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Technical Vs. Fundamental Analysis: Choosing Effective Strategies In Taiwan – Fundamental analysis (FA) measures the intrinsic value of a security by examining relevant economic and financial factors. Intrinsic value is the value of an investment based on the financial condition of the issuing company and current market and economic conditions.
Fundamental analysts study everything that can affect the value of a security, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors such as the effectiveness of company management.
Technical Vs. Fundamental Analysis: Choosing Effective Strategies In Taiwan
The ultimate goal is to determine a number that an investor can compare to the security’s current price to see if the security is valued or overvalued by other investors.
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Fundamental analysis is typically done from a macro to micro perspective to identify securities that are not being priced correctly by the market.
Fundamental analysis uses publicly available financial data to estimate the value of an investment. Data is recorded on financial statements such as quarterly and annual reports and documents such as 10-Q (quarterly) or 10-K (annual). The 8-K is also informative because public companies must file it any time a reportable event occurs, such as an acquisition or a change in top management.
Public and many private companies list their annual reports on the investor relations sections of their websites, highlighting financial decisions made and results achieved throughout the year.
For example, you can perform a fundamental analysis of a bond’s value by taking into account economic factors such as interest rates and the general state of the economy. Then, you would evaluate the bond market and use the financial data of similar bond issuers. Finally, you will analyze financial data from the issuing company, including external factors such as potential changes in its credit rating. You can also read the 8-K, 10-Q, 10-K and annual reports of the issuer to find out what they do, their goals or other issues.
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Fundamental analysis uses a company’s revenues, profits, future growth, return on equity, profit margin, and other data to determine a company’s underlying value and future growth potential.
One of the key assumptions behind fundamental analysis is that the current stock price often does not fully reflect the company’s value compared to publicly available financial data. The second assumption is that the value reflected from the company’s fundamental data will be closer to the true value of the stock.
Intrinsic value means something different in stock valuation than in options trading. An option price uses a standard calculation for intrinsic value, while it can be calculated in different ways for a stock.
For example, say a company’s stock was trading at $20, and after extensive research on the company, an analyst determines that it should be worth $24. Another analyst does equal research but decides it should be $26.
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Many investors consider the average of these estimates and suggest that the intrinsic value of the stock could be as high as $25. Often investors find these valuations highly relevant because they want to buy stocks that trade at prices significantly below these intrinsic values.
This leads to the third basic assumption of fundamental analysis: over the long term, the stock market reflects fundamentals. The problem is that no one knows how long the “long run” is. It could be days or years.
This is what fundamental analysis is all about. By focusing on a particular business, an investor can assess a firm’s intrinsic value and find opportunities to buy at a discount or sell at a premium. The investment will pay off when the market reaches the fundamentals.
Fundamental analysis is most often used for stocks, but it is useful for evaluating any security, from bonds to derivatives. If you consider the fundamentals, from the broader economy to the details of the company, you are doing fundamental analysis.
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This method of analysis stands in stark contrast to technical analysis, which attempts to predict price direction by analyzing historical market data such as price and volume. Technical analysis uses price trends and price action to create indicators. Some indicators create patterns that have similar names to their shapes, such as the head and shoulders pattern. Others use trend lines, support and resistance lines to demonstrate how traders view investments and indicate what will happen next. Some examples are symmetrical triangles or wedges.
Fundamental analysis relies on financial information reported by the company whose stock is being analyzed. Ratios and metrics are created using data that indicate how a company is performing compared to similar companies.
The problem with defining the basics of the word is that it can cover everything related to the economic well-being of the company. They include numbers like revenue and profit, but they can also include everything from a company’s market share to the quality of its management.
The various fundamental factors can be divided into two categories: quantitative and qualitative. The financial meaning of these terms does not differ much from the well-known definitions:
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In this context, quantitative bases are complex numbers. They are measurable characteristics of a business. Therefore, the largest source of quantitative data is financial statements. Income, profit, assets and more can be accurately estimated.
Qualitative foundations are less tangible. They may include the quality of the company’s key executives, brand name recognition, patents, and proprietary technology.
There are four basic fundamentals that analysts always consider when reviewing a company. All are qualitative, not quantitative. They contain:
What exactly does the company do? It’s not as straightforward as it seems. If a company’s business model is based on selling fast food chicken, does it make its money that way? Or is it just the cost of royalties and franchise fees?
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A company’s long-term success is primarily determined by its ability to maintain a competitive advantage and maintain it. Strong competitive advantages, such as Coca-Cola’s brand name and Microsoft’s dominance of the personal computer operating system, create a moat around the business that allows it to keep up with competitors and enjoy growth and profits. When a company can achieve a competitive advantage, its shareholders can be rewarded for decades.
Some consider management to be the most important criterion for investing in a company. It makes sense: even the best business model is doomed if the company’s leaders fail to execute the plan properly. While it’s difficult for retail investors to meet managers and truly evaluate them, you can browse the corporate website and check the resumes of top brass and board members. How well did they perform in their previous jobs? Have they been unloading much of their stock lately?
Corporate governance describes the policies within an organization that outline the relationships and responsibilities between management, directors and stakeholders. This policy is defined and defined in the company’s articles of association, its bylaws and corporate laws and regulations. You want to do business with a company that is run ethically, fairly, transparently and efficiently. Pay particular attention to whether management respects shareholder rights and shareholder interests. Make sure their communication with shareholders is transparent, clear and understandable. If you don’t get it, it’s probably because they don’t want to.
It’s also important to consider the company’s industry: its customer base, market share among firms, industry-wide growth, competition, regulation, and business cycles. Knowing how the industry works will give an investor a deeper understanding of a company’s financial health.
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Financial statements are the means by which a company publishes information about its financial performance. Followers of fundamental analysis use quantitative information from financial statements to make investment decisions. The three most important financial statements are the income statement, the balance sheet, and the cash flow statement.
A balance sheet is a record of a company’s assets, liabilities, and equity at a specific point in time. It’s called a balance sheet because the three sections—assets, liabilities, and stockholders’ equity—must be balanced using the formula:
Assets are resources that a business owns or controls at a given time. This includes things like cash, inventory, vehicles, and buildings. The other side of the equation represents the total financing cost that the company used to acquire these assets.
Financing comes as a result of liabilities or equity. Liabilities are debts or obligations that must be paid. In contrast, equity represents the total value of money that the owners put into the business—including retained earnings, which is the profit left over after paying all current liabilities, dividends, and taxes.
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While the balance sheet takes a snapshot approach to studying a business, the income statement measures a company’s performance over a specific period of time. Technically, you might have a balance sheet for a month or even a day, but you’ll only see the public company report quarterly and annually.
A cash flow statement is a record of a business’ cash inflows and outflows over a period of time. Typically, the cash flow statement focuses on the following cash-related activities:
The statement of cash flows is important because it is difficult for a business to manipulate its cash position. There’s a lot aggressive accountants can do to manipulate earnings, but it’s hard to fake cash in the bank. For this reason, some investors use the cash flow statement as a more conservative measure of a company’s performance.
Fundamental analysis relies on the use of financial ratios derived from corporate financial statement data to draw conclusions.
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