Fundamental Analysis

Fundamental analysis attempts to measure a security's intrinsic value by examining related economic and financial factors, which can be both qualitative and quantitative in nature. Fundamental analysts study anything that can affect the security's value, including macroeconomic factors (e.g., economy and industry conditions) and microeconomic factors (e.g., financial conditions and company management). The end goal of fundamental analysis is to produce a quantitative value that an investor can compare with a security's current price, thus indicating whether the security is undervalued or overvalued.

All stock analysis attempts to identify whether a security is correctly valued within a broader market construct. Fundamental analysis is usually done from a macro to micro perspective and seeks to identify securities that are not correctly priced by the market. Investors can utilize this information to optimize their portfolio's performance.

Analysts typically study, in order, the broader economic state (bear market or bull market) then industry strength before concentrating on individual company performance to arrive at a fair market (intrinsic) value for the stock. If this intrinsic value is higher than market price then the stock is deemed to be undervalued and a buy recommendation is given. Conversely, if the intrinsic value is lower than market price then the stock is considered overvalued and a sell recommendation is issued.

Investors go long (purchasing with the expectation that the stock will rise in value) companies that are strong, and short (selling shares that you believe will drop in value with the expectation of repurchasing when at a lower price) companies that are weak. This method of security analysis is considered to be the opposite of technical analysis, which forecasts the direction of prices through the analysis of historical market data, such as price and volume.

Fundamental analysis uses real, public data in the evaluation of a security's value. Although most analysts use fundamental analysis to value stocks, this method of valuation can be used for just about any 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. He can also look at information about the bond issuer, such as potential changes in credit ratings.

For stocks and equity instruments, 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. In terms of stocks, fundamental analysis focuses on the financial statements of the company being evaluated. One of the most famous and successful fundamental analysts is the so-called "Oracle of Omaha," Warren Buffett, who is well known for successfully employing fundamental analysis to pick securities.