The usage of fundamental analysis in stock trading is a point of debate among many investors and traders. Some question the efficiency of its usage, as well as its effectiveness.
However, there is no denying that many successful investors and stock traders achieved their success in part by the use fundamental analysis.
What is Fundamental Trading?
The fundamental way of valuing a company is gotten by the usage of an in-depth study of the economy, the industry, and the company itself.
The goal of the trader in using this strategy is to know the next developments in the market as well as the company’s stock’s intrinsic or true value.
For the trader, the trick is to find which stocks are under- or overvalued. With a successful analysis, the trader will find investment opportunities that have not yet been recognized by the market as a whole. This uncovering can then help the trader to make an investment that reaps profits.
The trader can study the current economic environment at which the company operates. This operation includes analyzing local and international events that can affect the business and the company’s stock price.
It would help the trader to study:
- Any regional conflicts
- Macroeconomic factors that could affect the company’s pricing structure
- Interest rates
- Industry outlook
- Disruptive events or factors that could adversely impact the niche of the company
After studying the larger economy in which the company operates, the next step is to turn the focus into the company itself.
The trader needs to have a clear understanding of the company’s business model, which is also the way the company makes money.
To do this, the trader needs to review the company’s financial statements. He or she also has to examine the cash flow statements, income statements, and balance sheets of the company.
In this process, the primary goal is to find clear signs of growth. At the same time, it’s wise to look for signs that the company’s management is effective.
Lastly, the trader needs to find the company’s competitive advantage, if any, and see whether it could propel the company into profitability and stock price appreciation.
Another very crucial step in fundamental trading is the analysis of the company’s competitor. In doing this, the trader needs to analyze competing businesses in the way that he or she analyzed the company in which he or she plans to invest.
The trader needs to compare his or her findings for both the target company and its competitors. Afterward, he or she will rank all of the potential investments he or she could make.
In this process, the trader gains a lot of advantages. He or she will be able to see if the company is a better investment than the others, or if the opposite is true.
Sometimes, the competitors are winning the game for good reasons. Or maybe, the underdog has a great potential to become the champion in a couple of months or years.
Lastly, the trader may even find out that none of these companies are worth investing in, so he or she can move on to the next opportunity.