Fundamental Analysis: A Valuable Tool for Savvy Investors

Fundamental analysis measures a security’s intrinsic value using a number of quantitative and qualitative assessments. Investors, day traders, and analysts need to know whether a business’s fundamentals are reflected in the “fair market price.”

If you’re confident in your fundamental stock market analysis, then spotting an undervalued security could generate decent upside returns if the price rises.

In this article, we’ll explain what you need to know about applying fundamental analysis in practice, including what fundamental analysts and investors need to know about a company, its financials, and other key considerations.

What Is Fundamental Analysis? 

Fundamental analysis in trading is a way of examining the fundamental factors of a business so you can more accurately judge its share price. It’s more about taking a long-term view of a company rather than worrying about short-term details, such as the end-of-day share price.

Investors who use fundamental analysis usually fall into two categories:

• Growth investors: Examine the future growth potential of a company and pick undervalued long-term investments to increase a portfolio’s returns
• Value investors: Assess whether the current share price accurately reflects the health and financial performance of a company

Say the market prices a company at $100 a share, with normal fluctuations. But after applying fundamental analysis, you think it’s undervalued and should be $120. Buying now, before the market catches up, could be a smart move.

On the other hand, if security is overvalued, it could drop to $80. As with any investment, it’s a data-backed judgment call, and the more data you’ve got for analysis, the smarter decisions you can make.

The goal is to understand the “fair market value” and whether a stock appears to be undervalued or overvalued by other fundamental analysts.

What Are Fundamentals in Trading?

Stock fundamentals are a company’s key metrics for a company, such as cash flow and return on assets (ROA). Fundamental analysts predict a stock’s price by looking at the company’s financial health and market position to determine if it is likely to outperform or underperform its sector.

Conducting a fundamental analysis involves going over the following stock fundamentals (and several others, depending on how in-depth you want to go):

• A company’s financial statements
• Business model
• Competitive advantage
• Market share, moat, intellectual property (IP) and their unique selling point (USP)
• Macroeconomic and microeconomic weightings 
• Share price ratios, e.g., the price-to-earnings ratio (p/e ratio)
• Impact of the global economy 
• Management and leadership 
• Sector(s) and operating markets for growth, contraction, or stagnancy

Once you’ve collected this information and analyzed it, you might have a different view as to the true value of a security compared to the market and other analysts.

Fundamental Analysis vs. Technical Analysis

Technical analysis and fundamental analysis are like the opposite of each other. Which someone uses is usually a matter of personal preference.

Both methods rely heavily on data. However, technical analysis is a method of forecasting future price movements based on historical share price analysis and trading volumes over a fixed period (e.g., six months, two years, etc.). Price trends and actions are compared to other companies in that sector or asset class.

Investors and analysts can use a number of approaches, such as finding a symmetrical triangle or the wedge to assess how one’s security compares to similar businesses.

In some cases, investors try to get as close to real-time data analysis as possible to make faster investment decisions. With this approach, you need vast amounts of market data, clean data sets, and machine learning tools to help make quick trades.

Fundamental analysis can still play a role; although more so in narrowing down securities to focus your efforts on when trading in the stock market. In this scenario, market data and historical data is useful, as is a clear understanding of the fundamentals of the companies you’re interested in.

Fortunately, it’s not an either-or situation. You can use fundamental and technical analysis combined to get an even clearer picture of the strength, value, and potential of companies you’re interested in.

How to Do a Fundamental Analysis of a Stock

Step 1: Understand the Business
Fundamental stock analysis starts by understanding what the company does, its products or services, its business model, and its place in the industry. Look into the company’s annual reports, press releases and news articles. Analyze the industry’s growth potential, the competitive landscape, and any regulatory or technological changes that might come into play.

Step 2: Analyze Financial Statements
Review the company’s stock fundamentals like revenue, expenses, and profits over several years to assess its profitability and growth trends. Examine its assets, liabilities, and shareholder equity to get an idea of its financial health and stability. Look at its operating, investing, and financing cash flow to gauge its liquidity and cash management efficiency.

Step 3: Evaluate Financial Ratios and Metrics
Fundamental investing focuses on Return on Equity (ROE), Return on Assets (ROA), and profit margins to see how effectively the company is generating profits. The current ratio and quick ratio let you calculate its ability to meet short-term obligations. Price-to-Earnings (P/E), Price-to-Book (P/B), and Price-to-Sales (P/S) ratios help you determine if the stock is fairly valued, while debt-to-equity and interest coverage ratios provide a picture of the company’s leverage.

