An Overview Of Fundamental Analysis For The Stock Market part 1

An Overview Of Fundamental Analysis For The Stock Market. Part 1 of a 2-part series. In this part we'll go over what it is, what it can do and what it can't do.
Previously I posted a brief, simple overview of technical analysis for the stock market.

My reasoning was simple: You can't invest blindly and rudimentary technical analysis is easier to pick up than fundamental analysis.

Again, I'm not a professional trader, expert, nor do I have decades of experience. 

But since this is a personal fiance blog, I'd be remiss if I didn't at least try to give an overview of fundamental analysis. So in this post, I'll try to share a little bit on how ordinary investors can perform fundamental analysis. (Bear in mind, it's an introduction to guide people on understanding it and hopefully encouraging them to do it.)

What is it?

Simply put, it's knowing the business that you're investing in. First you need to know what they do, where the business is, who the customers/target demographic are, and how they operate.

And then you take a look at the finances. And you do that by looking at the publicly-available financial documents (Available at PSE's official website here). Basically you want to know their expenses, how much they make every year (revenue), how much profit they're making, how much debt they have, and how much cash they have to respond to threats or opportunities (cashflow).

And of course, you take a look at the company's management. It can give you an idea if the company is in good hands.

In practice though, it's pretty hard to analyze the management. Mostly, you'll just see biographies with glowing praise. Instead, it might be better to look at their track record. If they worked somewhere else before, what happened there? If they've been with the company for some time, how did the company do over that time span?

An Overview Of Fundamental Analysis For The Stock Market. Part 1 of a 2-part series. In this part we'll go over what it is, what it can do and what it can't do.

What can it do? 

Assuming it's done right, it can:

  • tell you if the business is growing
  • tell you if the business is currently under or over-valued (based on it's current share price)
  • give you confidence that at some point it should give returns on your investment
  • (and most importantly) prevent you from selling your shares at a loss during a tough market dip, since you'll know if the business is really affected or not.

What it can't do

It can't guarantee a return on your money. For at least two reasons:
  • A lot of outside forces (acts of nature, technological advancement, or even simply shifting personal or cultural tastes) can impact the business. So keep vigilant even after completing your analysis
  • Also, there's no guarantee that the stock market will reflect the "true" value (based on your analysis) of the company. Even if you did everything right. It may be overlooked, underestimated or just ignored for some reason.

Lastly, it's important to note that there are variants of fundamental analysis. Just like different technical analysis techniques lean on different indicators/metrics, it's possible to perform fundamental analysis a few different ways.

So I'd like to end part one, by letting uber-famous Warren Buffet say how he does it (skip to 1:41 for the goods):

Note: Valuation = stock price x number of shares.

In part 2, we'll go over key concepts and free reference materials.

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photo credit: BrainBought via photopin cc

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