Fundamental Analysis For Trading | ProfitlineTradingWorld.com

Trading using fundamental analysis can help you find great companies that are financially strong with increasing revenues and earnings as well as ones that are leaders dominating their industries. These types of companies can turn into big trading winners making you substantial profits.

Fundamental analysis is the study of both internal and external factors that can influence the intrinsic value (true value) of what the price of a company’s stock should theoretically be worth. Once the intrinsic value has been determined, it is then measured against the current value of the stock’s price. This will help to determine if the stock’s price is currently – overvalued, undervalued, or priced fairly.

Fundamental Analysis – Internal Factors

What is the health and strength of the company’s financial statements?
Financial ratio analysis – how strong are the company’s key financial ratios such as price-to-earnings (P/E) and earnings-per-share (EPS) when measured against the respective historical ratio’s as well as against the competitors ratio’s?
What is the company’s market share of products & services compared to the rest of the competition?
How effectively and efficiently does management run the company?
Any abrupt company departures of the Chief Executive Officer (CEO) or Chief Financial Officer (CFO) or other top leading management officials?
Any superior products and services creating huge customer demand?
What is the projected future growth for revenues and earnings?
What are the future strategic business plans and innovations of the company?

Fundamental Analysis – External Factors

How is the overall national (and even global) economy doing?
Are there any industry related events or conditions that could have a dramatic impact on a company’s stock price?
Who is the company’s competition and which ones are the leaders?
Any new governmental laws being passed (or ones expiring) that might be beneficial or detrimental to the company?

Fundamental analysis can assist you in determining “why” to buy a company’s stock from doing sound financial due diligence and research, but not necessary “when” to buy it.

There are times when the price of a company’s stock should theoretically be higher (or lower) than where it’s currently valued at under the theory of fundamental analysis yet it’s trading in a poor “technical” manner under the theory of technical analysis.

Under such conflicts between the two pricing theories, it may be better to wait to trade the stock until the stock’s price shows an improving “technical” manner especially when engaging in shorter-term trading styles like day trading and swing trading.

In the meantime, however, you can always keep your eyes on these fundamentally strong companies by creating your own personal stock watch list or even having stock alerts sent electronically to your mobile devices such as smart phones, tablets or laptops.

Fundamental analysis is usually used more for longer-term trading styles such as position trading.

Financial Ratios

Financial ratios are another part of fundamental analysis to help gauge the company’s internal financial strength as well as to measure itself against other companies in related industries for ratio comparison purposes. There are many kinds of financial ratios that can be used to measure all kind of things including:

Debt-to-Equity and Debt-Service-Coverage
Return on: Assets, Investments and Equity
Earnings-Per-Share and Price-to-Earnings

The Father Of Fundamental Analysis – Benjamin Graham

Benjamin Graham (1894 – 1976) is considered the father of fundamental analysis who also taught at the prestigious Columbia Business School. One of his students just happened to be Warren Buffett who later in his own life became a legendary billionaire investor. Warren got much of his investing wisdom and inspiration from the teachings and theories of Graham.

Benjamin Graham wrote the following books about his own methods and theories on investing that are considered bibles on the subject of fundamental analysis.

Security Analysis (1934)
The Intelligent Investor (1949)

Graham’s investment theory was centered around the value approach to investing where he believed that the intrinsic value (true value) of a company’s stock price should be significantly higher than the current price to actually acquire it. If this test was favorably met indicating inherent significant value, Graham would then considered the price of the stock to have a “Margin of Safety.”

When making investment decisions in undervalued companies, Graham would do his own due diligence using his theories of fundamental and financial statement analysis with doing the likes of the following:

Finding companies having strong and healthy financial statements (surplus cash balances, low debt levels, and growing & sustainable revenues and earnings)
Investing in larger mature companies with a big diversified customer base to help maintain financial strength and stability
Companies paying good enough dividends
Relative low price-to-earnings ratios & price-to-book values
Having a cushion for “margin of safety”

Graham also believed that when making investment decisions you should:

Treat investing as “most business like” since you are potentially buying into a business and becoming part owner of it. Do your analytical due diligence with respect to fundamental and financial statement analysis. Don’t worry so much about adverse short-term price movements.
Make your own independent investment decisions. Disregard the “noise and chatter” of the crowd which is often wrong.
Avoid making emotional investment decisions. Investments decisions should be well researched and objective instead of being negatively influenced by overreacting emotions.

Other notable and respectable investors and fund managers who also have used fundamental analysis for great investment success include the likes of – Peter Lynch, Mario Gabelli and Sir John Templeton – all who went on to make massive investing fortunes.

Analyzing Audited Financial Statements – From A Financial & Investment Analysis Standpoint

You can easily obtain the audited financial statements including the accompanying footnote disclosures of a publicly traded company that are filed with the U.S. Securities and Exchange Commission (SEC) by going to the SEC website and using the free company filings system called “EDGAR”.

You can also go directly to a company’s website to obtain their audited financial statements as well.

There are many traders and investors who enjoy digging through the financial statements of a company (not to mention many highly paid institutional security analysts who serve this sole purpose) to better understand a company’s financial (and non-financial) position as well as potential prospects before making trading or investing decisions.

In digging through the company’s financial statements, it can help you better understand (to a certain degree) important information pertaining to fundamental analysis and financial questions such as:

What Is The Nature Of The Company’s Assets?

What is the composition and nature of the assets as to current assets versus non-current assets?
Are the assets mostly in cash and other liquid assets, or are they illiquid assets stuck in slow moving inventory that is undesirable (or even obsolete), or old and inefficient property, plant and equipment that is considered pretty much worthless, or research and development costs that hasn’t materialized into full production and profitable sales cycles?
Are there significant accounts receivables that have severe aging problems that are hard to collect or possibly even on the brink of being completely worthless?
Are there sufficient current assets to cover short-term financial obligations such as being able to pay debts and dividends?
Would they be able to convert non-current assets to current assets in a reasonable amount of time to prevent a liquidity crisis if needed?

What Is The Nature Of The Company’s Debts?

Is the company highly leveraged with debts on its balance sheet?
Are the debts more (or less) than the assets recorded on the books?
Are they behind (or in default) on any liabilities or worse yet on the verge of declaring bankruptcy?
Has there been any unloading of debts to other affiliate entities to make their own balance sheet appear stronger than it really is?
Are the debts steadily growing for no good apparent reasons?
Are there any large contingency debt obligations that may arise in the future?
Are there any significant unfunded liabilities such as to pension plans?
Are they locked into any harsh or unfavorable long-term lease agreements?

What Is The Nature Of The Company’s Revenues, Earnings, And Growth Prospects?

Have revenues stabilized and matured over time providing for consistent revenues or are revenues growing steadily (or even rapidly), if so, at what rate?
Are revenues on pace to surpass last quarters and last years results or are they possibly dropping?
Have revenues declined due to falling product demand or even from having production problems?
Are there any significant revenue sources that will not be recurring in the future?
Are the bottom-line earnings increasing with new revenue growth or is it being done by cost cutting measures instead?
What are the future growth prospects to increase revenues? Are revenues expected to rise due to increasing demand for existing products and services or even with new product innovations? Or, are there any new major product developments coming soon out of research and development (R&D) that will add significantly to the overall revenues? Or, possibly even new “revenue streams” being created from buying other companies through mergers and acquisitions deals?

Lastly – About Fundamental Analysis

Fundamental analysis can help you find great trading opportunities by uncovering companies that are financially strong and are dominating the competition which can lead to big winners and profitable trading gains.