Fundamental analysis is a process of mapping a security’s inner value by analysing the economic and financial factors, that are related to the security. The main reason behind performing fundamental analysis is that the investor assumes that markets may wrongly price an asset in the short-term. Still, in the long-term, the fair price will be eventually reached, meaning that investor can profit from temporarily undervalued or overvalued assets.
As fundamental analysis can be considered analysing anything, that can influence the security’s value in the future, from various microeconomic indicators to macroeconomic factors such as industry conditions, political system or GDP growth rates. Alongside technical analysis, it is one of the two primary forms of market analysis. The process of fundamental analysis is performed on historical and present data, and the primary goal of fundamental analysis is to make a particular forecast of either current inner value or future value of a security.
The process of fundamental analysis can be done in two different ways. Either top-down or bottom-up. The top-down analysis considers a more extensive view of the economy. Beginning with the whole market, the top-down analysis continues to narrow down into a sector, industry and finally, a specific asset. On the other hand, the bottom-up analysis starts with a particular asset and continuously broadens out to examine all the factors that affect its price. Fundamental analysis can be applied to various types of market instruments, but it is mostly used to analyse stocks prices.
The key to stock’s fundamental analysis and finding its inner value is to analyse the company’s financial statement. The most crucial statements are the company’s Balance sheet and the income statement. The balance sheet provides a summary of the company’s assets, liabilities and equity at a particular moment. On the opposite, the income statement provides an overview of the company’s performance over a particular period. From the obtained data, an investor can calculate various financial indicators such as earnings per share, P/E ratio, P/B ratio and many others.