Fundamental Analysis

Accurately evaluating the value of a stock is what makes an investor successful. To be able to achieve that, people use a variety of methods but most can be categorized into technical analysis and fundamental analysis. With fundamental analysis, investors use macro and microeconomic factors to determine the intrinsic value of a stock. If a stock is thought to be undervalued, investors will buy it in anticipation of a higher price in the future. On the contrary, if it's thought to be overvalued, investors will start selling their current shares or even short selling the stock to make a profit when the price drops. Mastering fundamental analysis will undoubtedly make you a better investor.

Why Use Fundamental Analysis

Fundamentalists look at the big picture and then zoom in to smaller details in an effort to determine if a stock is valued correctly at the current price. When the market price doesn't reflect the real value or potential value of a stock, its price is bound to go up in the future. Warren Buffet is a famous value investor who uses fundamental analysis to help him make sound investment choices. Even though people who use fundamental analysis tend to be buy and hold investors, many short term traders do look at fundamental factors when screening for potential trades. They run a scanner for stocks that are fundamentally strong before using their technical tools for entry and exit points.

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How to Use Fundamental Analysis in Stock Trading

Fundamental analysts first look at the overall state of the economy to determine whether the market is in a bull or bear phase. During a bear market, even the most valuable stock can become oversold and trade well below its intrinsic value. That's a buying opportunity for a shrewd value investor. From the state of the economy, the analyst then zooms in to the specific industry he's interested in. Companies in the same industry tend to move in correlation since they are often exposed to the same factors that are typical of the industry. When making comparisons, it's important not to compare stocks of different industry, since their fundamentals are very different depending on the industry they are in. Only by comparing stocks of the same industry can you gain insights about how a stock performs in relation to others of the same industry. The analyst determines the intrinsic value of a stock by looking at its financial statements over a long period of time. By analyzing its earnings, profit margins, return on equity, debt ratio, etc., he can have a better picture of how good or bad the company is performing and if the price the stock is trading at reflects that performance.

Quantitative and Qualitative Fundamental Analysis

There are many factors to consider when it comes to fundamental analysis. However, they can all be categorized into two groups:

Quantitative fundamentals

The data can be measured and presented in a numerical way. For example, the sales figures, revenues, debt ratio, quick ratio, etc. are all measurable in number. Investors can tell right away from looking at these numbers whether the company is performing better this year compared to last year or not.

Qualitative fundamentals

This data cannot be measured but is just as important. For example, the brand image value, competency of current management, or customer satisfaction ratings are things that are important to a company's growth but cannot be measured and presented in a numerical way.
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How to Trade Using Fundamental Analysis

Most investors who rely on fundamental analysis shared that they have a strategy or trading system in place to give them an edge over the market. For example, a trader may find success trading a system in which he buys whenever P/E ratio is above its historical average or sells when EPS is expected to grow next quarter based on the consensus analyst estimates. Most real trading systems are more complicated than these two simple examples. However, the most important thing is to make sure you follow the system without deviation or changing rules on the fly.

Don't Get Emotionally Involved

Most traders fail to make money trading because they let their emotions take over when there's real money involved. Some have success trading a demo account but lose money when trading with real money because it's hard to think straight and follow the plan when a trade moves against you. Part of being a successful trader lies in the ability to control your emotions and not letting them dictate your trading. This can only be achieved with much practice and perseverance.
Fundamental analysis is a powerful tool in an investor's arsenal. As you build your portfolio, sound fundamental judgment can help you spot undervalued stocks that will earn you significant returns in the future.

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