Fundamental Analysis

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Definition of Fundamental Analysis:

Fundamental analysis is an evaluation of a company based on the underlying strength of the business as determined by analyzing financial statements and macroeconomic trends.

Detailed Explanation:

Fundamentalists are investors who take a long-term approach. Fundamental analysis evaluates a business based on the underlying strength of the business as determined by analyzing financial statements and macroeconomic trends including demographics and future trends to assess the probability of future profits. Each element affects the supply or demand for a stock. A fundamentalist asks, “How does a particular change (financial, demographic, or any other change) impact the supply or demand for a company’s stock?” In the long-term, profits lead to the appreciation of a stock because expected profits change the demand for a stock. Short-term gains or losses in a stock are normally tied to the overall trend of the stock market or an industry. Short-term movement can also reflect a recent corporate event. For example, a pharmaceutical company’s stock may jump dramatically after the Federal Drug Administration approves one of the company’s new drugs. 

Basic questions considered in fundamental analysis include:

  • Are the company's revenues growing?
  • Is the company consistently earning a profit?
  • What has been the trend of the profit? Is it growing at an increasing rate?
  • What caused the growth? Is it expected to continue to grow?
  • Is the company over burdened with debt obligations?
  • Has the company consistently paid a dividend? If so, has there been a consistent increase in dividends?
  • How does the company compare to its competitors? Is it a market leader?
Fundamental analysis is one school of choosing a company. Other investors rely more on technical analysis. Technical analysts only study graphs and charts, seeking patterns that point to the future direction of a stock. They seek “support levels,” “breakouts,” and other patterns. 

Dig Deeper With These Free Lessons:

Supply and Demand - Understand The Dynamics of The Stock Market
Capital - Financing Business Growth

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