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Fundamental Analysis: Definition & Examples

Instructor: Michelle Reichartz

Michelle has lead multiple training initiatives and has a master's degree in Business Administration.

In this lesson you will learn what Fundamental Analysis is, how its used to evaluate shares in a company, and what pieces of information are used to complete that evaluation.

What to Buy?

Let's say you were given a million dollars to spend on stocks. How would you determine what to purchase? Would you trust someone else's advice or instead trust your own instincts? How could you confirm that you were making the right choice in what to buy? How would you determine whether a stock is overvalued or undervalued or figure out the right time to sell that stock?

What would you use your money to invest in?
What would you do with your money to invest?

The stock market can seem like a scary place, but knowing what to buy comes down to understanding the information behind the stocks. Behind every stock is a company; when you take the time to empower yourself and evaluate that company, you are more capable of determining what is a good investment and what is not. The process of using company information, economic factors, and industry standards to evaluate the stock of a company is known as Fundamental Analysis.

Analyzing Company Financial Statements

The core documents used to complete this evaluation are the company's financial statements. This includes the income statement, balance sheet, and statement of cash flows.

The income statement gives a breakdown of a company's income and expenses to determine its profits. It also tells you some more specific information such as earnings per share, which is how much money the company is making per share of stock currently issued in the company. For example: If a company had $5,000 in earnings with 500 shares of stock, the earnings per share would be $10 per share ($5,000/500).

The income statement is mainly used to determine if the company is profitable. If the company is profitable, is it well off or is it just scraping by to pay the bills? Profitability is important.

Next, the balance sheet offers a brief glance at what assets and liabilities the company currently has. The assets section shows what the company currently has, such as cash, inventory, and accounts yet to be paid. The liabilities section shows what the company owes to its lenders and suppliers, such as loans or payments owed to supply companies. Lastly, the equity section shows what the shareholders currently own. The equity section, in short, is total assets minus total liabilities.

The balance sheet is primarily used to evaluate where the company's money is currently tied up. Does it have a lot of money stuck in inventory or is it in cash? The more cash that is available, the more likely the company will be able to handle quick debt needs. In addition, does the company have a lot of money tied up in receivables? If the company isn't getting paid in a timely manner, the shareholders don't get paid swiftly either. Another area to check is liabilities. Is this number going down over time or going up? If the number is going up, it could be a sign that the company is taking on more debt than it can potentially handle.

Finally, the Statement of Cash Flows tells you what the name implies: it says where the money is coming in and going out based on three categories. These three categories are operating, financing, and investing. Operating tells you what money comes in and out based on the sale of the company's goods or services. Financing tells you the outside cash coming in and out of the company. This includes anything related to bank loans or stock changes. Investing breaks down money spent on capital such as equipment or space.

The Statement of Cash Flows is focused on just what the name says: where is the cash flowing? Is it all focused on keeping the business going or is it being dropped into new debt? Is the new debt being used for new assets, such as equipment, that will have value for years? You want to determine whether the company is investing in itself for the future or if it's just trying to keep business going as usual.

Outside Factors

Although a company's financial documents are your primary source for information, that isn't the only information to take into consideration. There are other factors to take into account when completing Fundamental Analysis.

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