Stock fundamental analysis involves looking at the fundamentals of a company and trying to ascertain the intrinsic value.
The words “intrinsic value” are commonly used to stock trading, it simply means the price you feel a company is worth.
There are many different factors that could be considered when valuing a company, I will talk about the main ones below.
The Current Economic Climate
The profitability of many companies is highly related to the current economic climate. If the economy is booming, many companies will do a lot better than if there is a deep recession taking hold. Stock prices often reflect the state of the economy.
Even some of the biggest companies can fail during a recession. Many of the major banks were thought by most to be safe, but many of them failed and lost most of their value during the 2008 financial crisis.
For example the well known company, Bank of America lost over 90% of its value during the crisis. If you want to see this stock in more detail you can visit google finance.
Level Of Competition And Competitive Advantages
When analyzing the value of a company, the level of competition within the industry is a big consideration. When assessing competition it is highly useful to assess if the company has any competitive advantages now and in the future.
As an example let’s look at cell phones. The cell phone industry is big business and it is highly competitive. At the time of writing this article, the Apple iPhone is by far the most technologically advanced cell phone.
This provides Apple with a significant advantage over competitors like Nokia and Sony Ericsson.
Another significant competitive advantage could be the price of the product in question. If the company in question is able to sell a similar or better product cheaper than its competitors, this could be considered a big advantage.
The core people behind the running of the company can be a crucial factor in a company’s success or failure. A solid team with a proven track record is significantly more valuable than a team of unproven individuals.
Another important consideration is the demand for a particular product both now and in the future.
It is important to look at trends in demand. Going back to the example of cell phones again, the demand for them has been growing for many years and is likely to for many years to come.
If demand for a particular product is likely to fall in the future, this needs to be factored in to the valuation. An example of where demand may fall in the future could be for notepads, as an increasingly number of people use email.
Demand can also be related to the current economic climate too. During a recession many people have less deposable income than during the boom times.
Size Of The Market
The size of the market is very important. You need to establish the current market share of a company and decide if you feel the company will be able to increase its market share in the future.
The factors that may influence future market share are the ones we have already discussed such as competitive advantages and the management of the company.
Stock Trading Ratios
Stock ratios can be very useful when valuing a company. They can be useful to compare valuations across the sector and see how the company in question compares. Commonly used stock ratios include:
Earnings per share (EPS)
This is a very useful ratio. It tells us the amount we have made for each share we own. This ratio also considers outstanding shares. This ratio can be easily worked out using this formula:
Net Earnings / Number of outstanding shares of common stock
Price/Earnings (P/E ratio)
This ratio is related to the EPS. It tells us how many times more a company’s stock price is than its earnings per share. This ratio can be worked out by using the following formula:
Stock Price / Earnings per share (EPS)
When To Use Stock Fundamental Analysis
Fundamental analysis is best suited to long term buy and hold investing. Once you have valued a company using this type of analysis, you may then need to wait for the company to become undervalued before making your purchase.
It is often not helpful for short term trading as prices can often move with little correlation to the underlying fundamentals in the near term.