Key takeaways
- Fundamental analysis is a method that investors use to ascertain a stock’s true value.
- Revenue, earnings and profit margin are just a few factors that help determine intrinsic value and paint a clear picture of a company’s health.
- Fundamental analysis differs from technical analysis, which examines stock price movements, market patterns and charts to predict future price behavior.
Fundamental analysis is the process by which investors determine a stock’s true value by taking into account things like revenue, earnings, profit margin and even what’s going on in the broader economy.
Here’s a look at how fundamental analysis works, how to determine whether a stock is overvalued or undervalued and when to use this method.
What is fundamental analysis?
Fundamental analysis is a method of research that investors use to determine the intrinsic value — that is, the true underlying worth — of a stock. Fundamental analysis assesses this by examining factors like revenue, earnings and profit margin. The goal is to determine whether a stock is overvalued (if the market price is higher than the intrinsic value) or undervalued (if the market price is lower than the intrinsic value).
Evaluating a company’s financial health can determine a business’s true stability and potential for growth over time despite market volatility and sentiment, which is especially important for long-term investors.
Fundamental analysis also has the potential to minimize risk in a portfolio by focusing on solid, tangible data to determine whether a company is performing well.
Fundamental analysis has two main buckets: quantitative and qualitative. Quantitative data comprises numerical information found in a company’s financial statement. Qualitative data includes external factors that influence a company’s value, such as inflation, monetary policy and consumer spending.
Fundamentals to look for
When analyzing a company’s fundamentals, there are a few key aspects to consider that help determine intrinsic value. These factors combine to paint a clear picture of its health, and many can be calculated from or found within a company’s annual (10-K) and quarterly (10-Q) reports.
- Past earnings
- A company’s earnings can tell investors how profitable the business is by showing how much money is left after covering necessary expenses. This helps gauge growth potential and financial health.
- Price-to-earnings ratio (P/E)
- Investors can calculate the P/E ratio by taking the company’s current stock price and dividing it by its most recent trailing-12-month earnings per share. This figure is one of the most well-known metrics to determine whether a stock is trading high or low relative to its peers. Meanwhile, qualitative data involves non-numeric information like management quality, brand strength, and industry trends. Both types of analysis are important in understanding a company’s performance and potential for growth.