The heart of fundamental stock analysis is what is called "quantitative" analysis. This involves examining the company financial statements such as income statements or cash flows and balance sheets to try and evaluate the company's future performance (let us never forget that stock prices are determined largely by investor expectations of future earnings). But it's not all about number crunching alone or else computers would be extremely successful traders. The second area of company fundamental analysis involves what is called "qualitative" analysis which is using your judgment to evaluate the findings of the quantitative analysis and to examine factors which cannot be quantified.
| Fundamental stock analysis concentrates on the economic factors that underlie performance of a company in an attempt to establish what the company is actually worth. Necessarily, this involves the company's financial statements rather than stock price movements and their implications. You are actually trying to answer questions such as: |  |
- Is the company actually growing in profits or revenue?
- Is their growth sustainable for the future?
- Is it in a strong financial or cash position?
- Are the accounts reliable as a guide to future performance?
The factors that you would be considering in your analysis will fall into one of the two following categories:
- Quantitative: factors that are capable of being expressed in terms of money or numbers
- Qualitative: economic factors that cannot be expressed in numbers and involve the use of judgment.
So we see that fundamental stock analysis involves a balancing act between qualitative and quantitative factors before you start searching for value stocks to invest. However, let us go back to the question: why should we go through all this trouble?
A major assumptions in fundamental stock analysis is that the company's stock price does not always reflect its true value. This has two implications-you can sell stock that you believe is over valued and buy stock that you believe is under valued. This brings us to the second major assumptions in fundamental stock analysis. In the long term, stock prices will tend to reflect the intrinsic or true value of the company. As a value investor, you will naturally be looking to pick stocks that trade below what you believe is the intrinsic value and then expect the stock price to correct itself upwards. The two uncertain factors here on the accuracy of your intrinsic value estimate and the time taken for the stock price correction.
So we see that it is possible to be a successful stock trader by using an intelligent mix of qualitative and quantitative analysis. You should be warned that no two is perfect and that you could make mistakes in your analysis. The remedy for this is to diversify your investment and not put all your eggs in one basket.
Once you have mastered fundamental stock analysis, you will soon join the ranks of investors like Warren Buffet who had proven that this investment method does work.
