Fundamental Analysis

Fundamental analysis involves the use of financial and economic data to evaluate the liquidity, solvency, efficiency and, most importantly, the earnings potential of a given company.

The fundamental analyst's kitbag of tools includes the corporate annual report and its financial statements, legal comments by corporate officers, industry statistics and market trends, as well as macro-economic data.

With this information in hand, the fundamental analyst’s goal is to determine undervalued stocks, and then buy them in anticipation of the appreciation that should occur when this value comes to light.

While it is not critical for the average investor to fully understand how the fundamental analyst goes about his job, it is useful to have a broad understand of what goes on in his mind when assessing the value of a share. They place a value on individual shares by:-

Making projections for the economy as a whole using key economic indicators

These indicators include the stockmarket itself, interest rates, the GDP (Gross Domestic Product), real business investment, corporate profits, prices, the balance of payments and the external value of the dollar.

1. Stockmarket: Historically, a marked downturn in the stockmarket indicates an impending recession some six to nine months away. In these circumstances, it is advisable to sell economically sensitive shares. Conversely, stocks tend to turn upward well before the end of a recession. Thus, a generally good time to buy shares is about six months after the onset of a recession while the overall economy is still mired in the shadow of public gloom. Historically, a marked downturn in the stockmarket indicates an impending recession some six to nine months away. In these circumstances, it is advisable to sell economically sensitive shares. Conversely, stocks tend to turn upward well before the end of a recession. Thus, a generally good time to buy shares is about six months after the onset of a recession while the overall economy is still mired in the shadow of public gloom.
     
2. Interest Rates: Falling rates are generally bullish for the economy and the stockmarket, while rising rates are bearish, tending to restrict growth. falling rates are generally bullish for the economy and the stockmarket, while rising rates are bearish, tending to restrict growth.
     
3. GDP (Gross Domestic Product): Is a measure of the health of the nations economy. A slowdown in the GDP’s rate of growth is negative, while an increase in growth is positive for the economy and the share market.
     
4. Real Business Investment: If companies are spending money to expand markets, develop new products or build new products, they obviously expect the economy to be healthy enough to make a positive return on their investment. When they cut back, it usually means they are expecting a downturn.: if companies are spending money to expand markets, develop new products or build new products, they obviously expect the economy to be healthy enough to make a positive return on their investment. When they cut back, it usually means they are expecting a downturn.
     
5. Corporate Profits: Rising profits generally follow an upturn in the economy, stable profits a transitional period and falling profits a downturn. rising profits generally follow an upturn in the economy, stable profits a transitional period and falling profits a downturn.
     
6. Prices: A little inflation is considered good as it acts to spur growth and increase corporate profits. However, too much inflation begins to eat into profits and could signal a downturn. A little inflation is considered good as it acts to spur growth and increase corporate profits. However, too much inflation begins to eat into profits and could signal a downturn.
     
7. Balance of Payments: When Australia’s foreign debts rises, the government and Australian companies have to spend more money to service the overseas debt. However, when foreign debts fall, more resources are freed up to fuel expansion at home.
     
8. External Value of the Dollar: When the Australian dollar is weak, more of our internal assets are required for foreign purchases and debt service, leading to a dampening of our economy. However, when the dollar is strong, the cost of foreign financial activities falls and more money is available for internal investment. when the Australian dollar is weak, more of our internal assets are required for foreign purchases and debt service, leading to a dampening of our economy. However, when the dollar is strong, the cost of foreign financial activities falls and more money is available for internal investment.

Analysing a company’s earning and dividends

As fundamental analysts examine a company they forecast each company's growth (or lack thereof) for the next year, as well as for some reasonable longer-term horizon - such as the next five years.

Forecasting the market’s perception of your company’s growth

Once analysts have predicted the future growth of a company, they then project how the market will respond to those figures partly by review the average price/ earnings multiple (P/E ratio) that the market has assigned to stocks in the same industry with the same growth rate over the past few years and extend the trend to encompass the future earnings they expect.

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