investing

What Are Stock Fundamentals?

Stock fundamentals are key metrics for a company, such as cash flow and return on assets (ROA). Analysts often perform fundamental analysis to analyze a stock by looking at its fundamentals. This involves looking at any data which is expected to impact the price or perceived value of a stock.

Key Takeaways

• Fundamental analysis involves looking at any data which is expected to impact the price or perceived value of a stock.
• Some of the fundamentals of stocks include cash flow, return on assets, and conservative gearing.
• Performing fundamental analysis can be challenging because it requires digging through financial statements to know when the stock price is wrong.

How Stock Fundamentals Work

In the broadest terms, fundamental analysis involves looking at any data which is expected to impact the price or perceived value of a stock. This is, of course, anything aside from the trading patterns of the stock itself, As the name implies, it means getting down to basics.

Fundamental analysis focuses on creating a portrait of a company, identifying the fundamental value of its shares, and buying or selling the stock based on that information. Some of the indicators commonly used to assess company fundamentals include:1

• Cash flow
• Return on assets
• Conservative gearing
• History of profit retention for funding future growth
• The soundness of capital management for the maximization of shareholder earnings and returns

Fundamental analysts have a staid approach to analyzing stock performance. They look at a variety of factors that they believe influence a stock’s performance. These include the industry as a whole, the competition, a company’s management structure, its income and revenue, as well as its growth potential.

Example of Stock Fundamentals

All of the data is public and readily available, generally through a company’s financial statements. The goal is to ultimately identify which stocks are priced correctly—and incorrectly—by the market.

To help you visualize it, let’s use the following analogy. Think of the stock market as a shopping mall, where stocks are the items for sale in the retail outlets. Their sights are set solely on the products in the mall. Shoppers are dismissed as an unreliable, emotional herd with no inkling of the real value of the goods for sale.

Fundamental analysts move slowly through the stores seeking the best deals. Once the crowd moves on from, say, the personal computers (PCs), they will take a closer look at the ones that were passed over.

Fundamental analysts may take a stab at determining the scrap value of the PC stripped down to its hard disk, memory cards, monitor, and keyboard. In the stock market, this is akin to calculating the book value, or liquidation price, of a company.

These analysts also take a very close look at the quality of the PC. Is it going to last or will it break down within a year? The fundamental analysts will pore over the specifications, scrutinize the manufacturer’s warranty, and consult consumer reports. Similarly, equity analysts check a company’s balance sheet for financial stability.

Then, the fundamental analysts may try to understand the performance of the PC in terms of, say, processing power, memory, or image resolution. These are like the forecast earnings and dividends identified from a company’s income statement.

Finally, the fundamental analysts will put together all the data and come up with the intrinsic value, or value independent of the current sale price. If the sale price is less than the calculated intrinsic value, the fundamentalists will buy PCs. If not, they will either sell the PCs they already own or wait for prices to fall before buying more.