Fundamental Analysis: How To Use It, Examples, and Tools

fundamental analysis

Before you make a trade, you’ve got to build a case for why it’s a good idea — and fundamental analysis should be part of that process.

Fundamental analysis is one of the two key types of stock analysis. The other? Technical analysis.

I base most trades more on technical analysis. I look at historical price action on the stock’s chart to try to determine how the stock might move in the future.

But here’s the thing: One doesn’t work without the other.

To back up your trading thesis based on the price action, you need to do some fundamental analysis, too. You evaluate its financial health and any business developments or news related to the company that could affect the stock price.

By digging into the company’s fundamentals, you can gain access to information that works alongside your technical analysis. That can give you a broader view of the stock’s potential and help you make better trading decisions.

So … what’s the process of fundamental analysis, what sorts of tools should you be using, and how can you use it to choose stocks to trade? We’ll cover it all in this post.

What’s Fundamental Analysis?

Fundamental analysis is a way to try to measure a stock’s intrinsic value. It involves looking at the company’s finances, the economy, and other direct and indirect factors relating to the company.

You want to look at anything and everything that could affect a stock’s price and value…

Yes, this includes company-specific factors, such as a new product, earnings, and expenses.

But it also includes things that may not be company-specific but that could still impact the stock’s price — changes in the economy (trade war, anyone?) or legislation that could affect the company or stock in question.

Typically, this type of analysis relies heavily on things like balance sheets, cash flow trends, income statements, and SEC filings. (Learn how to read SEC filings here.)

But it could also include reviewing things like press releases, blog posts, and articles in the media.

For example, is the company getting good (or bad) press for an event or product? Did it post profits last quarter, or did its profits dip dramatically? This is stuff you should find out in the course of your fundamental research.

Fundamental Analysis of Stocks

Wondering how to do fundamental analysis? Here are some fundamental analysis tools to get started…

Stock Screeners

Before you can begin to dig deep, you have to identify stocks worthy of your attention and your time.

By using a stock screener, you can filter based on criteria that you set, like biggest gainers, upcoming earnings, and more. A strong watchlist is fundamental to your analysis.

Get my no-cost weekly watchlist sent right to your inbox — subscribe here.

Financial Statements

Public companies are obligated to release financial statements to shareholders. And traders should watch for earnings reports.

A company’s earnings report is kind of like reading its diary. It can give you important insight into a company’s inner workings.

Earnings can be huge drivers of stock prices. If a company exceeds earnings projections, it could create great momentum. On the flip side, disappointing earnings can drive prices down.

Best of all? Earnings reports are free, public, and easy to access. They can give you great information about the company’s finances, performance, and where it might be going in the future.

The News

News can have a big impact on stock prices. Be sure to do a thorough search for any news related to the company in question. Sure, look at the company’s website, but don’t stop at company-issued press releases, because they could be self-serving. Also look for mentions in news outlets, blogs, and even on social media.

A good stock screener can help with scanning the news. For instance, StocksToTrade has features beyond just charting software. Ticker pages also include links to relevant company news, press releases, and even social media mentions.

It’s super handy to have access to both technical analysis and fundamental analysis tools on the same platform.

Fundamental Analysis Types

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There are two types of fundamental analysis: quantitative and qualitative. Let’s break them down…

  • Quantitative: This type of analysis takes into account the business’ numbers. Its earnings per share, income, return on equity, future growth … basically, information you can derive from the company’s financial statements.
  • Qualitative: This type of analysis is based on information that’s less concrete. Things like the company’s brand, reputation, product, management, business, and style. This type of analysis will produce varying results based on an investor’s perception of the information.

Fundamental Analysis vs. Technical Analysis

Confused about the difference between fundamental and technical analysis? Let’s clear that up.

Fundamental analysis looks at the inner workings of the company offering the stock.

In contrast, technical analysis focuses on price action, trends, and patterns. This is where you look at the stock’s historical performance to try to understand how the stock might perform in the future.

Technical analysis focuses on the following:

  • Price action: Also called market action, this is where you look at the stock’s historical movements.
  • Price trends: Over time, prices can fall into trends that you can see on the stock chart. A trend lasts until it either changes or reverses some catalyst or news.
  • Stock patterns: I love stock patterns. The idea behind looking at patterns? History can repeat.

