Fundamental analysis is a method of evaluating the intrinsic value of an asset and analysing the factors that could influence its price in the future. This form of analysis is based on external events and influences, as well as financial statements and industry trends.
This is what fundamental analysis is
For example, let’s say that the U.S. dollar has been gaining strength because the U.S. economy is improving.As the economy gets better, raising interest rates may be needed to control growth and inflation. Higher interest rates make dollar-denominated financial assets more attractive. In order to get their hands on these lovely assets, traders and investors have to buy some U.S. dollars first. This increases demand for the currency. As a result, the value of the U.S. dollar will likely increase against other currencies with lesser demand. Since currencies are always paired, their performance is determined relative to that of another currency. Later on in the course, you will learn which economic data points tend to drive currency prices, and why they do so.You will know who the Fed Chairman is and how retail sales data reflects the economy. You’ll be spitting out global interest rates like song lyrics. To be able to use fundamental analysis, it is essential to understand how economic, financial, and political news will impact currency exchange rates.
- Fundamental analysis is a method of determining a stock’s real or “fair market” value.
- Fundamental analysts search for stocks currently trading at prices higher or lower than their real value.
- If the fair market value is higher than the market price, the stock is deemed undervalued, and a buy recommendation is given.
- If the fair market value is lower than the market price, the stock is deemed overvalued, and the recommendation might be not to buy or to sell if the stock is held.
- In contrast, technical analysts favor studying the historical price trends of the stock to predict short-term future trends.
Fundamental analysis is usually done from a macro to micro perspective to identify securities that are not correctly priced by the market.
Analysts typically study, in order:
- The overall state of the economy
- The strength of the specific industry
- The financial performance of the company issuing the stock
This ensures they arrive at a fair market value for the stock.
Example of Fundamental Analysis
The Coca-Cola Company is a prime example that can be used in fundamental analysis. To begin, an analyst would examine the economy using some published metrics:
- Consumer price index (inflation measure)
- Gross domestic product growth
- Exports/imports
- Purchasing manager’s index
- Interest rates
Then, the sector and industry would be examined using statistics and metrics from various reports and competitor companies. Lastly, the analysts would gather the reports from Coca-Cola or the Security and Exchange Commission’s Edgar filings database.1
Analysts might also use data gathered by another firm, such as CSIMarket. CSIMarket provides fundamental analysis data for investors, so you could begin by assessing the value of Coca-Cola’s assets, income streams, debts, and liabilities. You might find comparisons of objective metrics such as revenue, profits, and growth, especially in the context of the broader beverage industry.
Using CSIMarket’s analysis, the analyst could compare growth rates to the industry and sector Coca-Cola operates in, along with the other information provided, to see if the company is valued correctly. For example, as of August 2022, for the trailing twelve months (TTM), Coca-Cola had (using only a few of the possible ratios and metrics):2
| Coca-Cola | Industry | Sector | |
| Y/Y Revenue Growth | 13.48% | 10.86% | 16.18% |
| P/E Ratio | 29.12 | 25.16 | 18.68 |
| Price to Free Cash Flow | 24 | 7.45 | 4.23 |
| Debt to Equity (TTM) | 1.57 | 0.14 | 0.11 |
| Quick Ratio (TTM) | 0.16 | 0.24 | 0.2 |
| Return on Equity (TTM) | 13.14% | 30.21% | 23.16% |
| Return on Assets (TTM) | 11.5% | 8.69% | 7.91% |
| Return on Investment (TTM) | 13.14% | 19.76% | 15.84% |
| Revenue per Employee (TTM) | $111,578 | $55,015 | $66,896 |
One factor not shown in an analysis of ratios and numbers is how long a company has been around and the conditions they have weathered. Coca-Cola was founded in 1892 in Atlanta, Georgia.
It has stayed in business through several wars, depressions, recessions, epidemics, pandemics, stock market crashes, and a global financial crisis. Not many companies can claim a history like that.
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