Investments are a great way to save up for your future. Not only that, but it also ensures that the money that you currently have does not lose value over time due to inflation. But before you invest your money into anything, you need to be sure that it will make your investment worthwhile.
And that is why investment analysis is necessary to avoid making any blunders that you will regret. One of the best ways to calculate if an asset is a good investment is through fundamental analysis.
In this article, we will be discussing fundamental analysis and what pros and cons it offers. Let’s have a brief understanding of what FA is?
What Is Fundamental Analysis?
Fundamental analysis helps find the intrinsic value of an asset or a security. It includes methods through which they examine micro and macroeconomic factors.
Macro factors include the economic conditions and industry trends, whereas micro factors are the company’s financials. As a result, analysts achieve a number which the investors can use to compare the current value of the assets or securities.
If the number is over the current value, it will soon lose worth due to overvaluation. However, if the number is below the current value, it will go up due to undervaluation. This method of analysis is different from technical analysis.
Difference between Technical Analysis and Fundamental Analysis
The two methods of analysis are in complete contrast with each other. The fundamental analysis finds the worth of the company through analyzing factors such as economic conditions and the company’s financial background.
On the other hand, technical analysis relies on predicting the prices of a security or asset through examining its historical market data. They study the charts and previous trends to calculate whether the value of a particular commodity would go up or down.
Breaking down Fundamental Analysis
The fundamental analysis revolves around three main components, which include industry, economy, and company analysis.
For economic analysis, you examine the current state of the economic conditions. If the economy is in the boom phase, it will positively impact the value of a certain asset, security, or commodity. If it is the vice versa, then it won’t be performing well in the future.
Apart from that, the other factor is the industry. If the industry is in decline, there is a huge chance that the value will go down. For instance, the paper industry is declining due to the widespread use of electronic systems in businesses.
In addition to that, the company’s performance is a factor that you also need to consider. By comparing their current financial with the previous years, you will have an idea about their performance.
If there is an upward trend in their profitability and liquidity, the value would likely increase and vice versa.
In addition to these, you can also check the following things that get a broader perspective about a company:
- Leadership:Take a closer look at the company’s top leadership and the skills and capabilities. See the company’s progress in the recent years under their management.
- Competition:Look at the financials of the big players and other firms in the market. Compare their performance with the company you are looking to invest in.
Advantages and Disadvantages of Using Fundamental Analysis for Investments
Like other investing methods, the fundamental analysis also has some pros and cons.
The Advantages of Fundamental Analysis
The biggest advantage of fundamental financing is that it can help you evaluate the correct worth of an asset in the future. It is ideal for someone looking to invest in the long run. Instead of trading on it based on trends, you will be backing your investment by comprehensive analysis.
Therefore, it will yield good results for you in the future. It will help you make decisions that have the backing of financial data rather than just a personal opinion or volatile trends.
Moreover, you better understand the complexities and technicalities that can impact the value over time. As a result, you can determine whether you should be making an investment in that asset or not.
Furthermore, it is also helpful in preventing you from herding behaviour. Herding behaviour is when investors start panic selling or panic buying of a particular stock, commodity, or asset. Since you did your research by following the principles, you won’t have to worry much about it.
The Disadvantages of Fundamental Analysis
While fundamental analysis is a blessing for long-term investors, it is not that amusing for short-term investors. With fundamental analysis, you can get results in the long run. And that is why daily traders of securities or commodities don’t find benefit in it.
Investors trading daily will be better off with technical analysis. It can help them understand the day-to-day trends through which they can make quick investment decisions.
Also, unforeseen circumstances can complicate things for investors using fundamental analysis. Since they don’t take into account any sudden changes, it can disrupt their planning. Any negative political or economic change can cause a massive change in the value.
One of the examples of such change is the Covid-19 pandemic. It led to huge disruption throughout the world and had a significant impact on the investments of people.
Finding the right investment strategy is imperative to ensure it is fruitful in the future. And the best way to do that is through financial analysis. By simply looking at a few factors such as the economy, industry trends, and company ratios, you can make a wise decision.
Warren Buffet is a perfect example whose firm uses fundamental analysis to make investments. His quotes about value emphasize the need for fundamental analysis when it comes to investment.
You can use either one of the two approaches, which are the bottom-up approach or the top-up approach. In a macro approach, you consider the economic and global factors and then make your way down to the company’s finances. On the other hand, the micro-level is when you focus on the company’s finances first and then go up to the global and economic conditions.