Fundamental Analysis involves looking into a company’s financial statements, financial health, management, competitors, associated markets and competitive advantages. The goal of fundamental analysis is to evaluate a stock and predict its future direction. There are 3 main analyses that need to be performed to complete the fundamental analysis process.
Economic analysis: This involves looking at the economy as a whole and predicting its future direction.
Industry analysis: Due to certain events in the economy, there may be growth or contraction in a particular industry.
Company analysis: Using various financial ratios such as the P/E ratio, the financial stability of companies is examined and graded.
This particular flow is called top-down as it examines the large-scale economy first and then down to the specifics. The opposite approach is known as bottom-up, which involves the investor choosing a specific company before considering outside factors.
With fundamental analysis, there are only a few things that investors actually want to derive.
What is the intrinsic value of a stock?
How long will it take for the stock to reach its intrinsic value?
Intrinsic value refers to what a stock is actually worth, not what it is currently trading at. In today’s market, the difference between intrinsic value and trading value has gotten much smaller, especially for companies listed on major exchanges such as the NASDAQ.
From examining the elements of fundamental analysis, penny stock investors should be able to determine a stock’s intrinsic value as it compares to its trading value. Investors should buy if the intrinsic value is greater than the trading value, and sell if the intrinsic value is less than the trading value.