Introduction to Fundamental Analysis: Definition, Components, Macroeconomic Indicators
Earlier in the article devoted to trading strategies, we partially mentioned fundamental analysis. However, this topic requires a more detailed study, so we decided to take a deeper look at it. The first part will focus on the definition of fundamental analysis, components, methods, and macroeconomic indicators. In the second we will study industry attractiveness and the multipliers.
There are two types of analysis used in investing and trading – fundamental and technical. The first type allows you to assess the real value of an asset and its capabilities and prospects, while the second one studies the price change. In trading, a price change is necessary to determine the entry and exit points.
Fundamental analysis definition:
Fundamental analysis makes it possible to understand how attractive the acquisition of the shares is and what their growth prospects are. All investment processes originate from analytics. The decision to buy or sell a stock is based on various economic indicators. It can be inflation, the situation on the world market, changes in GDP, etc. There is always a definite correlation between all these indicators. Fundamental analysis allows you to notice this correlation, study it and make an optimal choice.
Fundamental analysis involves studying the accounting and financial statements of companies in order to determine the real value of assets. So the influence of the economy and the political situation in the country and in the world, the position of the company and the actions of competitors are taken into account. Fundamental analysis requires constant control of the market, since any news can have an enormous impact on the market. Therefore players speculating in the market exit the deal in order not to lose much during the publication of important news due to the trading turbulence.
Fundamental analysis components:
Fundamental analysis flows from Graham and Dodd’s book “Security analysis”. It proposes fundamental analysis components. It consists of macroeconomic analytics, then industry (sectoral) analytics, the study of the issuing company and the valuation of the securities. Graham was a successful investor. Warren Buffett is also a famous example of the use of fundamental analysis.
Fundamental analysis methods:
Let’s move on to the methods of fundamental analysis. The following classical methods of analysis are most often used in fundamental analysis:
- comparison of the object of study with other objects;
- correlation is used to study the dependence of objects, that means to measure how changes of one object affect the changes of another;
- deduction and induction imply a transition from the general to the particular (characteristics of the industry as a whole and a particular company) or from the particular to the general (studying of previous data of the company’s activities and their impact on economic indicators);
- seasonality involves the influence of cycles of production, social or weather processes on the formation of prices;
- generalization and grouping mean the division of the issuer’s indicators into groups according to certain characteristics. Such a study should be carried out on the basis of the company’s balance sheet.
Step № 1: Macroeconomic indicators
The fundamental analysis begins with the research of trends in the global economy as a whole. Then you move on to the research of the economy of countries and industries. Macroeconomic indicators include GDP growth, the inflation rate and the Central Bank rate.
Stable GDP growth signals that the country’s economy is developing, and the national currency is getting stronger. Such a signal is important since due to the depreciation of the currency, part of the profit from assets in this currency can be “eaten up”. If GDP grows, it means that funds are being poured into the stock market and in this case there are more chances to earn money on it.
The Central Bank’s rates represent the cost of money, the availability of loans and consumer demand. When interest rates are low, the value of shares increases since enterprises can get cheap loans and direct these funds to production. In addition, if domestic demand grows, the products of enterprises are bought more actively.
The unemployment rate significantly affects consumer demand, as well as the efficiency of enterprises.
Also oil prices, gold and foreign exchange reserves and the level of the money supply are additionally studied. It’s also important to pay attention to the current policy of the government and the Central Bank.
Thus, fundamental analysis is based on the research of macroeconomic indicators, industries, company’s position and on the analysis of securities. In the article, we have considered the first stage of the analysis. In the near future, MonInvAI plans to add indicators of fundamental analysis for more accurate forecasts.
