Stock Investing – Fundamental Analysis

Stock Investing – Fundamental Analysis

This article will attempt to highlight why fundamental analysis should be a crucial part of any stock investing criteria.

Stock price charts and quotes are readily displayed across all forms of media which can result in investors being overly fixated with share price movements. Also, the visual aspects of stock price charts can lead novice investors into the following misconceptions:

If a stock traded at $ 10 one year ago and is now a bargain at $ 4
A stock with a low share price (say $ 1) is cheap whereas a high share price ($ 70) is expensive

To help novice investors start thinking like savvy investors we suggest a simple brain storming exercise. The brainstorming exercise is to compile a list questions you would ask to the owner of a small business you are interested in buying.

The following non-exhaustive list contains some of the most common questions (in no particular order):

How much income is being generated through sales?
What expenses are associated with generating this income? Advertising, rent, salaries, etc.
Are sales and expenses increasing / decreasing?
How much debt (liabilities) does the company have? Accounts payable, bank loans, etc.
How much assets does the company have? Property, equipment, value of inventory, etc.

For a quick first pass on whether the small business of interest may be a good investment you could compare the asking price to the total company assets minus any debt. Then compare the profit (sales minus expenses) and possible growth based on sales and expenses forecasts.

Notably absent from the list is what the previous owner bought the business for, the previous owner before them, the previous owner again, and so on. These questions would allow a graph of price versus time to be created similar to a stock price chart. The key point to be made is that the fundamental valuation of the business based on actual financial measures is the critical factor. Additionally, the details of previous purchases are inconclusive as they more than likely occurred in different economic conditions.

Buying a Stock is Buying a Share of a Business…

Therefore similar questions to those highlighted in the brainstorming example should be considered when buying a stock, which forms the basis of a fundamental stock analysis approach. Each publicly listed company must release their audited financial results so start using fundamental analysis criteria in your stock selection process!

Stop being fixated on share price alone. A company’s share price only becomes useful when taking the underlying fundamentals into account.

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