# Fundamental analysis

Professional traders use fundamental analysis and technical analysis. It is the fundamentals that make the trader’s eager to buy and sell off technical levels.

But we will not waste your time, just a quick explanation of technical analysis. Why?

While technical analysis evaluates the share price action of a stock, fundamental analysis evaluates the actual business operations to determine the financial health of the company, project future growth prospects and determine current and future valuation.

Fundamental analysis can be performed quickly with various widely available financial tools or be extensive depending on how much time and effort the investor wants to commit.

It uses key performance indicators such as cash flow trends, income statements, balance sheets.

Other sources include media articles, blog posts, and company press releases. Is this company near to release a new product into the market? Is there media news about it?

Did company record profits last quarter? Did profits take a dive?

Let’s see how does a company’s performance directly associate to the stock price?

The important measurement is earnings per share (EPS). This calculation is found by dividing a company’s profits by the number of common outstanding shares.

Earnings per share refer to the portion of a company’s profits that are allocated to every outstanding share of stock.

The ratio of earnings per share is a measurement of the net income of a given company that is available to pay stockholders of its common stock.

There is an example.

Say that some company had an enormous earnings increase. On the first glance, this is amazing news to the investor. So such an investor might think, it’s a good idea to buy its stocks.

Wait a moment!

Yes, the earnings have increased, but maybe the total shares haven’t gone up. Also, the EPS hasn’t increased noticeably. In this case, the earnings per share provide a piece of value information.

Another parameter is earnings growth, which means measuring the growth of a company’s profit over time.

Finally, you have what’s called a price/earnings to growth ratio (PEG). This is the price-to-earnings divided by the growth rate of a company’s earnings over time.

#### PEG  = PE Ratio  ÷ Earnings Growth Rate

This ratio can be used to compare a specific company with the industry, peers and or benchmark indices.

For example, if the consumer discretionary sector has a P/E of 20 and your stock has a P/E of 55, it may be overvalued. Some sectors traditionally have higher P/Es than others, like technology compared to utilities. The S&P 500 has a historical P/E ratio of 21.

Keep in mind that a company needs to generate profits in order to have a P/E. There are more ratios that can be used in the absence of profits.

#### The other financial ratios are:

Price-Sales (P/S) and Price-Book (P/B) are comparative valuation ratios that indicate if a stock is trading at a premium or discount compared to its peers and sector/industry. If a stock is trading at a very deep discount, then there could be an inherent structural problem with the business.

Cash-Per-Share (CPS) and Book Value (BV) are two valuation ratios that can help determine if the stock has been overly punished by investors. The cash burn rate and debt should also be investigated. Biotech stocks are notorious for these situations.

These ratios don’t apply well to financials like banks and insurance companies that tend to trade at or below CPS and BV, due to federal banking regulations and off-balance sheet entities.

Keep in mind that every sector and industry has an average financial ratio, which can be used for measuring. However, just because a stock has an aggressively high financial ratio doesn’t necessarily mean it is overpriced. Momentum stocks are notorious for exorbitant ratios.

So, as you can see the Fundamental Analysis is for long-term investors. They benefit the most with fundamental analysis since valuations and stock prices ultimately reach parity in the longer run.

The various components of research include analysis of the earnings reports, company business model/strategy, catalysts, and financials including assets/liabilities, financing/debt obligations, credit facilities, rumors, and press release documents, are components of Fundamental analysis.

Additional research on the company’s sector/industry and peers can also be performed. It also involves staying current on any executive changes with the management and board of directors. Intensive fundamental analysis can be tedious and time consuming for an individual investor.

Fundamental analysts use either top-down or bottom-up methods of analysis or sometimes both.

#### A top-down analysis might function in the following manner:

1) The entire market is analyzed, including global and macroeconomic indicators

2) The specific sector, such as Technology

3) The industry, for example, semiconductor manufacturers

4) The specific stock, for example, company XYZ

Conversely, a bottom-up analysis starts by investigating specific stocks first.

The fundamental analyst observes trends, market and price movements, company financial statements, interest rates, return on equity (ROE), and numerous other indicators with one goal in mind: buying or selling stocks that will provide a high return on investment (ROI).

Fundamental analysis, like technical analysis, tries to predict which stocks are valuable and which are not. Its proponents use to say the fundamental analysis offers a detailed picture of the possible movements of both the stock market and individual stocks because as many elements as possible are investigated. Technical analysis, on the other hand, only looks at past data of stock prices. One of the famous fundamentals proponents is Warren Buffett.

When you have to choose the stock to buy you must have various factors to observe.

But stock selection doesn’t have to be difficult. All you need is to be flexible. Don’t worry about whether the market is going up or down. Instead, look for markets that are moving and be willing to go short as well as long. Perhaps most important, you need to be disciplined.

Many students come into our courses using some technical system they have worked to improve for years without much success.

Their ‘lightbulb moment’ often comes upon realizing that fundamental drivers are what causes traders to buy and sell off specific levels instead of the technical levels themselves.

In the end, their technical system is often fine, it’s their fundamental understanding that needs improvement. Once this really sinks in, progress is rapid.

In this lesson, we will be demonstrating just how you can combine a technical system with the fundamentals.

You can use your existing technical system with a fundamental understanding and turbo charge your results!

Also, if you are new in this field you can learn the basic.

So, let’s see!

How to combine?

# Quiz yourself about Fundamental analysis in the following quiz:

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