Of course, that’s never a sure thing. And history usually doesn’t repeat itself to the letter. But it’s often close enough that it’s worth considering. I always look for patterns. Because once you notice one, there’s a chance it may repeat sooner or later.

So to review:

  • Technical analysis is when you focus on historical data and price action. Or, as I put it in this post, it’s where you wear your ‘economist hat.’
  • Fundamental analysis is where you focus on the inner workings of the business and its financial health — and how that can affect the stock price. Or, it’s where you wear your ‘business hat.’

Pros of Fundamental Analysis

Doing your research and due diligence is always smart before you make a trade.

Penny stocks don’t really have fundamentals. That’s why I stick mostly to technical analysis. But if you’re investing in or trading real companies, knowing the finances and details can be a big advantage.

Know what you’re buying.

Cons of Fundamental Analysis

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Too much analysis can cause paralysis. There’s so much information available on the internet — enough to make your head explode.

You can find one analyst report that says a company’s in trouble and another that says it has a bright future.

You can study financial statements until your eyes bleed and still have no idea what you’re actually reading.

It can cause you to freeze up and not bother with it at all … But don’t give up. Just do the best you can. And if you’re wrong, you can always cut losses quickly.

6 Fundamental Analysis Tools

Ready to dig in and get down to basics? Here are six vital tools to help you do it right.

Earnings Per Share

Earnings per share, or EPS for short, is a super simple — and highly valuable — tool for conducting fundamental analysis. It refers to the amount of a company’s profits allotted to each outstanding stock share.

There are two formulas for computing earnings per share:

Formula One:

Net Income / Total Number of Shares Outstanding = EPS

Formula Two:

Net Income / Weighted Average of Shares Outstanding = EPS

Read more about the EPS formula in this post.

Price-to-Earnings Ratio

The price-to-earnings ratio, also called the P/E Ratio, is a popular ratio. It lets you look at the relationship between the EPS and the stock price. It can give you an idea of the company’s value and market expectations based on their earnings.

Generally, the P/E ratio is calculated by dividing the stock price per share by the EPS, like so:

Market Value per Share / EPS = P/E Ratio

Price/Earnings-to-Growth Ratio

The price/earnings-to-growth ratio, or PEG ratio, is used to figure out a stock’s value while also taking into consideration the anticipated earnings growth. Some consider it to be a more robust indicator than the P/E ratio alone.

To calculate the PEG ratio, the P/E ratio is divided by the rate of growth of the company’s earnings within a specific time period. So, it might look like this:

P/E ratio / Earnings Growth Rate = PEG

Price-to-Book Ratio

The price-to-book ratio, or P/B ratio, takes into account the current book value per share relative to the stock price. Wondering what the book value is? That’s the total assets of the company, minus outstanding liabilities. This ratio can be an indicator of undervalued stocks.

Calculate the P/B ratio by dividing the stock price by the aforementioned book value. It looks like this:

Market Price per Share / Book Value per Share = P/B Ratio

Dividend Payout Ratio

The dividend payout ratio, sometimes simply called the ‘payout ratio,’ can help you figure out the dividends issued to shareholders relative to the company’s net income.

It can give you an idea of how much the company will pay shareholders in contrast to how much it has on hand. A lower dividend isn’t always bad, especially if the company is using retained funds to invest in future growth. But it can help you get a better picture of the company.

Net Income / Dividends Paid = Dividend Payout

​Dividend Yield

The dividend yield shows the ratio of the annual dividend relative to the per-share price. High yield typically follows high dividends. This can be a sign of high earnings. Of course, this isn’t always the case — it could be because the stock’s actually losing value.

Learn more in this post about high dividend stocks!

Here’s how to calculate the dividend yield:

Annual Dividend / Current Share Price = Dividend Yield

Return on Equity

Return on equity, or ROE, is a way to measure a company’s performance based on its net income and shareholders’ equity, or a company’s assets minus debt.

You can use it to help you determine whether the company is effectively using its assets to generate profits. The calculation for ROE goes like so:

Net Income / Average Shareholder Equity = Return on Equity

What’s the Process of Fundamental Analysis With an Example?

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The first step to make a short list of stocks you’ll further research. Use your stock screener to search for stocks based on sector, earnings per share, P/E ratio, or by dividend if you want a stock that pays dividends.

You can search by one criterion or multiple at a time to limit the number of results.

Once you have a shorter list of stocks, do more thorough research. Dig into the financials. You want to know its balance sheet, profit and losses, net income, and growth.

