Fundamental Analysis For Dummies
Overview
Become familiar with the key concepts of fundamental analysis and learn how to put them into action in the real world
Fundamental Analysis For Dummies is a valuable guide for investors who want to know the future. Okay, it’s not a crystal ball, but fundamental analysis will help you gain insight into a company’s staying power, as you evaluate revenue, expenses, assets, liabilities, competitors, management, interest rates, and other key business details. This Dummies resource makes it easy to get a handle on the underlying forces that affect the well-being of the economy, industry groups, and companies. You’ll explore the tools and strategies of fundamental analysis, and you’ll get easy-to-follow examples of how they’re used in relation to stock and commodity investing. This latest edition is fully updated with coverage of today’s investment landscape.
- Apply fundamental analysis techniques to your investments and increase your profits
- Learn strategies for making smart investments in stocks, currency, bonds, and commodities
- Harness the same tools used by Warren Buffett and other successful investors
- Protect your investments during an economic downturn
Investors looking to become proficient in using fundamental analysis will love this plain-English breakdown of all the must-know information.
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About The Author
Matt Krantz is a nationally recognized financial journalist who specializes in investment topics and personal finance. He’s the management editor for Investor’s Business Daily, and his work has appeared in USA Today and Money magazine.
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fundamental analysis for dummies
CHEAT SHEET
Make the most of fundamental analysis by getting familiar with financial statements and investment terms as well as knowing the best places to find fundamental data.Gathering the key documents for fundamental analysisCompanies create plenty of financial documents, so you need to know which ones are most important to fundamental analysis.
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Fundamental analysis also has its limitations. Rather than trying to ignore the shortcomings of fundamental analysis, it's important to recognize upfront what they are and adjust your strategy accordingly. If you don't approach fundamental analysis with reasonable expectations and knowing what the risks are, you may certainly be disappointed with the results.
General Investing
Performing a complete financial analysis of a company takes time as you run through all the financial statements, calculate dozens of financial ratios, and study the industry, just to name a few things. Following are ten types of fundamental analysis you should always make time for.
Measuring how much of a company's earnings are "real"
If you're not a full-time fundamental analyst, and you own more than a handful of stocks, it would be a full-time job to constantly monitor in real-time every bit of financial data you'll want to be aware of.
General Investing
After a huge annual report arrives in the mail, you may not know where to begin. So here are six things you should always consider when you get an annual report to make sure you are picking up the key elements needed in fundamental analysis:
Compare this year’s annual report with last year’s annual report. The best way to read this year’s annual report is side-by-side with last year’s.
General Investing
One technique used in long-term forecasts in fundamental analysis is the moving average. With this analysis, investors attempt to smooth out unusual bumps in a company's results. A moving average serves the same role as your seatbelt when your airplane hits turbulence.
Moving averages may be applied to annual results or to quarterly results, based on how volatile the company's profits are.
While fundamental and technical analysis couldn't be more philosophically opposed to each other, there are ways to marry the two approaches. In fact, the shortcomings of both fundamental and technical analysis, in some ways, balance each other out.A few ways to potentially boost your fundamental analysis success using techniques from technical analysis include:
Cutting your losses: One of the fatal flaws of many pure fundamental analysts is stubbornness.
Fundamental analysts look forward to earnings season. Four times a year, shortly after the end of the quarter, companies will begin to report their financial results to investors. Because most companies are on a calendar year, the results generally start trickling out two weeks after the quarter ends.Four times a year, usually in January, April, July, and October, thousands of companies report their financial results en masse.
General Investing
One of the basic rules of investigative journalism is following the money, and you do the same in fundamental analysis for investing. Tracing the movement of dollars through an organization will quickly show you the motives of the leaders, availability of resources, and vulnerabilities. Regulators will often follow the movement of money to pinpoint illegal cartels, Ponzi schemes, and other frauds.
General Investing
Make the most of fundamental analysis by getting familiar with financial statements and investment terms as well as knowing the best places to find fundamental data.Gathering the key documents for fundamental analysisCompanies create plenty of financial documents, so you need to know which ones are most important to fundamental analysis.
General Investing
Fundamental analysis requires you to pay close attention to the income statement for any sign the company isn't progressing as it should or, conversely, doing better than many thought it could. By buying shares of stock, you're claiming a piece of the company's future revenue and profits. The trick, though, is making sure the company is keeping its end of the bargain by generating a profit.
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Companies create plenty of financial documents, so you need to know which ones are most important to fundamental analysis. The following list helps you determine which documents can help you the most with fundamental analysis:
Earnings press release: Curious how a company’s just-completed quarter went? That’s exactly what a company must spell out in a press release it provides investors, called the earnings report.
General Investing
Some technical analysts love charts so much, they might even plot out some data that are traditionally considered to be for fundamental analysts. Even if you're not onboard with technical analysis, there's no question that sometimes, seeing fundamental data presented graphically may help you spot trends.
