Often, stocks are bought and sold based on hunches, dreams, chatroom chatter and just plain old “gut feelings.” Others rely heavily on technical analysis, or the ability to spot trends by examining historic prices based on the theory that share prices follow certain cycles over time. And the “rumor mill” theory of stock market investing does in fact work well for some; even unfounded rumors will cause share prices to rise or drop on a dime.
What investors refer to as a company’s “fundamentals” is the data that reflects the actual performance of a corporation. A stock fundamentalist would place less emphasis on things like candlestick charts, and more emphasis on the actual financial performance of a company and its position in the marketplace. While it’s not unusual for a technical trader to buy and sell stocks without even knowing what the company produces, a fundamental trader would always do some research into the company and its industry.
A fundamental investor or trader will look at financial statements and information from the corporation’s 10-K and 10-Q, to review numbers such as a company’s cash flow, available cash, return on assets, and earnings per share (EPS). They will look at numbers like accounts receivables and payables, and will compare current sales with the previous quarter’s and previous year’s sales.
Fundamental analysis will also look at a company’s current projects and future plans and how likely those are to bear fruit. Based on the actual financial returns of the corporation, a fundamental analyst will derive an intrinsic value of an equity, which represents the company’s actual value (expressed in share price). The actual value is often different from the share price. The fundamental theory is that although prices will fluctuate up and down based on outside factors, the price will tend to gravitate back to that intrinsic value over time.
If the intrinsic value is more than the current share price, then the stock is undervalued, and should be purchased immediately. On the other hand, if the intrinsic value is below the current share price, external forces have probably driven the price up, and the price is therefore destined to go back down.
Information is for educational purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Consult your financial advisor.
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