As defined in www.markets.com, Fundamental analysis is a method that attempts to predict the intrinsic value of an investment. It is based on the theory that the market price of an asset tends to move towards its ‘real value’ or ‘intrinsic value’.
Fundamental Analysis is performed with the end goal to produce a value that an investor can compare with the security’s current price, with the aim of figuring out what sort of position to take with that security – to buy when it is underpriced, to sell or short when it is overpriced.
Though many uses Fundamental Analysis to evaluate the true value of stock, this method of valuation can be used for just about any type of security. When speaking about fundamental analysis, most will agree that one of the most famous and successful fundamental analysts is the Oracle of Omaha, Warren Buffett. His abilities have turned him into a billionaire.
In Fundamental Analysis, one needs to look into two sides of studies – quantitative, and qualitative.
- Quantitative Analysis: This is an analysis of factors that can be measured or expressed in numerical terms, that is the numerical characteristics about a business. The quantitative information about a company are obtained from financial statement. All listed companies are required to make available three main financial statements on a quarterly and annual basis, and these are Balance Sheet, Income Statement, and Statement of Cash Flow. These become great sources of performing quantitative analysis.
- Qualitative Analysis is a study of other factors that aren’t numerical but are related to the character of the business and affect it’s success. Some example of qualitative factors are: the management team, the brand’s value, corporate image, competitive advantage, etc.
When carrying out Fundamental Analysis, you look at both qualitative and quantitative factors. For example, when considering Public Bank as a stock, fundamental analysts will take into account not only its financial statement, but also its management capabilities, the bank’s image, its efficiency, competitive advantage, and so on. Public Bank is a good example of a bank with proven record as the most prudent financial institution in Malaysia, low non performing loan, and very capable management team. The other side of the coin is that a relatively ageing team of this bank has caused a bit of concern, especially that of the succession plan for somebody in Teh’s family to take over the running of the bank.
The explanation above has of course been simplified as there are many ways of looking at the fundamental of a company. Some most common ways of deriving the true ‘value’ of a company involve working on a few sets of ratios. The typical ones are Earning Per Share (EPS), Price to Earning (P/E) ratio, Price to Book (P/B) ratio, Dividend Yield, Book Value, etc. These approaches will be shared in more detail in upcoming articles from financial-savvy.com.
In a nutshell, Fundamental Analysis strives to work out the true value of a company with the objective to invest in the business of the company so that the increase in value of the business will produce good Return on Investment (ROI) in the form of Capital Appreciation and Dividends to its shareholders.
Back to the basic, it is crucial for stock investors to think of himself as one of the business owners by owning X number of shares of the company via stock market. He has vested interest in the running of the business, and with the intention that the business will grow, and that the return will be channeled back to him as one of the owners. With this in mind, buying into stock in the eyes of fundamental analyst would then be a sensible move without any element of speculation.
There are huge collections of books, and resources out there on the topic of fundamental analysis. To be honest, some are just too complicated and hard to follow, with lots of jargon, financial terms, and complex calculation. For ordinary people like me, I really appreciate books which are easy to understand, and easy to follow. I personally like Secrets of Millionaire Investors by Adam Khoo, and Value Investing by Glen Arnold. If you understand Chinese, there is a very good book by 冷眼 (冯时能）called 《30年投资心得》which is available at major book stores in Malaysia. Check it out here for more reference resources.
Next – My method of Value Stocks Screening