Step 4: Consider Qualitative Factors
Research the company’s leadership, their track record, management style, and corporate governance practices. Determine its unique selling propositions, patents, brand strengths, and market share. Look at expansion plans, new product developments, and innovation strategies to evaluate future growth prospects.

Step 5: Compare and Make a Decision
Fundamental analysis of stocks compares the company’s performance, ratios, and growth prospects with its industry competitors. It also looks at interest rates, inflation, economic growth forecasts, and other indicators of the overall economic environment. Based on that analysis, decide if the stock is undervalued, overvalued, or fairly valued and make your investment decision accordingly.

What Are the Risks of Fundamental Analysis?

The main risk of fundamental analysis is that your analysis is incomplete, and markets are pricing in something that you’re not aware of or have not given the same weighting either. When you take a value-based approach to fundamental analysis, you are betting on a reversion to the mean.

For example, if your fundamental analysis leads you to believe a stock should be valued at $80, and right now, it’s trading at $60, you’re making a bet that the overall market will reach $80. In practice, due to macro factors, this may not happen, or it may take many years to happen. There could be a systemic crash that affects all stocks, and that $60 stock could go to $20. Additionally, there is an opportunity cost when it comes to fundamental investing.

Your analysis might be right and the stock does eventually reach $80, but it took 10 years to get there. Your money could have been more effectively used elsewhere. As with any investment, whether it’s $1,000 or $1 million, it’s a judgment call, and fundamental analysis is one way to make a decision.

While these risks exist, famous fundamental investors like Warren Buffett and Charlie Munger have had huge success using fundamental analysis to make investment decisions.

The Best Fundamental Analysis Tools for Traders

Here’s a list of some of the most helpful tools for fundamental analysis. If you want to determine whether a stock is worth your investment, these data points will help you make an informed decision.

Business Model

Start with the basics. Take notes from the company’s website, investor relations, and annual reports. This should answer the following questions for you:

• What’s their business model?
• What are their core products or services?
• Is their revenue recurring or cyclical?
• Who are their customers (e.g., SMBs, enterprises, consumers, etc.)?

From this fundamental analysis of a stock, you should have a fairly clear top-level overview. Now it’s time to go a bit deeper.

Financial Statements: Balance Sheet, Income and Profit and Loss

The balance sheet is a snapshot of the company’s assets, liabilities, and equity. The formula for whether these figures balance is: Assets = Liabilities + Shareholder Equity

Likewise, assessing a company’s P&L is always useful. You need to know whether they’re making a profit or losing money, and if so, what are their earnings before interest and taxes (EBIT)?

EBIT is an important fundamental analysis tool to know as this shows how much income a business is generating from core operations, thereby giving investors a clear view of net profit.

A company’s balance sheet, income statement, and cash flow statement are among your best fundamental analysis tools. They offer direct insight into a company’s financial operations and let you assess financial health, profitability, debt levels, and cash management. By looking at financial statements you can achieve a clearer view of a company’s real underlying valuation than you can by simply exploring its stock’s historical trends.

SEC Filings

SEC filings are the best fundamental analysis tools for publicly traded companies in the U.S. They provide a detailed overview of the company’s financials, risks and management decisions in comprehensive, legally required documents. Here are the key SEC filings you should look at when doing fundamental analysis of a stock.

• Form 10-K (Annual Report) Form 10-K provides comprehensive details about the company’s financial condition, including income statements, balance sheets, cash flow statements, and notes on the financial statements. For example, Apple Inc.’s 10-K report includes a detailed breakdown of its revenue streams, costs, and profitability. It might note any risks related to supply chain disruptions, regulatory changes, or technological advancements, and it also discusses Apple’s growth strategies, market trends, and operational challenges.
• Form 10-Q (Quarterly Report) These are summarized quarterly versions of the financial statements provided in the 10-K. While it is less comprehensive than the 10-K, it is important for fundamental investing analysts because it includes updates on risks and management’s discussion of quarterly performance.
• Form 8-K (Current Reports) Form 8-K reports major events that shareholders should know about, such as mergers, acquisitions, leadership changes, or financial restatements.
• Proxy Statements (DEF 14A) These statements provide information on executive compensation, board structure, and shareholder proposals. For example, Google’s DEF 14A includes details about the salaries, bonuses, and stock options of its top executives.
• Form S-1 (IPO Filing) Companies planning to go public file a Form S-1 that offers detailed information about their finances and business models.

