What Is Fundamental Analysis

Fundamental Analysis is a method of evaluating a security by attempting to

measure its intrinsic value by examining related economic, financial and
other qualitative and quantitative factors. Fundamental analysts attempt to
study everything that can affect the securitys value, including
macroeconomic factors (like the overall economy and industry conditions)
and individual specific factors (like the financial condition and management
of companies).
Fundamental analysis, in accounting and finance, is the analysis of a
business's financial
statements (usually
to
analyze
the
[1]
business's assets, liabilities,
and earnings);
health; and
its competitors and markets. When applied to futures and forex, it focuses on
the overall state of the economy, and considers factors including interest
rates, production, earnings, employment, GDP, housing, manufacturing and
management. When analyzing a stock, futures contract, or currency using
fundamental analysis there are two basic approaches one can use: bottom
up analysis and top down analysis. [2] The terms are used to distinguish such
analysis
from
other
types
of investment
analysis,
such
as
quantitative and technical.
Fundamental analysis is performed on historical and present data, but with
the goal of making financial forecasts.

OBJECTIVES OF FUNDAMENTAL ANALYSIS

To predict the direction of national economy because economic activity

affects the corporate profit, investor attitudes and expectation and
ultimately security prices.

To estimate the stock price changes by studying the forces operating in

the overall economy, as well as influences peculiar to industries and
companies.

To select the right time and right securities for the investment

To conduct a company stock valuation and predict its probable price

evolution;
To make a projection on its business performance;
T o evaluate its management and make internal business decisions;
And/or to calculate its credit risk.

THREE PHASES OF FUNDAMENTAL ANALYSIS

1) Understanding of the macro-economic environment and developments
(Economic Analysis)
2) Analyzing the prospects of the industry to which the firm belongs
(Industry Analysis)
3) Assessing the projected performance of the company (Company Analysis)
The three phase examination of fundamental analysis is also called as an EIC
(Economy Industry-Company analysis) framework or a top-down approach
Here the financial analyst first makes forecasts for the economy, then for
industries and finally for companies. The industry forecasts are based on the
forecasts for the economy and in turn, the company forecasts are based on
the forecasts for both the industry and the economy. Also in this approach,
industry groups are compared against other industry groups and companies

against other companies. Usually, companies are compared with others in

the same group.
For example, a telecom operator (Spice) would be compared to another
telecom operator not to an oil company.
Thus, the fundamental analysis is a 3 phase analysis of
a) The economy
b) The industry
c) The company

Phase

Nature

FIRST

of Purpose

Tools

Analysis
Economic

To

Analysis

general economic indicators

access

situation
Industry Analysis
SECOND

of

nation.
To
assess
prospects
various

To

techniques
the Economic
the
the Industry life cycle
of analysis,

industry Competitive

groupings
Company

and

analyze

analysis

of

industries etc.
the Analysis
of

Analysis

Financial

and Financial aspects:

Non-financial
THIRD

aspects

of

company

Sales,
a Profitability,
to etc.

determine

Analysis

EPS
of

Non-financial

whether to buy, aspects:

sell or hold the management,
shares
company.

of

a corporate image,
product

quality

etc.

STRENGTHS OF FUNDAMENTAL ANALYSIS

Long-term Trends
Fundamental analysis is good for long term investments based on long-term
trends. The ability to identify and predict long-term economic, demographic,
technological or consumer trends can benefit investors and helps in picking
the right industry groups or companies.

Value Spotting
Sound fundamental analysis will help identify companies that represent a
good value. Some of the most legendary investors think for long-term and
value. Fundamental analysis can help uncover the companies with valuable
assets, a strong balance sheet, stable earnings, and staying power.
Business Acumen
One of the most obvious, but less tangible rewards of fundamental analysis
is the development of a thorough understanding of the business. After such
painstaking research and analysis, an investor will be familiar with the key
revenue and profit drivers behind a company. Earnings and earnings
expectations can be potent drivers of equity prices. A good understanding
can help investors avoid companies that are prone to shortfalls and identify
those that continue to deliver.
Value Drivers
In addition to understanding the business, fundamental analysis allows
investors to develop an understanding of the key value drivers within the
company. A stocks price is heavily influenced by the industry group. By
studying these groups, investors can better position themselves to identify
opportunities that are high-risk (tech), low-risk (utilities), growth oriented
(computer), value driven (oil), non cyclical (consumer staples), cyclical
(transportation) etc.
Knowing Who's Who
Stocks move as a group. By understanding a company's business, investors
can better position themselves to categorize stocks within their relevant
industry group. Business can change rapidly and with it the revenue mix of a
company. This happened to many of the pure Internet retailers, which were
not really Internet companies, but plain retailers. Knowing a company's
business and being able to place it in a group can make a huge difference in
relative valuations.

