Fundamental Analysis

You know you are wading into stock market deep waters when you wish to know what fundamental analysis means. Perhaps your goal in life is to become a hotshot stock analyst, or maybe you just want a basic understanding of securities. In the simplest terms, fundamental analysis is the study of factors that affect a company's earnings.

In addition to company financials as contained within the annual report, an additional resource for the investor is the share appraisal form. This form serves as indicator of the company's health and provides a method to help you in decision making.

Points in Summary

• When buying shares, you invest capital and you become part owner of a company. Evaluating the company beforehand thus becomes necessary. Fundamental analysis is the study of factors that affect a company's profits.

Earnings Per Share

Earnings per share (EPS) is a part of the company profit allocated to each outstanding share and indicates a company's profitability. The EPS value is used to calculate price to earnings ratio. The formula for EPS is net profit after tax (NPAT) divided by number of shares on issue, with the results expressed as cents per share.

EPS (cents per share) = Net profit after tax ÷ Number of shares on issue.

Analyst reports are created by professionals who interpret annual reports. Analysts use annual report data to create forecast and calculate financial ratios. Financial ratios are used to compare a company's performance for a specific period to its previous results, competitor results and market averages.

Although there are disadvantages to using ratio analysis (imperfect data or too much data), reviewing analyst reports will add objectivity to your interpretation. An objective approach avoids knee jerk reactions and takes out the emotion from the equation.

Per Share Data

So where do you get all the data to analyse a company? You look at financial statements. Financial statements are documents containing an incredible amount of information about a company's activities. The sheer volume of data in these reports can be confusing at first, but like all things, practice makes reading them easier.

Calculations can put off the beginner trader or stock market student. It's good to remember that calculations are a way to distill raw market data into a manageable value. Think of numbers as a way to simplify rather than complicate things. In case you get scared off by balance sheet analysis, you can always employ the services of a stockbroker or a professional analyst. Before crunching numbers, list the facts you are trying to learn.

• Growth. Is growth from mergers and acquisitions or is it organic?

Fundamental analysis introduces the concept of intrinsic value. Intrinsic value is the "real" value of a security. This implies that market prices are not true reflections of a stock's worth. This is where fundamental analysis comes in. For example, Trader X is following stock ABC, which is trading at $25. After doing his analysis however, he finds that stock ABC has an estimated value of $30, its 'intrinsic' value.

Many investors in the stock market have come to hear of the term 'yield curve'. This term actually is used to denote the relationship between the cost of borrowing or the interest rate and the time or term of maturity of a certain debt instrument in a particular currency.

Traders in the different markets closely watches the US dollar interest rates paid on US Treasury securities in varying maturities by plotting them on a graph known as the yield curve. Any movements in rates and maturities of US Treasury securities as plotted by the yield curve will impact on stock markets worldwide.

Stock trading beginners often wonder if they should be using technical analysis or fundamental analysis. The first question you should be asking is whether you are going to be an investor or a trader of stocks. There is a fine line between an investor and a trader.

Fundamental analysis is a method of forecasting the future price movements of a financial instrument based on economic, political, environmental and other relevant factors and statistics that will affect the basic supply and demand of whatever underlies the financial instrument. In practice, many market players use technical analysis in conjunction with fundamental analysis to determine their trading strategy. Fundamental analysis focuses on what ought to happen in a market. Factors involved in price analysis: Supply and demand, seasonal cycles, weather and government policy.