There is no ‘boil-it-down’ explanation to Fundamental Analysis. It’s a broad topic, and depending on your definition can either be very complex to perform or nearly impossible without the right training and tools. To be reductive, Fundamental Analysis tries to find the intrinsic value of an asset by reading into the very fundamentals which make up its price. For example,when performing Fundamental Analysis on a company to decide whether its stock is worth an investmentone is expect to read financial statements, regulatory publications in the company’s field, credit rating information and so and so forth while also having a good understanding of the market in which it operates and the competition. When one manage to get the information from all the different sources put together, one can decide whether an asset is over-sold or over-bought by comparing your underline asset value as resulted from the analysis to current trading value. It is no wonder most investors say that one cannot really be investing unless one is doing fundamental analysis. For traders (especially those focusing on the short term), however, Technical Analysis is still the preferred method.
A Short History
Many trace the history of Fundamental Analysis to the 1934 publication of Benjamin Graham’s book, Security Analysis. This book, now in its sixth edition, defined the framework of Value Investment. Since then many aspects of Fundamental Analysis have evolved to include a wide range of elements as part of an asset’s fundamentals.
The Logic Behind Fundamental Analysis
Unlike Technical Analysis, Fundamental Analysis believes that financial markets may temporarily price an asset wrongly and create an opportunity to invest until the market corrects itself. The fundamental analyst takes into account as much information as possible trying to create a more accurate evaluation than the one on the market where aspects of crowd psychology may play a role. When factoring all the information available into their analysis, the analysts believe they can make better decisions than other, less informed, participants on the market.
HOW FUNDAMENTAL ANALYSIS IS IMPLEMENTED?
Investors can use one of two approaches when performing Fundamental Analysis: top down or bottom up. The top Down approach means starting with the big picture – the state of the global economy, inflation, etc. – until they slowly focus in on the specific things relating to the asset. Bottom up analysts start with the asset and broaden their scope (basically the same thing in reverse).
Fundamental analysis usually includes the following three parts: (1) Economic Analysis, (2) Industry Analysis, (3) Asset/Company Analysis. This may, of course, vary with the nature of the asset. After performing theses three parts one can determine the underline or intrinsic value of the asset, which will be considered its real value, and the compared to the value at which it is currently traded on the market. If the underline value is higher than the market value it is recommended to buy the asset. If the value is equal one should hold. If the value is smaller, sell.
Fundamental Analysis is perhaps the most time consuming and difficult way to locate opportunities. Today one can subscribe to services which make the task of finding opportunities easier. Nevertheless, if one were to perform his own fundamental analysis, by the time he is done, his result may already be irrelevant. Fundamental Analysis is best used by large organizations that can devote the manpower, time, and resources needed for it.