Fundamental Analysis in Trading

Analysis in Trading

When making a purchase, you often think about the money you’re paying and the value you will derive from what you’re buying. Furthermore, sometimes it can be challenging to estimate the value of certain goods and services and depend on the market to set the price. This can be especially true if you’re a trader or investor when valuing securities. However, fundamental analysis can help reduce uncertainty. 

Fundamental analysis is a way of establishing a security’s actual market value. Analysts look at a security’s current trading price and other market factors to determine if it’s trading higher or lower than it should be. If there is any disparity, they make recommendations by deeming it either under or over-valued. This trading guide will look at fundamental analysis and how it can apply to your trading. 

What is a Fundamental Analysis?

Fundamental analysis in trading is the process of establishing the intrinsic value of a security. It examines different economic and financial factors related to a security and its market to determine a fair price. The analysis looks at factors that could affect a security’s value, such as volatility in the economy, to the competence of a company’s management team. 

The fundamental analysis then produces a number or value an investor or trader can use to compare against the security’s current market price. This process helps determine if it’s undervalued or overvalued in the market and what action you should take. If the security’s price is under the number the analysis gives, it deems it undervalued and a good investment opportunity. 

While on the other hand, an overvalued security will be priced over the number and might not be a viable long-term investment. However, you can still short the security if you feel or analysis shows that the market is about to correct itself and still come out on top. 

Fundamental analysts use financial data in the public domain to assess a potential investment value and determine its viability. Furthermore, the analysis usually follows a specific format, with the general study of the state of the economy coming first. Followed by the strength of the industry in question, and finally, how the company issuing the security is performing financially, which ensures they arrive at a fair price. 

Types of Fundamental Analysis

1. Qualitative Fundamentals

Qualitative analysis has to do with the quality, standard, or nature of something. These are the factors to consider:

  • Business model- means what precisely the company does. If it’s an electric car manufacturer, it needs to make money from selling units and not charging fees for its software. This helps determine if the model is working. 
  • Competitive advantage- a company with an edge over the field has better success potential in the long term than one without. For instance, coca-cola has an established brand that’s hard to compete against. This minimises competition and ensures investors see rewards well into the future. 
  • Management- good oversight over a company’s processes is key to success. Even the best business models and competitive advantage is worthless when the administration is wanting. 
  • Corporate governance- these are the policies governing an organisation. They denote the relationship between management, directors, and shareholders. The best companies are the ones that value ethics, fairness, transparency, and efficiency. 
  • Industry- this includes the available customer base, market share, growth in the sector, competitiveness, regulations, and market cycles. Understanding these factors will paint a clear picture of a company’s standing.

2. Quantitative Fundamentals

Quantitative data is the info you can display in numbers, ratios, or formulas. Analysts consider three factors when analysing a company:

  • Balance sheet- presents how a company is doing by showing its assets, liabilities, and equity at a glance. The assets are the things the company owns, while liabilities and equity represent how it finances them and other business projects. 
  • Income statement- this examines a company’s performance in a given period. It represents the revenue, expenses, and profits gained in the period under question. 
  • Cash flow statement- represents a business’s sources of income and how it spends it in a given period. It emphasises investment cash used to acquire assets or proceeds from their sale. There is also financing cash that comes from financiers or received from creditors, and the money generated from the day-to-day running of the business.

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