Plotting fundamental information, rather than just looking at table stuffed with data, may give you a unique perspective and help you to spot trends you didn't notice before.
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Like index investors, investors who use technical analysis shake their heads in disapproval when they see fundamental analysts carefully examining spreadsheets and financial statements. They, like index investors, see all the effort that goes into fundamental analysis as a waste of time and calculator batteries.
General Investing
If fundamental analysis seems like a lot of work, you can probably identify with index investors. Index investors think taking the time to pour over companies' financial statements is a whole lot of trouble for nothing. Index investors figure any information to be gleaned from company reports has already been extracted by other investors and acted upon.
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You don't need a long memory to remember how fundamental analysis could have helped your investing. During the tech-stock boom of the late 1990s, investors were so enamored with dot-coms they were willing to pay boundless amounts for them. Just a few years later, in the mid-2000s, investors repeated their mistakes by creating a housing boom that drove up shares of homebuilders' stocks.
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The battle for companies, and entire industries, to remain relevant in light of new ways of doing things is something you need to account for in your fundamental analysis.The rise and fall of companies and industries follows a pretty standard script. Generally, things kick off when entrepreneurs get frustrated with existing products that don't seem to fit some kind of need they have.
Dividends are periodic cash payments some companies make to their shareholders. The dividends are paid out of the company's cash as a way of returning profits to the shareholders. Dividends are a very important piece of your total return on an investment.
Don't ignore dividends. These cash payments, over time, account for about one-third of the total return investors make on the market, according to Standard & Poor's.
The SEC's website is a treasure trove for fundamental analysis. You'll find all the financial forms you need. All the fundamental data are stored in the SEC's Electronic Data Gathering, Analysis and Retrieval, or EDGAR, database. You can use EDGAR to look up any public company's filings and even download the financial statements to your computer so you can do further analysis.
If you're going to attempt to pick individual stocks using fundamental analysis, you owe it to yourself to also learn how to track your performance. Every year, you should know how to calculate what your portfolio's return was and how much risk you took on in order to achieve that risk.
Being able to measure your portfolio's return and risk and compare it against the stock market is critical.
Some investors lack fundamental analysis knowledge. You might know some things about the income statement and balance sheet and have a great knowledge of what's contained in the statements. But when it comes to applying your know-how, that can be a bit trickier.Putting fundamental analysis in action requires taking everything you know about a company and mixing in some estimates and best guesses about the future to arrive at a decent expectation of whether or not to invest in a company.
If you're interested in fundamental analysis, you're probably looking to dig into company reports for a reason, which is most likely to make money. Fundamental analysis can be profitable. If you're able to find hidden value in a company or its stock and buy in before other investors discover what you know, you'll cash in once the rest of Wall Street catches up to you.
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One of the first things most technical analysts plot on a stock chart is the moving average. The moving average tells you what a stock's average price has been over a set period of time. Moving averages can be calculated for any period of time, but technical analysts usually use the following time periods:
10-day moving average.
General Investing
Buying and holding stocks over the long term can be a great way to make money. Just ask Warren Buffett. Fundamental analysis can help give you the insights in companies to have the faith to hold on.Fundamental analysis doesn't require you to constantly buy and sell stocks. In fact, many investors tend to do their homework, buy a stock, and hold on.
Value investors are often drawn to the idea that they can get an edge on other investors by doing their homework and studying a company's financial statements. These investors believe if they put in the time to understand a company's business, accurately forecast its future, and pay the right price, they can achieve greater upside and less downside than the market as a whole.
General Investing
Sometimes reading a company's financial statements using the SEC's EDGAR database isn't enough. If you want to perform much fundamental analysis, you'll likely need to download the data into a spreadsheet.
If the company you're analyzing provides XBRL data, it's easy to download into a spreadsheet.
Luckily, there's a handy trick using Microsoft Excel all fundamental analysts should know about.
Money for nothing is hard to find on Wall Street. But sometimes investors get additional shares — well, sort of. When a company's stock price rises dramatically and begins to approach $50 a share or more, the executives might decide to split the shares. In a stock split, the company cuts its share price, say in half, by cutting the shares into multiple shares.
Technical analysts are often interested in following the momentum of stock prices, meaning the prevalent trend either upward or downward. Just as college basketball teams often get momentum during big games and start going on a hot streak, technical analysts believe stocks can turn hot and have the gust of investor enthusiasm at their backs.
Beta, or the beta coefficient, is one of those rare market indicators that both fundamental and technical analysts can agree has value. Beta is a statistical measure of how volatile a stock is relative to the stock market at large. Beta is used in the capital asset pricing model used to build a discounted cash flow model.
If there's a time when investors often turn off their reasoning and fundamental analysis skills, it's with initial public offerings (IPOs). With an IPO, a company that had been private offers its shares to the public for the first time. There's often a great deal of hoopla and excitement when a company's shares are in the public's grasp.
