Let’s dive into more details. Fundamental analysis is actually divided into three main branches: qualitative, qLet’s get into the information. Actually, fundamental analysis is divided into three main branches: qualitative and quantitative factors along with economic ones. So, don’t let these terms scare you; I’ll break down each one step by step.
- Qualitative Factors: The Ones That Can’t Be Measured in Numbers
Actually, there is a number of things that influence the stock price of a company and can’t directly be portrayed in numbers. For instance:
Management Team: How seasoned and reliable would you say a company’s CEO, board of directors, or leadership team is? Do they possess the vision to take the right path? For instance, would Tesla have become what it is today if Elon Musk were not there? The quality of management will directly impact long-term growth and profitability.
Brand strength is: what, if you suddenly find yourself in a place with an Apple logo? The instantaneous associations may have something to do with quality and innovation, and perhaps trust. This brand value represents one of the qualitative factors that contribute to the long-term success of a firm.
Industry Competition: In what industry is the company operating, and what is the intensity of competition in that industry? What advantages does the firm enjoy over its competitors? For example, Amazon maintains such a strong lead in the e-commerce market that it enjoys an enormous advantage over its nearest competitor. But will it always be able to maintain that lead? These are questions you need to consider through qualitative analysis.
- Quantitative Factors: Everything Related to Numbers
While quantitative analysis deals with numbers, it will involve the financial statement, financial indicators, profit and loss status, and balance sheet of a company. Let’s consider some of the important metrics that one would look at in quantitative analysis:
Price/Earnings Ratio (P/E Ratio): The price-to-earnings ratio relates the stock price of a company with its earnings. A high P/E ratio indicates the investors hold the stock in high regard but also overpriced. If a firm’s P/E ratio is low compared to firms in the same sector, that firm may be undervalued. Again, it is all about right interpretation; the P/E ratio does not say it all.
P/B Ratio: It is the comparison of market value against the book value firm, or its equity on the balance sheet. When it is low, it means the company may be undervalued regarding its assets. Value investors like Warren Buffett usually seek companies reporting low P/B ratios.
Debt/Equity Ratio: This shows how much the company has borrowed compared to the equity. A very indebted company may be in danger, especially when there is an economic downturn. On the other hand, borrowing is one of the main ways of financing companies in certain industries, such as real estate and energy.
Profit Margins: Profit margins indicate how much of the revenue translates to profit. High profit margins are indicative of the company being in control of its costs and also having sufficient resources to invest in growth.
- Economic Factors: Seeing the Big Picture
Analysis of any firm cannot be effectively done unless and until one has considered the surrounding market, economic, and sectoral surroundings where the company is situate. Some of the key factors to consider here will include:
Interest Rates: The interest rate has a direct impact on the company’s cost of borrowing money. A low level of interest encourages companies to borrow cash for investment. High rates are stressful for those firms that have high levels of debt.
Inflation is the rise in goods and services within a particular period. High inflation forces companies often to transfer increased costs to their customers. On the other hand, some companies fail to manage costs in the case of rising inflation, which may dent profits.
Economic Growth-every country’s economic growth influences the performance of its companies. Slowing down of economic growth may reduce sales and profitability for companies.
Industry Conditions: The fact that a business falls into an emerging and profitable industry provides the foremost stimulant to success. For example, the technology industry has been quite attractive for investors during these years as it has grown very quickly. Other industries, however, such as oil, show less growth and are highly uncertain.
Fundamental Analysis and Investment Strategies: A Closer Look
Let’s take a closer look at investment strategies supported by fundamental analysis.
- Value Investing
Value investing is one such strategy where you buy stocks the market has undervalued. Here, fundamental analysis becomes crucial because, in order for you to find the real value of an enterprise, it is needed to get deep into the financial reports. In general, a value investor is oriented for long-term results and does not pay much attention to temporary market fluctuations. Though the stock price has tumbled, if the fundamentals show the company is healthy, buying that stock could be an opportunity.
This would mean that, for instance, if a technology company had launched a failed product, the stock price would plummet. Through fundamental analysis, it could come out that the underlying company has great financials, low leverage, and huge market share, so buying the stock at cheap prices would give great returns in the long run.
- Growth Investing
Growth investing involves the buying of stocks of those companies that grow rapidly, usually at high profit margins. As these companies see a rapid increase in their revenues, investors hope to make big gains. Under this strategy, fundamental analysis is carried out to evaluate a company’s growth prospects.
Example: Early in the 2000s, Amazon was a sexy target of growth investors. It was perhaps not that profitable at that time, yet the revenues were growing at high speed. Now we can judge it, when all is obvious.
- Dividend Investing
Dividend investing is all about investing in companies that regularly pay out dividends with their earnings. You could use fundamental analysis to analyze a company fundamentally for its continues dividend-paying capability. First, it needs to be profitable, not being highly indebted.
Example: Companies like Procter & Gamble have been paying dividends for years. When you analyze their financial statements, fundamental analysis shows that these companies are healthy enough to sustain these dividend payments.
The Future of Fundamental Analysis: A Look into the Crypto World
Unlike traditional investment vehicles, cryptocurrencies have lately come under the radar of investors. So, how do you perform fundamental analysis for crypto?
The crypto world does fundamental analysis a little differently. Out goes the look at company balance sheets or profit margins, and in comes technological innovation, the quality of the project teams, the quality of community support, and anything else that speaks to the utility of the cryptocurrency.
Bitcoin: Supply is limited and is usually decentralized, which also could be seen as the most important factors in the fundamental analysis of this currency. Where demand rises and supply is fixed, its price in the long term has to rise.
Ethereum: In the fundamental analysis of Ethereum, more factors are analyzed, such as the number of projects built on its network, the developer community, and features like smart contracts.
Voila! There you go-a detailed breakup of all the building blocks of fundamental analysis! Now you can approach stocks intelligently, evaluate quantitative and qualitative factors, and make more informed investment decisions.