How to Perform Fundamental Analysis on Stocks
In determining whether a stock is overvalued, leading to a sell recommendation, or undervalued, leading to a buy, the two most common types of analyses are Fundamental or Technical.
The basic difference between the two is that technical analysis relies almost exclusively on historical trading prices and volume, while fundamental analysis may include that data but only as part of a wider review of the company and economic structure surrounding it. Both approaches are commonly used, and it depends on the type of stock as to which one may give a more realistic valuation.
Fundamental analysis is generally not used by active or short-term traders as it is based on a more long-term strategy where the expected payoff will occur in the future when the undervalued stock begins to rise in price. Performing a fundamental analysis is centered around understanding the company as a whole and comparing its stock price to related companies within the same industry.
Both quantitative and qualitative measures are used in fundamental analysis, the first providing data based on the available numbers from financial statements. The second comes from reviewing the company’s overall character and quality.
4 Key Qualitative Measures
- A company’s competitive advantage within its industry. Is it keeping pace with its competitors, ahead of them in areas like brand recognition, or are they falling behind with a lack of social media presence?
- The business model and how well it is performing in its main function. A look at a company’s financials can provide a great deal of insight into their sustainability. Other aspects to look at will be if there are plans to expand or diversify into other areas.
- The management structure and its key figures. In the age of social media, how the public figures in charge of large corporations comport themselves can cause drastic rises and falls in stock price. Within the company, new management or corporate “shake-ups” can be either a pro or a con depending on what caused the change.
- The policies in place that declare how it enacts corporate governance. These policies should be clearly outlined in the company charter and bylaws. How a company communicates with its shareholders or whether they have committed to operating fairly and ethically are all ways to judge how they will treat an investor.
3 Key Quantitative Measures
- The balance sheets provide a snapshot of the assets a company has at a specific point in time. It shows the resources a company has in its possession (assets) and how the company paid for those resources in the form of debts (liabilities) plus shareholder’s equity.
- Income statements are usually provided quarterly and annually and provide a more comprehensive overview of a company’s financials than the balance sheet. However, both generally offer the same type of information.
- The cash flow statement is an integral part of an analysis. It provides a clear idea of cash on hand, which is usually more difficult to manipulate than earnings statements.
Case Study: AT&T, Inc.
- Pro: 25 years of dividend growth and payout
- Pro: Well-established in its industry
- Pro: Multiple revenue streams
- Con: The 2018 purchase of DirecTv satellite was poor timing due to the surge in streaming technology
- Pro: New management is taking steps to curb underperforming areas
- Pro: AT&T is a strong contender for the 5G market, which caused a spike in stock pricing at the initial announcement
- Con: The spike didn’t last as 5G stalled out with supply/demand for the new tech not yet reaching its peak
- Pro: Demand for 5G is growing, and AT&T is well-placed to be able to meet it
- Result: Stock price is expected to rise along with the increase in 5G technology demand*
*Not intended to be financial advice
Fundamental analysis can provide insight into long-term investment opportunities, and the research performed on the industry surrounding the target company frequently results in finding additional stocks worth looking researching. This type of analysis can give a more in-depth view of a company’s long-term health and performance ratios to predict growth than technical analysis, but it has its limitations in short-term trading.