3. Fundamental Analysis

Edit 0 29 …

Fundamental Analysis

Fundamental analysis involves in-depth research into a company's prospects. Determining how fast a company can grow is a critical aspect of trying to calculate future stock prices. After you find a company and understand its fundamentals, you need to examine it's Valuation and Technical Analysis too.

Economic Analysis

The most important factor in determining a company's growth is the overall US economy. The economy goes through periods of prosperity ("good" growth) and more challenging periods ("low" growth). If the economy shrinks (has negative growth), then it is known as a recession. This is painful for both consumers and businesses. Consumers make less money because they may not get an annual increase or their bonuses may be smaller. In some cases, people lose their jobs (called layoffs) and their salary is zero. Businesses also suffer because consumers have less money and spend less money. This causes businesses to be more cautious. They delay building new factories or introducing new products. Most large companies sell their products outside of the United States. It is important to understand the growth other countries too. Below is a straight-forward description of an economic cycle from Investopedia. There are four basic stages of the economic cycle, and each phase of the cycle can last from a few months to a few years. Click here for a list of all economic cycles and dates.

  • Full Recession - Not a good time for businesses or the unemployed. GDP has been retracting, quarter-over-quarter, interest rates are falling, consumer expectations have bottomed and the yield curve is normal. Sectors that have historically profited most in this stage include:
    • Cyclicals and transports (near the beginning).
    • Technology.
    • Industrials (near the end).
  • Early Recovery -Finally, things are starting to pick up. Consumer expectationsare rising, industrial production is growing, interest rates have bottomed and the yield curve is beginning to get steeper. Historically successful sectors at this stage include:
    • Industrials (near the beginning).
    • Basic materials industry.
    • Energy (near the end).

  • Late Recovery -In this stage, interest rates can be rising rapidly, with a flattening yield curve.Consumer expectations are beginning to decline, and industrial production is flat. Here are the historically profitable sectors in this stage:
    • Energy (near the beginning).
    • Staples.
    • Services (near the end).
  • Early Recession -This is where things start to go bad for the overall economy. Consumer expectations are at their worst; industrial production is falling; interest rates are at their highest; and the yield curve is flat or even inverted.Historically, the following sectors have found favor during these rough times:
    • Services (near the beginning).
    • Utilities.
    • Cyclicals and transports (near the end).

Industry Analysis

The second most important factor in determining a company's grow is it's industry. An industry is a group of companies (called suppliers and competitors) that provide products or services to consumers or businesses. Examples of industries are fast food restaurants, automobile manufacturers, computer manufacturers, airlines, and so on. Suppliers provide components to other companies. For example, companies that manufacture PCs make very few of their own parts. It is cheaper and more efficient to get parts from their suppliers. Competitors are generally bad, because they help keep prices low. Low prices are good for customers, but not always good for the producers.

Industries progress through different phases of their life, similar to people. New industries are born when companies launch new products that are needed. An example is automobiles in the early 1930's and personal computers in the early 1980's. These products did not exist prior to their invention. The beginning phase of a new industry is known as "hyper growth". This is where a company has limited competition and can sell as much of their product as they can produce. It is no uncommon to for annual revenue growth rates to approach 100%. This means that the company doubles in size every year. Examples include Internet companies like Google. Over time, the "hyper growth" phase slows down to a more a "stable growth" phase. Customers buy less of the product and competitors have a negative impact on pricing. The industry still shows good growth (10-30%), but it is no longer growing as it did during the "hyper growth" phase. Examples of "stable growth" include pharmaceutical companies and some segments of The "stable growth" phase slows eventually slows down until the industry grows only as fast as the overall economy (called "mature growth"). "Mature growth" rates range between 1% to 4%. The majority of industries are "mature growth", such as restaurants and retailers. The exception is when they introduce a new product or popular product. Their growth can accelerate to "stable growth" levels, but it will eventually fall back to "mature growth" levels. Some industries sell products that are no longer needed, or are replaced with products from newer industries. These industries have "declining growth" because they are shrinking (known as negative growth). Negative growth means they sell less products every year. This means that they need to cut expenses (such as employee layoffs) every year to stay in business. Phones manufacturers are an example of an industry with "declining growth". Almost nobody buys an "old-fashion" phone with a cord. Instead, customers prefer to buy cordless phones or use their cell phone. CD manufacturers have "declining growth" as customers prefer to buy digital downloads of music. See this website for more details on industry lifecycles.

Company Analysis

Companies grow is related to growth in their overall industry, but not all companies grow at the same rate. Successful companies grow faster than the overall industry. They usually have a lower-priced product, a better product, or better customer service. These companies are taking market share from their competitors. Companies that grow slower than their competitors are losing market share. See this link for examples of brief company reports. Below are more in depth reports from sell-side analysts:


Financial Statement Analysis

Industry and company research provide important information about a company's future prospects. It is equally important to be able to analyze a company's financial statements. Financial statements are like a report card. We are not going to cover this type of analysis in Money Matters, but it is very important.

Information Sources


Financial Information Sources


Earnings Call Transcripts