Learn How to Explain Your Investment Analytically.
It doesn’t matter if you have a finance background or not. When you decide to use fundamental analysis, you can be your own stock portfolio analyst. Instead of just following your instincts, you can use this form of analysis to reach your goals and be successful.
Technical vs. Fundamental Analysis
Investors use two forms of analysis to determine their future investing prospects: fundamental and technical analysis.
The fundamental one takes the company’s corporate health into account. By using it, you will determine the stock’s real value and if it’s worthy of your time. Meanwhile, technical analysis does the exact opposite. Instead of looking at fundamentals, it tries to find out how the market will affect the stock’s progress.
Many investors, including the well-known Warren Buffett, have built their wealth by using fundamental analysis. Investing in unhealthy companies has never been their thing – so why should it be yours?
Business 101
Before delving further into the matter, you have to know a thing or two about business. More specifically, you should know what financial statements are. The three main ones are the balance sheet, income statement, and statement of cash flows. Without these, you won’t be able to assess the overall health of the company.
Think of it this way – a doctor cannot know what’s wrong with you if he doesn’t have your bloodwork. It’s the same with companies and financial statements. They have all the essential details you have to consider before investing.
The income statement tells you how much profit the company has actually made by subtracting the expenses from the revenue. Meanwhile, the balance sheet creates a comparison between the company’s assets and the stockholders’ equity and liabilities. The point is to have them balance each other – that’s where it gets its name from. Finally, the statement of cash flows tells you more about the company’s spending habits. It lists all the activities the company has spent money on (for example, operating costs).
These are crucial if you want your analysis to be successful. However, you cannot just use numbers to determine if an investment is worthy of your money. You also have to take qualitative information into account.
Hence, you should read the company’s annual report. It’s available to the general public, and you can read all about the company’s performance there. You will also find out more about its future endeavors.
You shouldn’t take this data lightly. It’s a chance for the management to explain why the numbers are high or low. Also, you can find out what you can expect from the company in the future.
A Word or Two About Performance
When it comes to performance, the stock price doesn’t really affect it – at least not when you’re doing fundamental analysis. Moreover, when deciding if a company is healthy or unhealthy, its performance plays a vital role.
You can use a variety of metrics to evaluate the performance. For example, if you want to know more about the company’s overall performance, you should look at the earnings. Meanwhile, if you want to see how certain assets have performed, then you have to look up these specific assets (for example, return on assets).
Some of the most useful metrics include price-to-earnings ratio and the gross margin. In addition to that, you should also check out the company’s earnings per share metric.
How to Compare Companies
It’s vital to know that companies are different, especially if they come from two different sectors. Hence, the results of the performance comparison won’t be absolute if you compare Google to U.S. Steel.
Google has a higher P/E ratio than U.S. Steel. But, that won’t give you much information about the performance. The basic materials sector cannot compete with the P/E of the tech sector, so it’s futile to compare them.
So, you should only use these metrics on companies that are actually comparable. They should come from similar sectors and industries. For example, you cannot compare eBay to the Bank of New York. They are not similar, which means that you won’t get the data you need.
However, you can compare eBay to Amazon or Yahoo!, or Bank of America and JPMorgan Chase to the Bank of New York.
Be a Pro
Day traders are able to generate huge gains fast. However, that’s not the point of fundamental analysis. This analysis allows you to find a fantastic stock, and use the financial advantages of an affluent company to grow your wealth.
The intrinsic value is far more important to fundamentalists than the market value. So, how do you become a pro at fundamental analysis? Sadly, there isn’t a definitive answer to this. It’s all trial and error, and even the most experienced analysts can make a mistake.
But, you can always practice and develop your skills further by benchmarking certain stocks. Thus, you can gain more knowledge about them and analyze the company’s performance. That will take time, but it’s the best way of finding out which “good” fundamentals you should take into account.
Practice it at Home
Here are a few things you can do at home to further develop your fundamental analysis skills:
- Pick two stocks – one you like and one you would prefer to stay away from. Look at their fundamentals, use them as the basis, and try to give an honest, objective opinion about both of them. Track their progress for about three months.
- Create a checklist and use it every time you’re analyzing a stock. It will be your own cheat sheet, and it should contain all the vital information about the stock in question. For example, all the important numbers and ratios. Thus, you will be able to review this data regularly and make sound decisions about your investments.
- Whenever you’re analyzing a stock, compare it to no more than one other company in the same sector or industry. This benchmark will be the first of many you will use during your career, and in time, you will create a mental library of benchmarks. Thus, you’ll probably have great success with fundamental analysis.