It’s good to see a few years of growth year over year. Also, look for red flags like too much debt.

In-depth financial research should weed out the worst companies…

Next, research the company’s product or service. Is it unique? Is there a lot of competition?

Could there be potential for future growth? Can it expand into other markets?

If you plan to hold a company long term, you’ll want to have a good idea of its future prospects.

Also, research the company’s management team and style. Do the executives or officers have a reputation for success or failure with other companies? You’re basically putting your money in their hands, so don’t overlook this step.

After you complete all the steps, you should have only a few remaining stocks that are potential candidates for your money. From there, you need to make some decisions based on your trading plan and strategy.

3 Best Software for Fundamental Analysis

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Looking for fundamental analysis software to help with research? Check out these options.

TradingView

TradingView offers trade ideas and articles based on input from its site users. You can search for trade ideas categorized by earnings, growth, value, and dividends.

Since the information is provided by other traders and shared on the site, it’s a bit like following someone else’s pick. If you don’t follow up on any of the ideas with your own research and due diligence, you’re trusting someone else’s opinion.

Powrbot

With Powerbot you can search up to 200 companies per month for free. You’ll need a spreadsheet with a list of tickers for the software to search for you.

Then upload the document on the website and it will automatically fill in financial information and websites for you to research further.

Simply Wall St

This website provides institutional data and puts it together in easy to read visuals, like infographics. This can be really helpful if you’re a visual learner.

They also have a portfolio analysis tool and it provides trade ideas.

Best Fundamental Analysis Books

  • The Intelligent Investor by Benjamin Graham — Even though this book is an oldie, it’s a goodie. It gives a good foundation for investing principles. Warren Buffet is the author’s student and has said of the book, “By far the best book on investing ever written.” 
  • How to Make Money in Stocks by William O’Neil — The author created the famous investing system, CAN SLIM. It’s an acronym where each letter stands for an indicator to use when choosing stocks to buy. I based my Sykes Sliding Scale on this idea. Learn about it in my “Trader Checklist Part Deux” DVD.

(As an Amazon Associate, we earn from qualifying purchases.)

Frequently Asked Questions About Fundamental Analysis

Who Uses Fundamental Analysis?

Long-term investors typically use fundamental analysis. They want to research a company thoroughly before investing their money in it. That’s great if you like slow returns … I like to trade penny stocks with a solid strategy and capture more momentum.

What Are the Types of Fundamental Analysis?

Quantitative and qualitative. Quantitative analysis takes into account the numbers of the business — its income, earnings, debt ratios, etc. Qualitative analysis is based on the company’s brand, management decisions, products, or services.

Why Fundamental Analysis Is Important?

Fundamental analysis is important for investors looking for long-term positions. It matters less to day traders. But it can still be smart to use before getting into overnight or swing trades. A bad balance sheet could be a warning to stay away or be ready to exit fast.

What Are the Three Factors Analysed Under Fundamental Analysis?

Fundamental analysis looks at economic, industry, and company factors. It’s looking at the big picture and narrowing it down to the individual company.

Conclusion

Fundamental analysis can help you make informed trading decisions. It’s how you can get a big-picture view of the stock you’re about to trade.

Of course, fundamental analysis alone shouldn’t be the final deciding factor when entering a trade. Consider a combination of both fundamental and technical analysis. If you’re day trading, you definitely want to look at the stock chart and price action.

But by looking at stocks from as many angles as possible, you can be better primed to sniff out hot stocks.

Trading Challenge

There’s a lot to consider when executing trades. Effectively researching stocks can take time … especially if you’re not sure what you’re doing.

I tell every trader to focus on education first. It’s why I created my Trading Challenge. I want to be the mentor I never had when I started trading 20+ years ago. You can be a self-sufficient trader and learn to navigate the markets … but you must put in the work.

So if you’re serious about finding your way in the markets, consider applying for my Trading Challenge.

In the Challenge, you can learn basic trading concepts and how to adapt to the ever-changing markets. You get access to an ever-growing library of DVDs, webinars, my watchlists, trade commentary, and so much more.

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But I’m only looking for self-starters who aren’t afraid to work hard. I don’t have time for laziness. If you think you’ll watch one DVD, place a few trades, and become a millionaire, think again.

It takes hard work and lots of practice to hit your trading stride. Up for the Challenge? Apply here.

What are your favorite fundamental analysis tools? Leave a comment and let me know!

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