The Basics of Fundamental Investing

December 9, 2021

How do you know what an investment is intrinsically worth? Is it possible to measure what an investment might be worth in the future before you sink your money into it?

In fact, it is possible—if you use fundamental investing analysis.

Here’s a look at what fundamental investing is, how it works, and how you can make it work for you.

What is Fundamental Investing?

Fundamental analysis is a method of measuring a security’s intrinsic value through analysis of underlying economic and financial factors. Essentially, you examine the big-picture factors that influence the overall value of a given security, such as macroeconomic trends in the industry or microeconomic trends in the company’s practices. Overall, fundamental analysis relies on three components:

  1. Company analysis
  2. Industry analysis
  3. Economic analysis

The goal is simple: to generate a number that the investor can compare to the security’s current price, thus allowing the investor to assess whether the security is overvalued, undervalued, or valued where it should be. This will allow the investor to assess why the asset is valued this way, and whether that makes the security worth investing in.

Fundamental investing is the practice of investing by using fundamental analysis as your core guiding strategy.

Fundamental Analysis and Investing

As a savvy investor, you know that a security’s price at face value doesn’t tell you everything you need to know. You can’t see all the factors behind it, nor can you tell just by reading the value how it stacks up to other securities like it.

This is where fundamental investing is crucial.

Fundamental analysis rests on creating models to determine the estimated value of the company’s share price, always based on publicly available data. It’s an estimate, not an exact number, and it may not account for all the information, so you might arrive at a different number if you had access to non-public information. However, the analysis provides an educated opinion about what the security should be worth, which allows you to compare against what it’s currently worth.

For example, let’s say you perform fundamental analysis on a stock. And let’s say your analysis says the stock should be valued much higher than what it’s currently worth. In that case, you want to buy the stock, since the stock is worth more than it’s selling for and you could make a profit once the market value grows to match intrinsic value.

Conversely, if you find the stock is worth less than what it’s selling for, you would want to sell the stock or avoid buying it in the first place. In this case, you’ll lose money once the market value shrinks to reflect the intrinsic value.

Understanding Intrinsic Value

As you can see, fundamental investing relies heavily on the concept of intrinsic value.

Intrinsic value is simply the measure of what an asset is worth. This is arrived at by using a complex financial calculation, not the asset’s current market value. As such, it’s important to remember that market value and intrinsic value are not necessarily the same thing. While they may often line up, there are plenty of times when they won’t .

Because of this, proper fundamental analysis requires an in-depth understanding of finance, economics, and accounting. You have to be able to read and understand financial statements, understand valuation factors, and measure them in tandem with economic trends.

That said, you don’t need private company data to estimate intrinsic value. In fact, analysts rely on publicly available data to arrive at intrinsic value estimates, often things like quarterly reports.

Quantitative vs. Qualitative Analysis

One major challenge of fundamental analysis is that, in principle, it can cover any economic factor that may impact a company’s financial well-being. Everything from the quality of management to profit numbers to industry interest rates are fair game.

Broadly, factors are classified as either quantitative or qualitative. Quantitative simply means any information that can be expressed as hard numbers, whereas qualitative information is related to the nature of something.

As such, quantitative fundamentals deal with measurable hard numbers. For example, if you’re making calculations based on the company’s financial statements, you’re doing quantitative fundamental analysis. On the other hand, if you’re dealing with nebulous concepts like patents, business models, competitive advantages, or public perception of executive leadership, you’re dealing with qualitative analysis.

Here’s the catch: while qualitative factors can be quite difficult to quantify, they’re just as critical to intrinsic value as quantitative factors.

Fundamental Investing vs. Technical Investing

At this point, we should distinguish between technical analysis and fundamental analysis, as it’s easy to get lost in the weeds of quantitative fundamentals and find yourself confusing practices with technical analysis.

In investing, technical analysis is the practice of analyzing statistical trends in trading activity. The goal is to scrutinize how supply and demand affect price, volume, and volatility, and in turn how those trends will affect the security’s value.

Fundamental analysis has a different focus. It looks at the intrinsic value of a specific asset, such as a stock, and it does so by looking at things like business sales and earnings. Technical analysis isn’t concerned with the company, but rather with how the security performs in comparison to similar securities and if its performance patterns relative to similar securities indicate a strong investment.

Put Your Investing Knowledge to Work to Grow Your Money

Fundamental investing is just one way that you can get smart about how you use your investing dollars. And it all comes down to having the right information.

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