Foundations of Fundamental Analysis
Fundamental analysis is the examination of the underlying forces that affect the well being of the economy, industry groups, and companies. As with most analysis, the goal is to derive a forecast and interpret a probable profit from future price movements. At the company level, fundamental analysis may involve examination of financial data, management, business concept and competition. At the industry level, there might be an examination of supply and demand forces for the products offered. For the national economy, fundamental analysis might focus on economic data to assess the present and future growth of the economy. To forecast future stock prices, fundamental analysis combines economic, industry, and company analysis to derive a stock's current fair value and forecast future value. If fair value is not equal to the current stock price, fundamental analysts believe that the stock is either over or under valued and the market price will ultimately gravitate towards fair value.
Fundamental Analysis – One problem with pure fundamentals is that stocks can fall a long way before problems show up in profits, sales or balance sheets – because of time lags between reporting or even manipulation.
Benjamin Graham is widely regarded as the father of fundamental analysis. Shortly before his death in 1976 he stated that fundamental analysis could no longer be counted on to produce superior investment returns:
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"I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities· This was a rewarding activity, say, 40 years ago· but the situation has changed" |
Edwards and Magee, authors of the classic book Technical Analysis of Stock Trends, suggest that we need not concern ourselves with the infinite number of factors that can affect a market, by stating:
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"Of course the statistics, which the fundamentalists study, play a part in the supply-demand equation - that is freely admitted. But there are many other factors affecting it. The market price reflects not only the differing value opinions of many orthodox security appraisers but also all the hopes and fears and guesses and moods, rational and irrational, of hundreds of potential buyers and sellers, as well as their needs and their resources - in total, factors which defy analysis and for which no statistics are obtainable, but which are nevertheless all synthesized, weighed and finally expressed in the one precise figure at which a buyer and a seller get together and make a deal" |
A chart will show a clear change in trend. At the most basic level, a trend line changes from going up to going down.
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