Fundamental analysis is defined as evaluating the intrinsic value of an option by analysing the related factors like financial, economic and other qualitative aspects. This analysis is based on the simple theory that the market price of any asset always tends to move towards its intrinsic or real value.
All the factors of macroeconomics as well as the specific factors are taken into consideration while making the investment decision. The ultimate goal of conducting fundamental analysis of any asset is to come up with a price that is comparable to the current price of the asset and helps the investor to better decide what position to take with that asset. For instance, if the asset is overpriced then it would be wise to sell it and if it is under priced then it is better to buy.
Put simply, the approach of fundamental analysis is opposite to technical analysis. There are many macroeconomic indicators which play an important role in fundamental analysis which and those include:
• GDP or Gross Domestic Product
• Interest Rate Announcements
• Inflation/Consumer Price Index
• Spending Indicators
• Employment Indicators
• Consumer Confidence and Retail Trade
• Government/ Fiscal
• Monetary Policy
• Deficit or Balance of Trade Surplus
There are other qualitative factors that play a major role in fundamental analysis.
The Qualitative Factor
When buying an option you are investing in the company of the underlying asset. It is very important to understand the company’s operation and the overall financial reputation so that you can reach an informed decision. Reckless ill-informed investing is likely to lead to losses.
It is important to study financial statements if you are considering long term investment. As an investor you should understand the purpose of these reports and how to interpret the data in them.
Here is a quick guide that will benefit you:
• Financial reports are mandatory and hold a legal status. They are published quarterly and annually.
• There are unaudited as well as audited financial reports with the latter being much more reliable.
• MD&A or Management discussion and analysis gives a better view of the operations of a company and the industry it performs in.
• On a balance sheet look for assets, shareholders’ equity and liabilities.
• Always remember the equation: (Assets = Liabilities + Shareholders’ Equity) and apply it to every balance sheet you see.
• In an income statement the revenue, expenses, earnings per share and earnings of a company are detailed.
• In the income statement non-cash items like depreciation are also detailed.
• The cash flow statement should list how much actual money is generated excluding all non-cash items.
• A cash statement has three important parts – cash from operations, from investing and from financing.
• For better fundamental analysis study the financial statements.
Using quantitative and qualitative parameters will allow reliable and accurate fundamental analysis that will help you make the best long-term investment..
In long-term investments, fundamental analysis is significantly useful. It helps in predicting the intrinsic value of an option as well as easily identifying the long-term opportunities. Profits made in long term investments are usually much higher than they are with hort-term investments.
Warren Buffett is one of the most successful analysts who has made a fortune from his ability to pick potential securities. If you have the patience and intelligence to make the right choices then you will definitely benefit from using fundamental analysis.
There is no doubt that fundamental analysis can be very helpful in making investment decisions. However it requires a lot of experience and knowledge of the markets. With so many macroeconomic indicators, any new trader may get confused and end up making the wrong decisions.
To become a proficient fundamental analyst you need to invest a lot of time and labour in mastering lot of economic terms. With the macro economical factors, like financial policies, government rules and market changes. You need to keep yourself updated all the time. There is no zenith in fundamental analysis and once you reach the top you have to be ready to grasp new reforms and changes as they evolve.
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