Investment Data Providers

Providers like Bloomberg Terminal, Reuters Eikon, and Tiingo are popular fundamental analysis tools with professional investors who need real-time comprehensive data and have the budget for it.

Tiingo’s stock API serves a similar function for individual and professional investors seeking a comprehensive and affordable financial data source with unique features and offerings. Our API provides access to a wide range of data for financial analysis uses, including stock prices, fundamentals, ETF data, and news. Its API functionality also allows for more tailored data analysis. This is especially useful for users who have specific data needs or who use algorithmic training. And unlike many other investment providers, Tiingo’s cost-effective pricing tiers make it more accessible to individual investors and small firms.

Share Price Ratios

Stock price ratios make it easier to understand if the stock fundamentals align with how a security’s priced. For this fundamental analysis tool, you’ll need access to a high-quality fundamental data API.

Cash flow, share price ratios, and credit ratings are just a few of the fundamental company financial metrics you’ll want to dig deeper into.

It takes time to build an accurate picture of a business, especially when operational leaders and accountants are keen to publish materials that paint them in a positive light. As an analyst or investor, you’ve got to look more closely into real metrics, including market data and historical data. Here’s what to look into:

• Earnings per share (EPS): To calculate this, divide gross operating profit by the number of shares. A higher EPS ratio indicates a profitable business. But does this mean it’s undervalued? Understanding that means checking this against the other key share-based metrics in this list.
• Price-to-earnings ratio (p/e ratio): Use p/e to compare EPS to the share price and get a more complete picture. A higher p/e ratio could indicate the stock is overvalued. A low p/e suggests the market could have undervalued the stock. On the other hand, a low p/e could also mean it’s accurate, and this is an unattractive investment.
• Price/earnings-to-growth (PEG): This metric is only applicable when shares have gone up based on earnings. PEG is p/e divided by the annual earnings growth per share. If PEG is above 1.0, it could mean a share is undervalued. But it’s worth checking against competitors and industry averages.
• Price-to-book ratio (P/B): This compares current pricing to the book value. Any valuation of around 3.0 indicates a market-factored valuation, whereas ratios around 1.0 could mean the stock is undervalued.

Industry Reports

The strength of a sector ⏤ whether it’s growing, contracting, or stagnant ⏤ can directly impact a company’s health. In most cases, this is factored into the share price. However, using fundamental analysis, you can spot what others have missed, such as:

• Is the company diversifying into high-growth sectors?
• How reliant is their business model on their core sector vs. other markets/sectors they operate in?
• What percentage of their revenue comes from domestic vs. overseas markets?

Industry reports are an important fundamental analysis tool for understanding the competitive landscape and external factors affecting a company. Fundamentals trading analysts study industry reports to get an idea of current and upcoming conditions in the sector. Where to Find Industry Reports:

• Market Research Firms like Nielsen, Gartner, and Forrester Research
• Financial Data Services like Tiingo API, Bloomberg, Thomson Reuters etc.
• Government Agencies like the U.S. Bureau of Labor Statistics, U.S. Census Bureau, and the European Commission
• Online Databases and Libraries like JSTOR, Google Scholar, and industry-specific databases

Economic Indicators

Analyzing the economy and its potential impact on the robustness of businesses you’re interested in is also important. You can look at indices, like the Consumer Price Index or Purchasing Managers’ Index. You can also consider metrics like the gross domestic product (GDP) in the countries a company operates in as well as interest rates.

Economic indicators are crucial for Top-Down fundamentals trading, where macroeconomic conditions are a primary concern. Fundamental analysis uses economic indicators to gauge the overall economic environment and its potential impact on investments and markets. Types of Economic Indicators:

Gross Domestic Product (GDP): GDP generally tracks rising and falling corporate earnings growth.
Unemployment Rate: Can predict both consumer spending and overall economic health. Inflation Rate (Consumer Price Index, CPI): Higher inflation typically leads to lower returns on equities.
Interest Rates: Higher interest rates are generally a drag on stock prices and earnings. Retail Sales: A useful indicator for examining and forecasting retail sector health. Manufacturing and Services Indexes (such as PMI): Considered one of the most accurate and timely indicators of upcoming business conditions.
Housing Market Indicators (Housing Starts, Home Sales): One of the most important tools of fundamental analysis for construction and housing market stocks.

