Key takeaways
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Fundamental analysis is a method that investors use to ascertain a stock’s true value.
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Revenue, earnings and profit margin are just a few factors that help determine intrinsic value and paint a clear picture of a company’s health.
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Fundamental analysis differs from technical analysis, which examines stock price movements, market patterns and charts to predict future price behavior.
Fundamental analysis is the process by which investors determine a stock’s true value by taking into account things like revenue, earnings, profit margin and even what’s going on in the broader economy.
Here’s a look at how fundamental analysis works, how to determine whether a stock is overvalued or undervalued and when to use this method.
What is fundamental analysis?
Fundamental analysis is a method of research that investors use to determine the intrinsic value — that is, the true underlying worth — of a stock. Fundamental analysis assesses this by examining factors like revenue, earnings and profit margin. The goal is to determine whether a stock is overvalued (if the market price is higher than the intrinsic value) or undervalued (if the market price is lower than the intrinsic value).
Evaluating a company’s financial health can determine a business’s true stability and potential for growth over time despite market volatility and sentiment, which is especially important for long-term investors.
Fundamental analysis also has the potential to minimize risk in a portfolio by focusing on solid, tangible data to determine whether a company is performing well.
Fundamental analysis has two main buckets: quantitative and qualitative. Quantitative data comprises numerical information found in a company’s financial statement. Qualitative data includes external factors that influence a company’s value, such as inflation, monetary policy and consumer spending.
Fundamentals to look for
When analyzing a company’s fundamentals, there are a few key aspects to consider that help determine intrinsic value. These factors combine to paint a clear picture of its health, and many can be calculated from or found within a company’s annual (10-K) and quarterly (10-Q) reports.
Where to find fundamentals
Many investors use fundamental analysis to determine whether a stock is a buy or sell.
You can find much of this information in a company’s annual or quarterly reports, but there are a few other places to consider getting additional data about a business’s performance.
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Annual reports are a great place to start if you’re looking at a company for the first time. Annual 10-K filings include an overview of the business, current financial statements, a discussion of the past year’s results and a list of various risk factors that impact the company. A 10-Q is the shorter version of this document that’s published quarterly and the form is required to be filed within 40 days of the end of the quarter for most companies.
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Company earnings calls are conducted quarterly by executives during which they discuss financial performance and other updates within the 10-Q. It’s a great place to get insights and even hear from analysts, who often have the opportunity to ask the leadership team questions.
How does fundamental analysis differ from technical analysis?
When determining a stock’s value, analysts and traders will also employ a technique called technical analysis, which differs from fundamental analysis, though sometimes the two are used together.
Technical analysis revolves around studying past market data and previous price movements of a stock, currency or other asset in an attempt to determine future price movements. This method involves using technical indicators and chart patterns (for example, candlestick charts and volume analysis) to identify potential entry and exit points for buying and selling stocks, often irrespective of other fundamentals surrounding the asset or even broader macroeconomic trends.
The method an investor chooses depends on what their goals are, their level of risk tolerance and how much time they have before retirement. In a general sense, investors who opt for fundamental analysis versus technical analysis tend to value different aspects of the market.
For example, fundamental analysts are known to place more emphasis on market efficiency and how many different factors come together to influence a company’s financial performance, and therefore, the stock price. Meanwhile, those who prefer technical analysis are sometimes known to view the market as inefficient and believe that stock price patterns are simply enough to determine whether to buy or sell shares of a company.
Bottom line
Fundamental analysis is a method that investors use to determine a stock’s intrinsic value, or the true underlying value of a stock, by studying the company’s financials alongside broader macroeconomic data. Fundamental analysis is different from technical analysis in that the method isn’t predicting future price movements based on its past performance alone. Many analysts and long-term investors use fundamental analysis to determine the value of a stock. How an investor chooses to analyze a stock depends on their goals, risk tolerance, time horizon and preference.
FAQs
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What are the two types of fundamental analysis?
Fundamental analysis generally falls into two buckets: quantitative and qualitative. Quantitative data comprises numerical information found in a company’s financial statement. Qualitative data includes external factors that influence a company’s value, like macroeconomic conditions.
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What is the best way to define fundamental analysis?
Fundamental analysis is a method used to determine a stock’s intrinsic value by studying a broad range of factors including the company’s financials and current macroeconomic conditions.
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What are the limitations of fundamental analysis?
Some downsides include the level of subjectivity associated with each individual investor’s findings and the fact that fundamental analysis often leans toward a long-term focus rather than short-term trading strategies.