Picking Stocks: It’s Fundamental

(eToro Blog) When analysts talk of a stock’s fundamentals, investors generally sit up and take notice because fundamentals are, well, fundamental… unless they’re not. The concept of fundamentals is simply a look at any relevant data which might impact a stock price or a stock value. An analysis of the fundamentals will focus on the creation of a company’s portrait, if  you will, by identifying the intrinsic value of the stocks’ shares and making a decision based solely on that analysis. It is unlike a technical analysis which focuses exclusively on the price history and trading action of a stock.

Return on assets and cash flow are two of the most common indicators which are used to assess a company’s fundamentals. But investors will also consider a company’s gearing (i.e. long term debt load relative to its equity capital), profit retention history (to determine if profits are plowed back into the company for future growth) and sound capital management (to ensure maximum earnings and returns for shareholders).

How fundamental analysis is different than technical analysis might be better understood with a shopping analogy; technical analysts will follow the crowd to whatever item it is that they’re flocking in droves to, under the assumption that the highest demand for that item (whatever it may be) will eventually drive the price higher. That item, then, is the technical analysts’ target.

On the other hand, the fundamental analyst will generally dismiss the technical analysts’ purchase as one driven solely by demand and emotions. While they might eventually take a look at the high-demand item in question, it will be only after they’ve scoured the sales floor for the item which provides them with the highest value relative to its price.

There are several things that fundamental analyst will take into consideration when determining which item will give them the highest value. First there is the item’s estimated book value, or the price the investor might receive at liquidation given the sum of its parts. Next, there is the estimated “life” of the item or how long it can reasonably be expected to last or be of value. And speaking of value, a fundamental analyst will attempt to put a monetary price on that item, over the course of its life, in terms of how it will enhance earnings or provide future dividends.

Lastly, the fundamental analyst will take all of that data into consideration and combine it to determine the item’s value independent of its current price. If the independent determination is more than the sales price then they’ll deem it a bargain and snatch it up. Otherwise, they’ll wait for the price to drop or for the fundamentals to improve at some point in the future.

Undertaking a fundamental analysis of a stock isn’t a simple task, but those investors who do say that they have a better understanding of what makes a company tick and will be well poised to take action, one way or another. Of course, there’s nothing written in stone which says that an undervalued stock as revealed by a sound fundamental analysis will ultimately turn a profit in your portfolio. There are always external and extenuating circumstances which can intervene in a stock’s rise.

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