As you begin to explore the world of investing you may find people talking about the 'fundamentals' behind an individual stock or even the wider market.
But what exactly are they talking about and why are these fundamentals important?
Fundamental analysis is a method of evaluating an asset that includes an attempt to measure its intrinsic value by examining anything that could affect its value. This might encompass macro-economic factors - such as the health of the overall economy or a particular industry or sector - and asset specific issues and attributes.
For a listed company, for example, you might look at its level of cash flow, the kind of returns it has achieved historically, the prospects for the business and its balance sheet.
By determining the intrinsic value of said asset you can compare it with the current market price in order to decide whether it should be bought or sold. As well as examining intrinsic value, you might also consider how an asset is valued compared to the wider market, using metrics such as price-to-earnings or PE for short.
FUNDAMENTAL VS TECHNICAL ANALYSIS
Technical analysis is frequently contrasted with fundamental analysis. A technical approach holds that prices already reflect trends before investors are aware of them. Uncovering those trends is what technical indicators are designed to do, imperfect as they may be.
So-called technical analysts or ‘chartists’ spend their time studying performance charts and then form an investment view directly from this analysis rather than a detailed examination of an individual asset’s merits.
Some investors use technical or fundamental analysis exclusively, while others use elements of both approaches to make investment decisions.
Taking these two approaches into the real world, if a technical analyst was in a shopping centre and they saw hundreds of people lining up to buy the latest smartphone they would dip their hands in their pocket to snap up as many as they could in the expectation the high demand would drive the price higher - allowing them to sell said phones on for a profit.
An investor focused on the fundamentals would instead take a closer look at the quality of the smartphone’s hardware, how features such as its camera perform, check the warranty and its rating on consumer websites as well as its price relative to other products on the market before deciding whether to buy.
This is the latest in a series of guides on the basics of the financial markets to appear on our website in the coming weeks.