Cash Flow and Income Statements

It’s always worth looking into a company’s statement of cash flows, as this fundamental analysis shows the inflow and outflow of money.

Cash flow is an indicator of the overall financial health of a company. There are a number of public ways a business has to demonstrate this, such as operating cash flow (OFC), cash from financing (CFF), and cash from investing (CFI).

Out of those three, operating cash flow is the most important as it shows how much revenue a company is generating from core activities. Ideally, a company should have more coming in from sales than investing or financing.

If that’s not the case, then either they’re in too much debt or their business model means that non-core activities generate more revenue than their main products or services.

Competitive Advantage

When a competitive advantage is easy to see, the market prices that into a stock. However, if this isn’t as clear to other investors, then it’s worth exploring further. So you need to understand:

• Does the company have a competitive advantage?
• Can you see if they are benefiting from this advantage? (For example, are they ahead of competitors but not so far ahead that the market price reflects this?)
• Does the business have a moat, a defensible position? Market leaders are usually in a fairly strong position, but you’re looking for companies with moats (e.g., IPs, patents, innovative products, loyal customers, etc.) that most investors haven’t spotted yet.
• What’s their USP, and does this give them an advantage over competitors?

Leadership Team Track Record

Look into everything you can about a company’s leadership, such as track record, performance, execution of the strategic plan, compensation, targets the board has set, and whether they’ve been buying or selling stock options recently.

A leadership team can make or break a company. For investors, you could be picking an undervalued stock if the market underestimates the C-suite.

How to Set Up Your Tools for Fundamental Analysis

You can set up your fundamental analysis tools in several ways.

Start with the investor relations sections of companies you’re interested in. Equally useful is the Security and Exchange Commission (SEC) Edgar filings database, where you can pull all of the usual reports: 8-K, 10-Q, 10-K, etc. Investors and analysts can find SEC filings on the SEC Edgar Page, which will require extensive joining of data fields and standardization across companies and within companies.

Tiingo already provides standardized, fundamental data that uses a combination of machine/statistical processes and human oversight to create a dataset that you can compare across companies & industries, and within companies.

Beyond public sources, investors and analysts need a reliable, in-depth, high-value source of clean data and financial news.

With high-quality data, analysts and investors can uncover all sorts of nuggets. Take the time to make a holistic assessment of the stocks you’re looking at, from P&L and cash flow to the executive team and how the sector is doing economically.

Different Approaches to Fundamental Analysis

Fundamental analysis of stocks isn’t just about crunching the numbers and churning through spreadsheets.

Go for a deep-dive mix of quantitative and qualitative factors, such as:

• Business model and leadership team.
• Any competitive advantages.
• State of the sector, economy, and impact of interest rates.
• Balance sheets, P&L, and cash flow.

Assuming your analysis shows the markets are underestimating the share price, then you could be onto a winner.

Top-Down vs Bottom-Up Fundamental Analysis
Top-Down analysis begins at the macro level. It looks at national economic data like GDP and unemployment, then hones in on individual companies. Bottom-Up fundamental stock analysis goes in the opposite direction. It starts by looking at a single company’s financial statements and then broadens its approach to looking at industry and national trends.

Top-Down Fundamental Analysis

Top-Down fundamental stock analysis starts with the analysis of macroeconomic factors and works its way down to the industry and individual company level. Top-Down is often preferred in stable or predictable economic climates. The top 10 items you should look into when doing Top-Down fundamental analysis are:

• Overall Economic Growth: GDP growth rates and economic forecasts give you an idea of what the investing future holds.
• Inflation and Consumer Prices: Inflation results in less disposable consumer income and can have a negative effect on a company’s bottom line.
• Interest Rate Trends: Current and projected central bank interest rates will influence a company’s ability to borrow and to refinance debt.
• Employment Data: Unemployment rates and job growth figures indicate future consumer spending.
• Consumer Confidence: Consumer confidence and spending patterns can be indicators of impending economic shifts.
• Sector Performance: Examine the historical and projected performance of relevant market sectors.
• Government Fiscal and Monetary Policies: Tax policies, government spending, and central bank actions.
• Global Trade Dynamics: Be aware of trade agreements, tariffs, and international trade relations.
• Currency Strength: International trade is heavily influenced by exchange rates and the strength of national currencies.
• Technological and Demographic Shifts: Emerging technologies and demographic changes can impact different market sectors.

