This analysis measures or evaluates the intrinsic value of an asset or commodity. It involves inspecting the factors that could affect the commodity’s future price in the market. In short, fundamental analysis is based on external influences and events, as well as financial statements and industry trends.
Fundamental analysis being one of the two major means of market analysis focuses on factors other than the actual price movement of an asset. However, unlike technical analysis which obtains its information from just chats, the fundamental analyst gives a broader spectrum of information regarding why price moves.
What Is Fundamental Analysis Used For?
This analysis is used to analyze the trend of the stock market. A fundamental analyst uses the intrinsic value of assets to determine what direction to trade and why the prices move. Also, traders use fundamental analysis to evaluate securities, and to determine where to enter their trade.
Why Is It Important?
It is important in many respects. Some of which are:
- It attempts to examine the entire market structure and even the general economy. In short, it is used to predict the price movement of the asset of interest.
- Based on specific parameters, the fundamental analyst attempts to predict price and market movement through a clearer lens. This gives a holistic view of the market while avoiding personal bias.
Main Objectives of Fundamental Analysis
The main objective of this analysis is that it gives the investor or trader a clearer and broader view of the asset of interest using past and present data. As a trader or investor, you must keep the following in view during fundamental analysis.
Asset Valuation & Projection
Asset valuation and projection are methods used to determine the change in the value of an asset with time. They are also used in determining the intrinsic or current value of an asset. These assets can be valued by:
- Alternative price models
- Deducted cash flow analysis
- Book value
Intrinsic value determines the value of an asset. In simpler terms, it is the current value of an anticipated cash flow. Additionally, it is the payment an investor is ready to make towards an investment regardless of its risk.
Credit Risk is the risk if a borrower does not repay their loan. When a lender gives a credit card, mortgage, or any kind of loan to a borrower, there is a possibility that it may not be repaid. The possibility of it not being repaid is the risk.
Likewise, if a company gives a loan to a client, there is a possibility that the loan may not be paid. These risks are evaluated based on the capacity of the borrower to pay the loan.
Types of Fundamental Analysis
There are two different approaches to this analysis: quantitative and qualitative.
This approach emphasizes statistical and mathematical analysis to help ascertain the value of a financial asset, such as a stock. Quantitative trading analysts make use of a variety of data to create trading algorithms and computer models. Also, it draws conclusions about the price of the assets from there. These varieties of data include stock market data and historical investment.
The data gathered by these computer models assists investors and analysts examine investment opportunities and develop a possible successful trading strategy. This trading strategy will consist of very specific data about entry and exit points, the expected risk of the trade, and equally expected returns.
Examples of Quantitative Analysis
Quantitative analysis concentrates on questions like, “What happened? What is the percentage of people reached by this brand? What’s the percentage that bought the product?”
Quantitative research methods and analysis often includes but, is not restricted to the following:
Trend analysis: Analysts use this to determine changes in financial statement and other information relevant to it within an organization over a period.
Common-size analysis: This helps in the comparison of an organization’s performance and financial position with respect to other organizations or industries.
Ratio analysis: Lastly, this allows analysts to evaluate possible relationships between financial statement items and other relevant information.
This approach makes use of non-quantifiable data like management skill, proper development and research, to evaluate the market. Also, fundamental analysis of stocks includes the financial accomplishment of a firm, value of the brand and the likes could be termed as a qualitative approach.
Examples of Qualitative Analysis
While quantitative analysis focuses on ‘what,’ qualitative analysis focuses on questions like: “Why do people behave in certain ways? Why do they make decisions they do?” Some of the methods include:
- Open-ended questionnaires and surveys
- Unstructured interviews
- Unstructured observations (like reading social media posts)
- Case studies
Qualitative analysis tends to look deeply into certain market outcomes to understand the “why” behind actions.
Some advantages of fundamental analysis are:
- It limits room for personal biases as decisions made are based on financial data.
- Secondly, it allows traders and investors to make logical decisions.
- Lastly, it takes a long-term view of the market to understand the full value of the asset. The traders can determine the numerical value of the asset and aim for a profit with the present market situation.
However, there are a few limitations to using fundamental analysis.
- It usually requires multiple areas of evaluation and can make the process complicated. As such, the procedure can be time-consuming
- Fundamental analysis is not adequate for quick decisions needed for short-term trades as it takes a long-term view of the market. For traders who intend to develop a working strategy for short-term trade, technical analysis is preferred to fundamental analysis
Fundamental vs Technical Analysis
Fundamental and technical analysis are crucial and have their various effects on the outcome of a trade if applied correctly. As fundamental gives a broader perspective to the market situation, technical analysis evaluates the current market state to enable quick trade decisions.
Fundamental analysis will evaluate for you the general market trend. While technical analysis narrows down the information to a quick and practical trading decision that will yield profit.
Both fundamental and technical analysis is very crucial to profitable market trades.
Fundamental analysis has the best application in long-term trades while technical analysis is effective for short-term trades. Irrespective of the asset or commodity of interest, proper understanding and usage of fundamental analysis is needful.
A balanced combination of both fundamental and technical analysis has proven to be a veritable tool for profitable trades. If however, you do not have adequate information about the use of fundamental analysis, we suggest you request the help of a financial advisor. This will help you understand the market structure and also make consistent profits.