Fundamental Analysis for Trading
Like technical analysis, fundamental analysis is a way to analyze a stock to determine favorable or unfavorable opinion of the stocks current price and/or likely direction. Where technical analysis focuses heavily on the price of a stock and how it trades and trends on a chart, fundamental analysis uses different criteria to formulate a value opinion.Â
The most common form of fundamental analysis is analyzing a company by it’s balance sheet and other key company filings and financial statements. Using overall market trends and cycles is another way fundamental analysis can play into a trade thesis. Fundamental analysis is typically a much longer time horizon than technical analysis. Using news, like company announcements or upcoming events, can be catalysts for trade that a fundamentalist would take into account.Â
We are not going to teach how to perform full fundamental analysis, there is a ton of great resources on YouTube/Google. If you have time, we highly recommend learning more about key filings, especially how to read financial statements like income statement and balance sheet. We will cover some of the most fundamental and key financial ratios like P/E (price to earnings) ratio. **Most brokers and trading platforms will have access to basic financial statements and financial ratios of companies at no extra cost.
QUICK RECAPÂ Do you understand the differences between Fundamental Analysis and Technical Analysis?
The key points are:
1. Fundamental Analysis evaluates stocks/assets/securities by attempting to measure their intrinsic value.
2. Technical Analysis is traders looking to statistical trends in various stock prices and volume changes.
Both of these forms of analysis are used for researching and predicting future trends in stock prices.
Financial Statements
Income Statement: A high level view of a companies income and expenses in any given period..
Total Revenue – Total Expenses = Net Income.
The income statement shows quarter to quarter the profitability, if any, of a company.
Balance Sheet: A high level view of the companies “health” in terms of financial standing at any given period in time.
Assets = Liabilities + Equity
The balance sheet can show quarter to quarter the amount of cash on hand, debt, and shareholder equity a company has.
Statement of Cash Flows: A statement that represents all activity in regards to cash inflows and outflows a company’s ongoing operations over a given period of time. It also includes investors external investment sources.
Net Change in Cash = Operating Activities + Investing Activities + Financing Activities
This is one of the most popular financial statements as it shows how a company is able to use its cash through operations, investment, and financing, to generate net cash flow.
Financial Ratios
For some of the ratios below, they are most useful when you compare them to their respective industry peers to gauge the relative valuation of a specific company. For example, some sectors, like tech, will trade at a higher P/E ratio than a sector like energy.
Quick Ratio: The ability of a company to meet its short-term obligations with it’s most liquid assets.
Working Capital Ratio: A company’s ability to pay it’s current liabilities with its current assets. This is a key measurement for measuring financial health of a company as it relates to creditors, as this ratio determines a company’s ability to pay off its debts.
Earnings per Share EPS: This is a measure of a company’s profitability as it relates to a per share basis.
This is calculated by:
EPS = Net Profit/ Outstanding Shares of Common Stock
Return on Equity ROE: Measures a companies profitability in relation to shareholder equity.
This is calculated by:
ROE = Net Income / Shareholder Equity
This measurement heavily relies on comparing with industry peers.
Debt to Equity Ratio: A key measurement for analyzing a company’s leverage position.
This is calculated by:
D/E Ratio = Total Liabilities / Shareholder Equity
Higher leverage ratios will indicate a company that poses more risk for investors.
Price to Earnings Ratio P/E: This takes EPS a step further by taking the market value per share and dividing it by the Earnings per share. This is a way to value companies on a earnings per share basis with market price vs peers. A company can have a 0 PE ratio if they do not generate income
These are the most basic forms of fundamental analysis explained here. To learn more about fundamental analysis and ask questions, check out our Trading Room Trial!. The more you learn, the more you earn! If you have any questions or comments about fundamental analysis, feel free to use the contact form below to get in touch with us.