Weaknesses of Fundamental Analysis

Time Constraints
Fundamental analysis may offer excellent insights, but it can be
extraordinarily time-consuming. Time-consuming models often produce
valuations that are contradictory to the current price prevailing on Wall
Street. When this happens, the analyst basically claims that the whole street
has got it wrong. This is not to say that there are not misunderstood
companies out there, but it is quite brash to imply that the market price, and
hence Wall Street, is wrong.
Industry/Company Specific
Valuation techniques vary depending on the industry group and specifics of
each company. For this reason, a different technique and model is required
for different industries and different companies. This can get quite timeconsuming, which can limit the amount of research that can be performed. A
subscription-based model may work great for an Internet Service Provider
(ISP), but is not likely to be the best model to value an oil company.
Subjectivity
Fair value is based on assumptions. Any changes to growth or multiplier
assumptions can greatly alter the ultimate valuation. Fundamental analysts
are generally aware of this and use sensitivity analysis to present a basecase valuation, a best-case valuation and a worst-case valuation. However,
even on a worst-case valuation, most models are almost always bullish, the
only question is how much so.
Analyst Bias
The majority of the information that goes into the analysis comes from the
company itself. Companies employ investor relations managers specifically
to handle the analyst community and release information. As Mark Twain
said, "there are lies, damn lies, and statistics." When it comes to massaging
the data or spinning the announcement, CFOs and investor relations
managers are professionals. Only buy-side analysts tend to venture past the
company statistics. Buy-side analysts work for mutual funds and money
managers. They read the reports written by the sell-side analysts who work
for the big brokers (CIBC, Merrill Lynch, Robertson Stephens, CS First Boston,
Paine Weber, DLJ to name a few). These brokers are also involved in
underwriting and investment banking for the companies. Even though there
are restrictions in place to prevent a conflict of interest, brokers have an
ongoing relationship with the company under analysis. When reading these
reports, it is important to take into consideration any biases a sell-side

analyst may have. The buy-side analyst, on the other hand, is analyzing the
company purely from an investment standpoint for a portfolio manager. If
there is a relationship with the company, it is usually on different terms. In
some cases this may be as a large shareholder.
Definition of Fair Value
When market valuations extend beyond historical norms, there is pressure to
adjust growth and multiplier assumptions to compensate. If Wall Street
values a stock at 50 times earnings and the current assumption is 30 times,
the analyst would be pressured to revise this assumption higher. There is an
old Wall Street adage: the value of any asset (stock) is only what someone is
willing to pay for it (current price). Just as stock prices fluctuate, so too do
growth and multiplier assumptions. Are we to believe Wall Street and the
stock price or the analyst and market assumptions?
It used to be that free cash flow or earnings were used with a multiplier to
arrive at a fair value. In 1999, the S&P 500 typically sold for 28 times free
cash flow. However, because so many companies were and are losing
money, it has become popular to value a business as a multiple of its
revenues. This would seem to be OK, except that the multiple was higher
than the PE of many stocks! Some companies were considered bargains at
30 times revenues.

Key factors of fundamental analysis

Company earnings
Company earnings form a crucial part of fundamentally analysing whether a
current share price is undervalued or overvalued.
Fundamental analysts can also get guidance on profit projections from
earnings reports while looking at key contributing elements to the bottom
line, and then use this information to ascertain whether a company could
outperform or underperform in their future earnings.

Natural disasters
Natural disasters, such as flooding, hurricanes and tsunamis can have a
major impact on the fundamental strength and weakness of an asset.
For example, the 2010 tsunami in Japan had a debilitating impact on the
region's manufacturing sector, which caused significant disruption to the
production of mobile technology and automakers. At the same time, the
tsunami also increased expensive insurance claims, which weighed on the
balance sheets of major insurance firms.

Economic growth and output

The key indicator of economic growth is Gross Domestic Product (GDP),
which calculates the sum of goods and services produced within the country.
Its one of the most important indicators of economic growth and output,
which tells us about the economic strength and performance of the country.

Inflation
Key indicator 1: Consumer Price Index (CPI) measures the change of the
average price of goods and services paid by consumers. Its a major indicator
adopted by governments for inflation targets and has a significant impact on
setting interest rates.
Key indicator 2: Producer Price Index (PPI) measures the changes in the price
of goods and services at the producers level.

Interest rates
Interest rates have a direct impact on currency rates. The demand on the
currency with a higher yielding interest rate is often greater than the one
with a lower interest rate.

International trade

As the demand for goods and services from a particular country increases,
demand for the countrys currency also goes up. This means the value of the
currency will appreciate (rise).

Political situation
Political crisis and uncertainty in a country often have a negative impact on
the demand for the currency. When a country is politically unstable,
investors confidence in its economy tends to decrease.

Fiscal policies
Fiscal policies, such as budget planning, government spending and taxation
encourage or discourage productivity and spending in the economy, and
therefore have a major impact on the currency markets.

Monetary policy
The monetary policy adopted by Central Banks has a big influence on the
near-term demand for currencies.
If, for example, the Bank of England adopts a hawkish monetary policy, this
indicates that interest rates are set to rise and may increase the demand for
the pound sterling, which could therefore appreciate as a result. (Hawks
generally favor using relatively high interest rates to help keep inflation in
check.)

Tools Of Fundamental Analysis

Fundamental analysis is the process of looking at a business at the basic or
fundamental financial level. This type of analysis examines key ratios of a business to
determine its financial health and gives you an idea of the value its stock.
Many investors use fundamental analysis alone or in combination with other tools to
evaluate stocks for investment purposes. The goal is to determine the current worth and,
more importantly, how the market values the stock.

http://stocks.about.com/od/evaluatingstocks/a/Fundanatools1.htm
https://www.tradeking.com/education/stocks/fundamental-analysis-explained
http://www.daytradingshares.com/growth_under_valued_stocks.html
https://en.wikipedia.org/wiki/Fundamental_analysis

https://www.google.co.in/webhp?sourceid=chromeinstant&ion=1&espv=2&ie=UTF8#q=STRENGTHS+OF+FUNDAMENTAL+ANALYSIS
http://www.cityindex.co.uk/learn-to-trade/how-to-guides/fundamentalanalysis/