Applying fundamental analysis is usually a top-down research task to identify securities that other investors aren’t pricing accurately (giving you an advantage). To determine fair market value, fundamental analysts look into:

• The impact of the economy on specific businesses and sectors.
• The sector/industry the company operates in.
• A company’s financial statements, profit and loss (P&L), income, cash flow, etc.

Example

Company: Global WindFarms Ltd., a company specializing in wind energy.
Global Trend: A surge in global initiatives for renewable energy, with governments committing to reduce carbon emissions by 30% over the next decade.
Industry Trend: The wind energy sector is projected to grow by 15% annually.
Company Analysis: Global WindFarms Ltd. has a market share of 20% in the wind energy sector and has recently secured contracts worth $500 million for new wind farm installations.
Stock Price Impact: Given the positive global and industry trends, and Global WindFarms’ significant market share and new contracts, the stock price could see an upward trajectory. If the sector grows as projected, the company’s revenue might increase by 25% in the next year, potentially boosting the stock price from its current $50 to around $65, reflecting the sector’s growth and the company’s strong position.

Bottom-Up Fundamental Analysis

Bottom-Up fundamental analysis of a stock focuses on individual company analysis, rather than on the broader industry or economic trends. Bottom-Up can be effective at identifying strong performers in otherwise weak sectors. The top 10 items to examine in a Bottom-Up analysis are:

• Earnings and Revenue Growth: Assess historical and projected earnings and revenue growth to gauge a company’s financial health and potential for expansion.
• Profitability Ratios: Analyze Return on Equity (ROE), Return on Assets (ROA), and profit margins to understand how effectively the company is generating profits.
• Debt-to-Equity Ratio: Evaluate debt levels relative to equity to understand its financial leverage and risk profile.
• Operating Efficiency: Look at metrics like inventory turnover and operating margin to assess how efficiently the company manages its operations.
• Liquidity Ratios: Examine current and quick ratios to determine the company’s ability to cover short-term liabilities and obligations.
• Management Quality: Evaluate the experience, track record, and effectiveness of the leadership team and board of directors.
• Competitive Advantage: Identify the company’s unique strengths or assets, such as proprietary technology, brand loyalty, or superior distribution networks.
• Market Share and Industry Position: Determine the company’s position within its industry and its market share compared to competitors.
• Business Model and Revenue Streams: Understand core business operations, main sources of revenue, and the sustainability of these revenue streams.
• Valuation Metrics: Use valuation ratios like Price-to-Earnings (P/E), Price-to-Book (P/B), and Price-to-Sales (P/S) to determine if the stock is fairly valued in the market.

Example

Company: FreshOrganic Eateries, a chain of organic restaurants.
Company Performance: Despite a downturn in the restaurant industry, FreshOrganic has shown a 10% year-over-year revenue growth, with current revenues at $200 million. The company has a strong balance sheet with a debt-to-equity ratio of 0.3 and a 20% return on equity.
Competitive Advantage: FreshOrganic’s focus on organic and locally-sourced ingredients has attracted a dedicated customer base. They have a 15% market share in the organic dining sector, which is growing at 5% annually, outpacing the general restaurant industry.
Stock Price Impact: FreshOrganic’s stock, currently priced at $30, could see an increase due to its robust financials and market position, despite the broader industry’s struggles. If the company maintains its growth trajectory, the stock could potentially rise to $40 in the next year, driven by its solid fundamentals and niche market leadership.

Use Clean, Complete Data for Your Fundamental Analysis

Using the fundamental analysis tools and metrics listed above, investors can reach intrinsic value for any security. Making it easier to determine whether a company is undervalued or overvalued.

Every investor and analyst will have their own view on “value,” so this research aims to collect enough data to reach an accurate valuation. One of the best ways to conduct effective fundamental analysis is to have access to the best, most reliable, and cleanest financial data on the market.

Tiingo ticks all of those boxes. It’s an enterprise-grade financial API with generous usage limits, cost-effective access for small to enterprise firms in the financial sector, and support for business customers. With Tiingo, you can access everything from crypto data to the Fundamental Data API specifically designed for fundamental analysis and fundamental investing.

Sign up for Tiingo’s reliable financial markets API to access clean financial data.