Basics of Fundamental Analysis
Fundamental analysis requires information provided by the company to develop a thesis about the business. These are some of the factors that should be included in the thesis.
Understand a Company’s Real Value
Observation is reality in the financial markets. Different investors and analysts will have differing valuations for a company. However, the continued declining sales forecasts caused the sector to drop, when the earnings reports revealed even larger revenue declines, as discernment shifted negative again.
Outlook Influences Discernment
The markets are the ultimate arbitrator and adjudicators as to which valuation pricing prevails and when. Outlook influences discernment, which is why stocks tend to overshoot their valuations in strong bullish markets and undershoots during weak bearish markets, fundamental analysts will work to develop their own valuation models using specialized metrics to calibrate them to any mechanisms. Companies can be valued based on financial metrics as well as assets that may not be efficiently priced in. The parts are worth more than the whole is a common validation for under valuation, which assumes that the company may follow up or sell certain assets to improve shareholder equity.
Reading Financial Statements
Publicly traded companies are required to file financial statements with the United Stated Securities and Exchange Commission (SEC). Investors can access this information directly from the SEC through the EDGAR database.
Quarterly earnings are initially revealed and filed as a 10-K document afterwards. Companies will usually pair the earnings release with a conference call an hour afterwards or the next morning. The conference call can be very disclosing, especially future earnings guidance estimates which may be increased or decrease from consensus analyst estimates, regulatory issues, impending proceedings and most important indenture wins or loses, which can result in significant share price volatility
Understanding Industry Trends
Stocks are segmented by sector and industry. To determine the true performance of a stock, it should be evaluated amongst its competitors within the industry. When a particular sector or industry is very strong, it tends to lift most of the companies within. The privileges in the particular industry usually establish the industry trend. Therefore, it is cautious to continue alongside each other of the industry trends for the particular stocks. The performance of the industry leaders sets the outlook with the group. When a leading stock in the heavy machinery industry lacerates its earnings guidance, it generates a top-down undulation effect for the examiner stocks as well. It is guilt by association until demonstrated otherwise as share prices sell-off.
Accounting for Company Growth
There are two types of accounting that is used with earnings reports. The official numbers are reported under Generally Accepted Accounting Principles (GAAP), which take into account all expenditure items including non-cash compensation like restricted stock and options. Companies like to also provide non-GAAP numbers, which excludes non-cash items. The purpose is to allow shareholders to better estimate the growth of the core business without being sidetracked by factors that doesn’t affect cash flow. However, opponents argue that non-GAAP accounting is misleading. Any and all compensation must be accounted for especially when existing shareholders face further strength in shareholder equity.