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You don't have to be a journalist to appreciate the earnings press release. Contrary to its name, the earnings press release is for all investors, not just the media. When it's time for a company to tell the world how it did after the quarter ends, the first move is to issue an earnings press release. The press release is usually, but not always, accompanied by a conference call for investors and analysts.
One of the great things about fundamental analysis is that you don't really need much to get started. If you have a computer and calculator, you're pretty much set.Unlike technical analysis, which may require sophisticated and costly stock chart services, most of the data you need for fundamental analysis is provided free from nearly every company.
Some investors, called short sellers, use a series of maneuvers to position themselves to profit if a stock declines in value. You're probably used to buying stocks and hoping the companies do well so that the stocks rise. But an entire community of investors does the opposite — they hope stocks will fall.Investors short a stock by first borrowing shares from another investor who owns them.
Fundamental analysis, while it's rooted in math and objective information, isn't without its flaws. After all, if fundamental analysis were perfect, everyone would quit their day jobs, analyze stocks, and make bundles of money. That's why it's important to understand the shortcomings of fundamental analysis, which include:
Vulnerability to wrong data, including your assumptions: Fundamental analysis is heavily based in fact.
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You may appreciate the importance of fundamental analysis and may even be able to download fundamental data from websites or from a company's annual report. But you need to have the tools to analyze the fundamentals to get any real value from them.
Staying focused on the bottom line
If there's one thing investors may agree is of upmost importance, it's the company's profitability.
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You don’t have to subscribe to costly online services to get the data you need for fundamental analysis. Much of the fundamental analysis data you need is available from high-quality sites including:
SEC.gov: If there’s one site you, as a fundamental analyst, need to know about, it’s this one. SEC.gov is a massive repository of financial information provided by the regulator, the Securities and Exchange Commission.
Technical analysts are very interested in the direction of a stock's price. But most technical analysts also pay close attention to how much trading volume is occurring. Trading volume measures how much investors are buying or selling a stock. If buyers and sellers are furiously trading shares back and forth, then trading volume is considered to be high, or active.
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Incorporating the economy's health into your fundamental analysis might seem like a daunting task. How can you consider something as grand as the U.S.'s economic growth when you're poring over one company's financial statements?Still, it's important to recognize the economy can have big-time effects on business, especially in regard to a company's:
Ability to service its debt: A company's level of debt might look very manageable during normal economic times.
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If you've ever run a 10-K race, you know that it can be pretty grueling if you haven't trained properly. The same goes for companies looking to report their annual financial performance in the form called the 10-K. This document is a monster, and producing it is one of the biggest financial chores a company faces.
When you're practicing fundamental analysis, knowing what makes a company tick isn't as convoluted as it may sound. Companies are so regulated and scrutinized, all the things you need to pay attention to are usually listed and published for all to see. Generally, when you hear about a company's fundamentals, the key elements to be concerned will fall into several categories including:
Financial performance: Here you're looking at how much a company collects from customers who buy its products or services, and how much it keeps in profit.
Fundamental analysis is one of the most sound and primary ways to evaluate investments. As a fundamental analyst, you carefully and thoroughly study every aspect of a company's operations. Much of your analysis will be focused on financial statements companies provide.
Going beyond betting
If you're like most investors, even the words fundamental analysis may turn you off a bit.
Technical analysts are often called chartists because they spend their time poring over stock price charts. These charts show where a stock price has been over time and how many investors have bought or sold the stock. Technical analysts believe historical patterns in a stock price's movement can give solid clues about where the stock might be headed in the future.
The 10-Q is the official financial report submitted by a company to summarize its performance during the quarter and usually follows an earnings press release.Most companies have 40 days from the end of each fiscal quarter to produce and provide the 10-Q to investors. Generally, companies file the 10-Q a week or two after they provide the earnings press release.
General Investing
Just about any company you can invest in must follow financial reporting rules. That includes companies that are publicly traded. But even some private companies, which haven't sold stock, must provide some financial information if they have $10 million or more in assets and have 500 or more owners.Most major stock market exchanges, including the New York Stock Exchange and NASDAQ, require their listed companies to provide quarterly and annual financial reports to investors.
You don't have to be a high-powered investor to use fundamental analysis. If you have an interest in finding out more deeply about how companies work, you're a candidate for learning about fundamental analysis. In fact, knowing how to read, analyze, and take action from information you glean about a company can be helpful for many users, including:
Stock investors: Those looking to take an ownership stake in a company have a great financial incentive to master fundamental analysis.
General Investing
You might wonder why you need to hassle with fundamental analysis. After all, at every family picnic there's undoubtedly the loudmouthed relative who's filled with all sorts of can't-go-wrong stock tips. Why bother with technical things like net income or discounted cash flow analysis when you can just turn on the TV, write down a couple of stock symbols, buy the stocks and hope for the best?
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