A Process to Conduct Fundamental Analysis

Fundamental analysis is a stock valuation process under which the investor examines company financials and operations. Under this process, the investor will pay particular attention to the company’s sales and, earnings (as well as growth potential), the company’s assets and liabilities, its management team, product line and competitors. Unlike technical investors, the fundamental investor will only consider those data points that are directly related to the company.

Every fundamental investor may operate in a different way with the goal of making an investment decision based on company fundamentals. A fundamental analyst will determine the intrinsic value of a stock for comparison against the current share price. When the market share price is below the determined intrinsic value, that stock is considered to be “undervalued”.

The steps to conduct the fundamental analysis process may include:

Screen for stock candidates: To find a list of like candidates for investment, the fundamental investor might start with a stock screener to filter for those stocks that meet a minimum set of criteria, which may include a low PEG ratio, low debt, high profit margins, and high growth expectations.

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Review the Company’s Business: As a next step, the investor may take a hard look at the company’s business to identify its competitive advantages and opportunities for growth, the outlook for the industry as a whole, the strength of its management team and any insider transactions. The fundamental investor will also take a more detailed look at the company balance sheet to verify its strength through the various balance sheet ratios.

Calculate the Stock Intrinsic Value: If the company holds up under the scrutiny, it may be worth the effort to arrive at the real or “intrinsic” value of the stock. There are a number approaches for this, including discounted cash flow, running the Benjamin Graham formula or, if it is a large, well-established company, the dividend discount model.

Determine the Margin of Safety: When the intrinsic value is assigned, the investor can compare that price to the current share price- the gap is known as the margin of safety. Conservative investors often look for a margin of safety of 40% or greater. All things being equal, the larger the margin of safety the better.

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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