Fundamental Analysis
In a very academic definition of fundamental analysis, we can say that it is assigning a value of an asset by analyzing macroeconomic factors. The aim of the fundamental analysis is to translate in quantity (the future price of the asset) the impact of macroeconomic events.
What is a Fundamental Analysis?
“Fundamental analysis is a wide approach to evaluate the performance of a business. When a trader wants to invest his capital in the long run, let’s say 3 up to 5 years, it is very important to know the company in detail and in different points of views. Anyone who has the determination to learn can be a fundamental trader, there is no need to have a strong background in accountability and other related fields. You need to have some fundamental skills: basic knowledge over financial statements, understanding how businesses inside an industry operate and basic mathematical operations.
There are some key factors which need to be analysed when deciding to go for a long term trading with stacks: earnings per share (EPS), price-to-earnings ratio (P/E), projected earnings growth (PEG), price-to-sales ratio (P/S), price-to-book ratio (P/B), book value, dividend payout ratio, dividend yield, return on equity. Compared to technical analysis, which is focused on the price action and trends to find out how the price direction will move, fundamental analysis considers all available data on news and events from the financial calendar. Traders who are focused on fundamental analysis are looking for differences between the most recent prices and their own valuation to spot trading opportunities.
Fundamental analysis is a method of measuring the value of certain instruments by analyzing economic and financial factors. This analysis takes into consideration macroeconomic factors such as political and economic stability of the national and regional economy, industry conditions, restrictions and trading tolerance, effectiveness of company’s management policies. Fundamentals use public data to evaluate the value of an instrument. For example, when it comes to stocks, fundamental users analyse revenues, earnings, future growth, profit margins. All these reports are published periodically by companies, so all the information is available for interested traders.
Fundamental analysis is quite a complex approach that asks for very good knowledge of accounting, finance, and economics. To be clear, fundamental analysis requires the ability to understand and interpret the numbers of financial statements, understanding the macroeconomic factors and knowledge of valuation techniques. It based its logic on public data, as for example the public historical data over profits, margins and this way it is able to project the future growth.
Top-down vs. Bottom-up Analysis
The top-down approach starts the analysis by considering the health of the overall economy first. Analyzing various macroeconomic factors such as interest rates, inflation, and GDP levels, an investor tries to determine the overall direction of the economy and identifies the industries and sectors of the economy offering the best investment opportunities.
The bottom-up approach starts the analysis from a different point of view. The traders who believe the bottom-up approach say that individual stocks may perform much better than the overall industry. They are concentrated on various microeconomic factors such as a company’s earnings and financial metrics. Traders who support their decisions on this approach try to gain a better understanding of the individual companies and its operations.
WHY performing a fundamental analysis?
Fundamental analysis is based on different data, issued for free from companies and governments for the public. They include corporate earnings reports, geopolitical events, central bank policy, environmental factors. There are many factors which influence these reports and eventually the markets.
Inflation
Inflation is the level at which the prices for goods and services raise. Central banks try to limit the raising rates, in order to keep the economy running safely. They try to do so by hiking the interest rates. When a rate hike is announced, the respective currency is appreciated.
Unemployment
Information from labour markets is presented by non-farm payrolls, which has usually high influence in indices and forex markets. It is released on the first Friday of every month. It shows the total number of paid US workers of any business. Let’s say for example that the non-farm payroll is increasing, this is usually interpreted as the economy is getting stronger and people tend to raise their investing levels.
GDP
Gross Domestic Product is a measure of all goods and services produced yearly. Traders and investors look at GDP growth to know if the economy is getting stronger or weaker. When the economy is getting stronger, companies generate higher profits and people generate more money, which eventually lead to a rise in the stock market and a stronger currency.
