What is Fundamental Analysis
Fundamental analysis is a method of evaluating a security in an attempt to assess its intrinsic value, by examining related economic, financial, and other qualitative and quantitative factors. Fundamental analysts study anything that can affect the security's value, including macroeconomic factors (e.g. economy and industry conditions) and microeconomic factors (e.g. financial conditions and company management). The end goal of fundamental analysis is to produce a quantitative value that an investor can compare with a security's current price, thus indicating whether the security is undervalued or overvalued.
Understanding Fundamental Vs. Technical Analysis
BREAKING DOWN Fundamental Analysis
Fundamental analysis determines the health and performance of an underlying company by looking at key numbers and economic indicators. The purpose is to identify fundamentally strong companies or industries and fundamentally weak companies or industries. Investors go long (purchasing with the expectation that the stock will rise in value) on the companies that are strong, and short (selling shares that you believe will drop in value with the expectation of repurchasing when at a lower price) the companies that are weak. This method of security analysis is considered to be the opposite of technical analysis, which forecasts the direction of prices through the analysis of historical market data, such as price and volume.
The Basics of Fundamental Analysis
Fundamental analysis uses real, public data in the evaluation a security's value. Although most analysts use fundamental analysis to value stocks, this method of valuation can be used for just about any type of security. For example, an investor can perform fundamental analysis on a bond's value by looking at economic factors, such as interest rates and the overall state of the economy. He can also look at information about the bond issuer, such as potential changes in credit ratings.
For stocks and equity instruments, fundamental analysis uses revenues, earnings, future growth, return on equity, profit margins, and other data to determine a company's underlying value and potential for future growth. In terms of stocks, fundamental analysis focuses on the financial statements of the company being evaluated. One of the most famous and successful fundamental analysts is the so-called "Oracle of Omaha," Warren Buffett, who is well known for successfully employing fundamental analysis to pick securities.
An Example of Fundamental Analysis
Even the market as a whole can be evaluated using fundamental analysis. For example, analysts looked at fundamental indicators of the S&P 500 from July 4 to July 8, 2016. During this time, the S&P rose to 2129.90 after the release of a positive jobs' report in the United States. In fact, the market just missed a new record high, coming in just under the May 2015 high of 2132.80. The economic surprise of an additional 287,000 jobs for the month of June specifically increased the value of the stock market on July 8, 2016.