Fundamental Analysis

What is fundamental analysis?

In this section we are going to review the basics of fundamental analysis, Examine how it can be broken down into quantitative and qualitative factors, Introduce the subject of intrinsic value and conclude with some of the downfalls Of using this technique.

The Very Basics

When talking about stocks, fundamental analysis is a technique that attempts to Determine a securitys value by focusing on underlying factors that affect a Companys actual business and its future prospects. On a boarder scope, you Can perform fundamental analysis on industries or the economy as a whole. The Term simply refers to the analysis of the economic well-being of a financial entity As opposed to only its price movement. Fundamental analysis serves to answer questions, such as: Is the companys revenue growing? Is it actually making a profit? Is it a strong-enough position to beat out its competitors in the future? Is it able to repay its debts? Is management trying to cook the books?

Of course, these are very involved questions, and there are literally hundreds of Others you might have about a company. It all really boils down to one question: Is the companys stock a good investment? Think of fundamental analysis as a Toolbox to help you answer this question.

Fundamental: Quantitative and Qualitative.

You could define fundamental analysis as researching the fundamentals, but that doesnt tell you a whole lot unless you know what fundamentals are. As we mentioned in the introduction, the big problem with defining fundamentals is that it can include anything related to the economic well-being of a company. Obvious items include things like revenue and profit, but fundamentals also include everything from a companys market share to the quality of its management. The various fundamentals factors can be grouped into two categories: quantitative and qualitative. The financial meaning of them terms isnt all that different from their regular definitions. Here are the custom definitions:

Quantitative capable of being measured or expressed in numerical terms. Qualitative related to or based on the quality or character of something, often opposed to its size or quantity.

In our context, quantitative fundamentals are numeric, measurable characteristics about a business. Its easy to see how the biggest source of quantitative data is the financial statements. You can measure revenue, profits, assets and more with great precision. Turning to qualitative fundamentals, these are the less tangible factors surrounding a business things such as the quality of a companys board members and key executives, its brand-name recognition, patents or proprietary technology.

Analyzing levels
The fundamental analysis comes in different classes start with the firm itself by analyzing financial statements, and surveying all the available information related with it by determining the points of strength and weakness in the company.

Then come after that through section analyzing the company work in- to determine companys chances in this industry and to get enough information about the dilemmas the company faces, future mighty problems and how to face them.

After that comes analyzing the economy as a whole, by watching indexes that reflect economic performing and how they can affect the companys perform or stocks prices. There are two ways in fundamental analysis: Top down analysis:

By this way whole economic analysis comes in first, then through section analysis, the finally analyzing the financial statements of the company. Bottom up analysis:

In this case we do fundamental analysis firstly, after that through section analysis, and whole economic analysis comes at last.

Technical analysis
This method analyses a companys stock price by using data such as stock price, volume of stock traded, stock price volatility and market trend. A person using technical analysis to value a stock doesnt look at company data at all. Instead they rely upon market trends to determine how a stock price may change in the future. Using technical analysis to value a stock will require the use of market data, financial charts and tables. By analyzing the data you will form an opinion about the stock price and market trend and make your decision accordingly. As you see technical and fundamental analysis are two very different ways of deciding whether a stock undervalued or overvalued. Which one is better depends on many factors but the most important one is the person doing the investing.

Three branches of Technical Analysis

Technical analysis can be broken down into three essential areas: sentiment, flow-offunds, and market structure indicator. Data and indicators for all three areas are available for the U.S. stock market. For other financial markets, the statistics are more or less confined to the market structure indicators. The major exceptions are futures market based in the United States, for which short-term sentiment data available. The following comments on sentiment and flow-of-funds indicators relate to the U.S. market.

1-Sentiment indicators
Sentiment or expectational indicators monitor the action of different market Participants, such as insiders, mutual funds managers and investors, and floor specialists. Just as the pendulum of a clock continually moves from one extreme to another, so the sentiment indexes (which monitor the emotions of investors) move from one extreme at a bear market bottom to another at a bull market top. The assumption on which these indicators are based is that different groups of investors are consistent in their actions at major market turning points.

2-Flow-of-Funds Indicators
The area of technical analysis that involves what are loosely termed flow-of-funds indicators analyzes the financial position of various investor groups in attempt to measure their potential capacity for buying or selling stocks. Since there has to be a purchase for each sale, the ex post, or actual dollar balance between supply and demand for stock, must always be equal. The price at which stock transaction takes place has to be the same for the buyer and the seller, so naturally the amount of money flowing out of the market must equal that put in.

3-Market structure indicators

Market Structure or the Character of the Market, these indicators monitor the trend of various price indexes, market breadth, cycles, volume, and so on in order to evaluate the health of prevailing trend. Indicators that monitor the trend of a price include moving averages, peak-and-trough analysis, price patterns, and trend lines.

Fundamental or technical analysis?

Fundamental and technical analysts have been arguing which is better since modern stock markets emerged. There is no clear answer as to who is right. It seems that investors following either one can point to periods of investment success but over the longer term neither side can point to a definitive answer. Some of the issues to consider are: If you are a long term investor looking for solid companies with good growth and income potential and a good track record then fundamental analysis may be of interest. If you are a short-term investor looking for exciting growth stocks that are undervalued then fundamental approach to analysis would be useful. If you are a short-term investor who thinks the market is undervalued and is looking for investor sentiment to change then technical analysis may be useful to you.

In practice the two techniques can be combined. In many cases experienced market investors may use fundamental analysis to identify undervalued companies and then use technical analysis to time their entry into the market place. A serious investor will familiarize themselves with both techniques and combine them to maximize their chances of success in the market.

References
Introduction to fundamental analysis by Ben McClure. Basics of finance by Dr. Hisham Ibrahim. Technical analysis by Martin J. Pring. Documents found on the internet related to topic.

Research studies in: Technical and Fundamental Analysis By/ Mustafa Mahmoud Kamel.