Compared to saving money, investing can seem like a treacherous and dangerous endeavour. Make one wrong move and you lose it all, or hesitate and miss out on a profitable asset. It can be super frustrating! But do you know there’s a way to minimise the risks of investing?
Fundamental analysis is a method of evaluating an investment by analysing the underlying factors that can influence its value. It involves assessing an asset’s financial health, performance and potential to determine its intrinsic value. This way, you can know if it’s worthwhile.
Investors use fundamental analysis for long-term assets (like stocks and bonds), and you can use it to supercharge your investments — regardless of your capital size or investment type. In this article, we’ll show you precisely how fundamental analysis works and share how you can start using it today.
How does fundamental analysis work?
Fundamental analysis involves examining the various aspects (or metrics) of a company (say, PiggyVest) or asset (like stocks, bonds and even real estate) to understand how it’ll perform over a certain period.
It’s basically forecasting an investment’s performance using accurate data — such as revenue, earnings, and industry trends — from various sources (we’ll discuss these later in the article) to gain insight into its future performance. The idea is that if you know how an investment vehicle is doing now, you can more or less tell how it’ll perform later.
To illustrate, let’s say you want to invest in a company that sells ice cream in Abule Egba, Lagos.
Instead of just making assumptions and trusting your gut, you can perform a fundamental analysis of the venture by studying industry and economic factors (say, the price of milk and the demand for dairy products in the area) to determine if it’ll be worthwhile.
Fundamental analysis can seem technical (and it is), but you can easily take the guesswork out of investing if you learn how to do it right. In fact, it’s such a core part of modern investing that forex traders and stock investors typically start by learning how it works before diving into more complex topics.
Who uses fundamental analysis and why?
When it comes to the world of finance and investing, fundamental analysis plays a crucial role for various stakeholders — from industry-affiliated analysts to independent investors.
Here are some of the key groups that use fundamental analysis and why:
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- Investors: Fundamental analysis helps investors assess the value of a company or asset and make informed investment decisions. It provides insights into a business’s growth potential and financial health — allowing individuals to determine whether an asset is undervalued or overvalued.
- Financial analysts: Analysts use fundamental analysis to provide recommendations and forecasts on stocks or sectors. They analyse key financial metrics and industry trends to evaluate the potential performance of companies.
- Fund managers: These professionals use fundamental analysis to conduct in-depth research on potential investment opportunities. By scrutinising factors such as a company’s revenue, earnings, and competitive positioning, they can construct portfolios that solve their clients’ problems.
Ultimately, the point of fundamental analysis is to find assets that have the potential to generate long-term returns. By understanding the underlying factors driving an asset’s success, you can make more informed and strategic decisions.
What are the components of fundamental analysis?
There’s so much to track when investing in an asset — from its actual price to the various metrics affecting its current and future worth. The components are the key areas you must consider when doing analysis. These key areas have metrics (factors or fundamentals) that help you paint the picture you need.
The main components of fundamental analysis include:
- Company analysis. This involves a deep dive into an asset’s financial statements, management team, competitive advantages and overall business strategy. Analysts examine metrics like revenue growth, profit margins and return on equity to gauge the asset’s financial health and potential for future success.
- Economic analysis. The broader economic conditions can significantly impact an asset’s performance. Therefore, you must consider factors such as GDP growth, interest rates, inflation and unemployment rates. These macroeconomic indicators help you understand the overall economic climate and its potential influence on your investments.
- External factors. Beyond asset-specific and industry-related factors, external events and trends can also affect investment decisions. This includes geopolitical developments, technological advancements, and social and environmental factors. Metrics like political stability indices, technological adoption rates and sustainability scores offer insights into potential risks and opportunities.
- Industry analysis. Understanding the way the industry in which a company operates is crucial. This includes assessing factors like market size, growth potential, competitive landscape and regulatory environment. Metrics like market share, industry growth rate and barriers to entry provide valuable insights.
- Qualitative factors. While numbers and financial metrics are essential, qualitative factors also play a significant role in fundamental analysis. These include factors such as the quality of a company’s management team, brand reputation and corporate governance practices.
While these five components provide a comprehensive framework for fundamental analysis, there may be even more considerations depending on the exact asset or industry you’re interested in.
What are the types of fundamental analysis?
We’re sure you already have an idea of just how fundamental analysis works. Now, it’s time to explore its types.
The two types of fundamental analysis are:
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- Qualitative analysis. This approach considers non-numerical factors that can influence an investment’s value. It includes a company’s management team, brand reputation, competitive advantage and industry trends. This analysis involves assessing intangible factors that may not be readily quantifiable but can significantly impact a company’s long-term prospects.
- Quantitative analysis. This approach focuses on measurable financial data and metrics. It involves crunching numbers from financial statements, analysing ratios and using statistical models to assess a company’s financial performance and valuation. Factors like earnings per share (EPS) and return on equity (ROE) are hallmarks of quantitative analysis.
