Let's Talk Fundamental Analysis

Last week, we started you off with a list of some of the most important questions you should ask yourself when starting your qualitative analysis research. The list covers the more subjective factors of a company’s business that can tell you a lot about its future growth.

While factors like these can be very helpful in understanding your investments, there’s no doubt that you should also look at some of the quantitative aspects that can describe a company, too. This week, it’s time to get down to the numbers with an overview of some of the most important starting points to your fundamental analysis.

Fundamental analysis is a research technique that focuses specifically on a company’s business and profits – basically a focus on the money. Sometimes, investors can use these criteria to estimate the economic stability and growth potential of a company.

We can even understand more about the company’s potential by applying these numbers to what we know about the current economy and the industry in which the company does business. Here are some of the most important details you should consider when starting your fundamental analysis research. Note: it is best to do this research alongside your qualitative analysis research, so that you can get a better understanding how a company operates.

Business Model

What does the company do and what is its plan to make money? Information like this can be found by reading through a company’s website closely. For retailers, business models can sometimes be more apparent, as they often advertise things like “we sell this product for this price!” On the other hand, the models of technology companies such as Facebook might be a little unclear, as it seems that their primary services to customers are through free accounts. Noticing aspects like advertising sales or membership fees might be important to your understanding of a company’s business model.

Income Statement

These statements are released quarterly (called 10-Q statements) or annually (called 10-K) by the Security and Exchange Commission (SEC) and contain the company’s most current numbers. Most times, they will give you a good feel for a company’s revenue, expenses, and earnings. A company’s revenue tells you how much the company made from selling goods or services since its last report.

The expenses number will tell you how much the company spent on making products and hiring labor and how much it lost through factors like people returning goods, etc. The earnings will tell you how much a company actually made since its last report – its revenue minus its expenses (more commonly called profit) during this period.

Finally, the earnings per share will tell you the company’s earnings divided by the number of shares of stock it has publically listed. You should look at these numbers in comparison to previous income statements – is the company building on itself? Is it presenting well relative to competitors? This will give you a better feeling for how well the company is achieving its goal of selling goods and how you might expect to see the company perform in the future.

Cash Flows

These are most commonly found in “Cash Flow Statements” that are given out every quarter of the year. Cash Flow Statements will tell you how much is going in to a company and how much is coming out, essentially which way cash is flowing. Cash flows consider three main activities: operations, investing, and financing. Basically, how much money comes in and out of the company in daily business operations? How does the company invest (in machinery, employees, or other monetary investments) and how might these investments put the company in a better position in the future?

Lastly, how can we factor in the money a company has from lending or borrowing funds? These three factors show you how much money moves in and out of a company during a standard period of time and may help you better evaluate how the company can expect to do in the future.

Audit Reports

Reports from outside auditors will give you more holistic opinions on how a company is representing itself financially, including opinions on its income and cash flow statements. Oftentimes, they will even be attached to these statements for quick access. These reports are mandated yearly for all publically traded companies and can give you more assurance that the information a company is providing about itself is truthful.

Market Share

What percentage of the market does this company occupy? This can be looked at more closely through the following question: if a random person were going to stay at a hotel, what percent of the time would they elect to stay at a Hilton hotel? This percentage can tell you a lot about a company’s competition in its industry and how it stacks up to other companies (in this case, hotels).

Industry Growth

Are the company and its competitors continuing to grow? This question connects very easily with qualitative analysis, but puts a number to your valuation of the industry. Do the companies in this industry seem to be expanding and profiting for the most part? Are the companies’ income statements and cash flows growing over time? The growth of the entire industry itself is important to consider before you invest in a specific company.

Debts

Does the economic information you’ve gathered about the company and its industry suggest that the company will be able to not only minimize, but also pay off its debts in the future? If the company seems to be making profit, minimizing costs, and paying off debts on time, this could indicate positive financial practices. Positive financial practices could be a good sign for the financial stability of the company.

Once again, this list may not be all-inclusive, but finding numbers for some of these categories could definitely give you a better indication of the company’s success level. By putting these numbers alongside your qualitative analysis, you can get a fuller picture of how the company is doing in both objective and subjective terms, too. The more you know about a company’s business, the more confident you will be in your investing decisions!