Definition: Fundamental analysis is investigating the fundamental sizes of a national economy or a firm in relation to the market and the important political news. Fundamental analysts collect information, which they use to forecast the future market trend and to determine which securities may be unfairly priced based on this information.
What Does Fundamental Analysis Mean?
What is the definition of fundamental analysis? The fundamental analysis focuses on calculating a security’s fair value and compares it to the market price to determine if the security is overvalued, undervalued, or fairly valued. By taking into account the economic variables that influence the investment decision-making, this analysis can estimate future trends based on a firm’s or the market’s real potential.
By carefully monitoring and studying the prospect of a particular firm based on its financial results, analysis can estimate the future corporate earnings, cash flow and return on capital, among other ratios. Furthermore, during periods when the market is not efficient, basic analysis can identify the securities with a potential to outperform the market with a risk-return relationship above the market average.
Let’s look at an example.
Example
John is a financial analyst specialized in the shipping sector. He is asked to perform a financial ratio analysis of a leading shipping company.
The first step is to find political and economic news that possibly affect the stock price. Scrutinizing the industry in which a firm operates is important in the rudimentary analysis as macroeconomic factors often explain how a stock price moves. In fact, the core analysis works best with the “big picture.”
The second step is to analyze the market outlook of the U.S. shipping sector and identify the competitive forces and macroeconomic indicators, including interest rates and historical trends, which potentially influence the future corporate actions and the behavior of the market as a whole.
The third step is to study the company’s financial statements to identify elements that potentially affect the stock price. Such elements could be the firm’s sales, EPS, net income or industry-related factors that have been identified in the previous steps.
The final step is to observe trends and forecast the future behavior of the stock.
Summary Definition
Define Fundamental Analysis: Fundamental stock analysis means examining a company, its history, the market, and the economy in an effort to make an investment decision about a specific stock.