You need both types of analysis to understand an asset and make informed decisions.
How to use fundamental analysis in personal investing
You can use fundamental analysis — even if you’re new to investing. It’s an excellent way to perform due diligence and helps you make better decisions when sinking your money into assets and ventures.
Here’s how to use fundamental analysis in personal investing:
- Understand your investment goals and risk tolerance. Determine your objectives and how much risk you are comfortable with.
- Research potential investments. Analyse assets, companies and sectors that align with your investment goals. Focus on options that you expect to perform well in the long term.
- Review financial statements. Examine an asset’s financial statements to assess its financial health and performance. For example, you could peruse a company’s financial records when buying stocks.
- Assess competitive position. Evaluate an asset’s competitive advantage and ability to sustain its position in the market. You can get this information by identifying and researching key players in the industry you want to invest in.
- Consider qualitative factors. Consider industry trends, management expertise and other qualitative factors impacting a company’s performance. Check everything — leave no stone unturned.
- Compare valuation. Assess an asset’s valuation relative to its peers, industry and historical performance. This information is crucial, so don’t be afraid to open a spreadsheet or two!
- Invest (or don’t). The next step is to decide based on the information you’ve gathered. If the asset is solid, go for it. If not, save your money or invest in an alternative vehicle.
- Monitor your investments. Ensure you regularly review and monitor your investments to stay updated on any changes affecting their value.
The 8-step guide we’ve provided above might be a little simplified, but you can use it to get started with fundamental analysis. In fact, we recommend applying it right now!
Log into your PiggyVest app and analyse any of the low-risk opportunities we offer on Investify. See if it’s worth sinking money into (spoiler alert: they all are — and you can earn up to 35% annual returns!) and then invest as soon as possible!
Where can you find fundamentals?
Knowing what to track is great. However, knowing where to find the information you need separates a good investor from a great one.
You can find data for fundamental analysis using any of these sources:
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- Company annual reports. Regulators require companies to publish annual reports that provide a complete picture of their financial performance, strategies and risks. For example, GTCO publishes reports on its website that can help investors looking to buy stocks.
- Financial news websites. Online financial news platforms often update companies’ financial performance, industry trends and expert analysis. An excellent example is Stears — an African data and intelligence company that connects investors with market intelligence.
- Stock exchanges. Stock exchanges maintain databases with companies’ financial statements and other relevant information. You can find all kinds of information on the Nigerian Exchange Group website — from market activities to information about investment vehicles.
- Financial analyst reports. Analyst reports from brokerage firms and research organisations often include extensive analysis and insights into companies and sectors.
- Investment research platforms. Several investment research platforms provide access to comprehensive financial data and analysis tools.
You can also find fundamentals by watching the news, following key figures and accounts on social media, or talking to professionals in the industry you’re investing in.
What are the pros of using fundamental analysis?
Let’s list some ways you could benefit from using fundamental analysis in investing.
Fundamental analysis offers several benefits to investors, including:
- Long-term focus. Fundamental analysis helps investors take a long-term perspective by focusing on the intrinsic value of a company rather than short-term market fluctuations.
- The ability to identify undervalued stocks. By analysing a company’s fundamentals, investors can identify stocks trading below their intrinsic (or actual) value, potentially offering opportunities for capital appreciation.
- The ability to understand risks. Fundamental analysis helps investors assess the associated risks, such as a company’s debt levels, competitive threats or regulatory challenges.
- Valuation guidance. By evaluating a company’s financial metrics and industry trends, fundamental analysis guides a stock’s fair value (an unbiased estimate) — allowing investors to make more informed buy or sell decisions.
What about the cons?
What are the limitations of fundamental analysis?
While powerful, fundamental analysis does have some limitations. We’ll highlight some of them in this section so you know what to look for.
Here are some of the limitations of fundamental analysis:
- It requires subjectivity. Fundamental analysis involves making subjective judgments based on various metrics and assumptions, which can introduce bias or errors.
- It doesn’t always account for external factors. Fundamental analysis may not fully account for external factors such as market sentiment, economic conditions or unforeseen events — which can impact a stock’s performance.
- It can be time-intensive. Conducting thorough fundamental analysis requires time and effort to gather data, analyse financial statements and stay updated on industry trends.
- Information availability can be a problem. Not all companies provide detailed financial information, making conducting a comprehensive fundamental analysis challenging.
These limitations imply that fundamental analysis is not a “fix-all tool” in investing. It’s just a convenient way to do due diligence before putting your money down.
Conclusion
Fundamental analysis is an essential tool for investors seeking to make informed investment decisions. By evaluating an asset’s financial health, performance and growth prospects, you can identify potential opportunities or risks.
But while fundamental analysis has its limitations, it remains a valuable approach if you’re looking to build a long-term investment portfolio.
