An old Peter Lynch adage for investing is, “Invest in what you know.” The renowned Fidelity investor and manager of the largest mutual fund of its time, Magellan used this principle as a starting point to help individual investors find undervalued stocks.
His approach from decades ago was developed out the necessity for investors that didn’t have the time or knowledge to evaluate the fundamentals of a company. They wanted a sound selection process, as opposed to throwing a dart at the Wall Street Journal pages. It was an arduous task to look at everything from corporate financial statements, cash flow and income states if the trader wasn’t a trained accountant.
A fundamental analyst looks at factors, from both the macroeconomic and microeconomic standpoint, to finding the intrinsic or real value of a company as an investment. That can range from the overall current unemployment and interest rates, to market share, or return on investment from quarterly corporate reports to evaluate worth. This longer term approach than technical analysis attempts to quantify all information to place a value on a company.
Technology advances have leveled the playing field for investors by providing access to analysis once only available to professionals. The internet and personal computers allow individuals to compile both fundamental financial report data and the technical price analysis for stocks.
Most brokerage and financial websites provide fundamental breakdowns for stocks as well as analysts ratings. This compiled information is easily available without the task of thumbing through pages and pages of annual reports or manually doing the accounting math. Specific stocks can be evaluated for their relative fundamental performance to their competitors and market sectors.
One major area of concentration in studying fundamentals for a company is the earnings track record. The widely anticipated quarterly numbers are a measuring stick of performance and often determine short term direction. Earnings per share growth can be an indicator of corporate strength like another fundamental of continuing high dividend yields.
The focus on earnings has accelerated in the last few years with expectations highly anticipated. Even if you knew exactly what the number was going to be, it’s still near impossible to make money because the markets reaction is often unpredictable. Some will be disappointed or relieved while others can find optimism and pessimism when the data is released. One certainty is that for only a few brief moments analysts can focus on the present before again looking to future reports.
Much like technical analysis which focuses on the price action of the stock, the fundamentals are only a tool in the investment process. There are not specific buy or sell thresholds for the fundamental ratios for sales, profits or earnings. They can provide a basis for further examination if certain personal fundamental criteria are met for investments.
Subjective analysis is used to both identify potential investment candidates and to maintain or exit current positions. Again, the intention for traders is to develop a disciplined plan that minimizes emotional decision making. An investment methodology that combines both some fundamental and technical analysis is commonplace for most individual investors.
