings.
The fundamental analysis explains that an investor or trader shouldn’t buy or sell a share based on tips and rumours. The primary step as per the share market basics is to review the detailed information about a company and the economy and then proceed further.
Types of Fundamental Analysis
A comparative study of the competition within an industry can help recognise those businesses that are doing exceptionally well and you can work out a strategy accordingly. This is only possible with fundamental analysis. There are mainly two types of fundamental analysis:
1) Quantitative Analysis
The quantitative analysis determines the outcome of a business based on measurement, mathematical research, and numerical data. The primary source of quantitative information is obtained from the financial records, which includes income statements, revenue, earnings, assets, and other quantifiable data. Any material including numbers can be quantified; thus, there are several industries in which quantitative analysis is practised and proves to be beneficial.
2) Qualitative Analysis
The qualitative analysis ascertains the potential of an organisation’s research and development (R&D), management, competition, products and services, etc. It is utilised to obtain insight into an organisation and get an edge over other analysts/investors who just use quantitative analysis. Since management plays an essential role in the growth of an organisation, it becomes necessary to review the quality of management making qualitative analysis an important factor.
Note: Quantitative analysis and qualitative analysis are based on different theories, and when used collectively, they can present useful data to make informed choices that help enhance business operations and improve financial situations.
Advantages of Fundamental Analysis
- Long-term Interest
Fundamental analysis is suitable for long-term investments based on long-term profits. The knowledge to recognise and foretell long-term consumer, demographic, economic, and technological trends can help investors who choose the right organisations or industry associations.
- Spotting the Real Value
A thorough fundamental analysis will help identify organisations that represent a genuine value. Some of the most legendary investors such as Warren Buffett and Peter Lynch are considered the champions of value investing. Fundamental analysis can further reveal organisations with a strong balance sheet, valuable assets, and constant earnings.
- Company Vision
One of the most prominent benefits of fundamental analysis is the development of a thorough understanding of the business and related industry. After meticulously analysing and researching, an investor will be familiar with the key profit drivers and revenue behind an organisation. Good knowledge of earnings can help traders and investors avoid businesses that are likely to disappoint and recognise those that give a high return on investment. Moreover, the fundamental analysis enables investors to acquire information about the chief businesses and value drivers within an industry. A share’s worth is heavily affected by its industry category. By analysing these categories, investors can properly position themselves to classify opportunities that are low-risk (utilities), high-risk (technology), growth-oriented (network and computer), income-oriented (high yield), value driven (oil), cyclical (transportation), and non-cyclical (consumer staples).
In a nutshell:
Fundamental analysis is a structured and conventional approach to research the value of a share and its potential growth. Some investors use price to book value (P/B) or price to earnings multiple (P/E) as the evaluating model to identify the actual worth of a share. If the share is expensive or overpriced, it may be traded to gain profits, and if it is low or undervalued, it can be purchased for anticipated gains. The analytical method facilitates the classification of undervalued and overvalued shares based on their dividend incomes potential, earning potential, and the asset value.
Fundamental analysis can be helpful in determining the value of a share. However, it should be dealt with caution as it is a lengthy and complicated process, which can lead to unyielding results. Many traders use fundamental analysis to evaluate the value of a share for investment purposes. The aim is to ascertain the current worth and how the market estimates the given share.