• Fundamental Analysis
  • Micro Analysis
  • How to Use it

What is Fundamental Analysis

  • Fundamental analysis is the cornerstone of investing
  • It is the study of all the relevant factors that affect an economy, market or asset class in order to find its intrinsic (fair) value
  • Analysis of factors affecting the economy as a whole is known as macroeconomic analysis
  • Analysis of the factors affecting a specific company is known as microeconomic analysis

What is the Intrinsic Value

  • Fundamental analysis assumes that the price on the stock market does not fully reflect a stock’s “real” value
  • This “real” value is known as the stock intrinsic value 
  • The second assumption of fundamental analysis is that in the long run, the stock price will reflect the fundamentals
  • If this intrinsic value is above the current market price, then the asset is underpriced and should be bought
  • If the intrinsic value is below the current market price, then the asset is overpriced and should be sold

Macroeconomic Analysis

  • Macroeconomic analysis is used in the evaluation of currencies, bonds, commodities, and stock indices
  • At the macro level, analysis examines factors that affect the economy in its entirety
  • Interest rates, inflation, rate of growth, employment, politics, and national sentiment
  • This analysis will tell us if the economy is expanding or contracting or if its booming or in a slump

Economic and Business Cycle

  • From boom going into recession the economic growth will slow and we will witness a decrease in investments and production
  • From recession to slump inflation will drop and unemployment will rapidly increase
  • From slump to recovery interest rates will decrease and housing activity and spending will increase 
  • From recovery to boom we have growth, spending will increase, inflation will rise, and employment will reach its full capacity
  • Where we are in the cycle decides on which asset class we should invest in. e.g. in recession stocks go down and bonds up

 

Microeconomic Analysis

  • Microeconomic analysis is used in the evaluation of  individual stocks or corporate bonds
  • The term refers to the analysis of the economic well-being of a financial entity as opposed to only its price movements
  • Traders analyze the financial statements of a company in order to decide if its stock is a good investment
  •  Is the company’s revenue growing? Is it making profits? Can it repay its debts? What is the fair value of its stock?
  • In the long run, a stock’s price is driven by a company’s ability to grow sales and earnings but also the economic conditions
  • Micro Economics
  • Company Financials
  • Financial Statements
  • Financial Ratios

Financial Statements – The Balance Sheet

  • Traders analyze the financial statements of a company in order to decide if its stock is a good investment
  • The balance sheet, income statement, and cash flow statements reveal the financial makeup of the company
  • The balance sheet compares the company’s assets to its liabilities and owner’s equity
  • The balance sheet explains to us how the company raises money in order to acquire its assets

Financial Statements – Income and Cash Flow

  • The income or profit and loss statement reveals how the company earns money
  • The cash flow statement shows how the company uses its cash to operate and how much of this cash is borrowed
  • In the profit and loss statement, expenses are deducted from the revenues to show the firm’s net profits (earnings)
  • The higher the company’s net profits, the bigger the returns for the owners, paid as shareholders dividend
  • The higher the profitability and hence the dividends of a company, the more attractive it is

 

 

Financial Ratios – Valuation

  • Out of several investment valuation ratios, the most commonly used is the P/E ratio
  • Since price alone doesn’t show the value, this ratio compares the price of the share to the amount of earnings it generates
  • It provides investors with a quick idea of how much they are paying for each $1 of earnings
  • Investors compare the Price Earnings ratio of one company to its competition – the best shares are those with the LOWEST PE

Financial Ratios – Dividend Yield

  • When a company earns profits, it can reinvest the profits into the business, called retained earnings
  • The part of the profits that is not retained, is distributed as a payment to shareholders, called dividend
  • Dividend yield measures in how many years, you will get your initial investment back
  • Investors compare the dividend yield ratio of one company to its competition – the best shares are those with the HIGHEST DY

Financial Ratios – Liquidity

  • Liquidity ratios look into the ability of a company to pay its debts and still fund its ongoing operations

 

  • The Current Ratio reveals whether a company has enough cash to pay off its short-term liabilities
  • A low liquidity ratio means the company does not have a lot of available cash which could hinder its operations
  • Investors compare the current ratio of one company to its competition – the best shares are those with the HIGHEST ratio

Financial Ratios – Return

  • Return on Assets (ROA) shows how the company is employing its assets to make profits – the higher the return the better
  • Return on Equity (ROE) measures how much the shareholders earned for their investment – the higher the ratio the better
  • Investors compare these ratios of one company to its competition – the best shares are those with the HIGHEST ratio

Financial Ratios – Debt

  • The Debt Ratio compares a company’s debt to its assets in order to know about the level of leverage – the lower the better
  • Debt-Equity Ratio measures how much creditors have committed to the company versus its shareholders – low percentage means low leverage 
  • Investors compare these ratios of one company to its competition – the best shares are those with the LOWEST ratios

Microeconomic Analysis

  • Among the dozens of financial ratios available, we’ve only covered few
  • These covered will give you a fair idea about the share you want to invest in
  • It is essential to research more about microeconomic analysis and use it for future better educated trading decisions