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Type of Securities Investment Strategies Fundamental Analysis Technical Analysis
Introduction to Fundamental Analysis Income Statement Analysis Balance Sheet Analysis Cash Flow Analysis Shareholders' Equity Analysis Ratios and Definitions


Introduction to Fundamental Analysis

 - The Accounting Process
 - Postulates and Principles
    of Accounting
    * Postulates of Accounting
     * Principles of Accounting

 -
The Financial Statements
   * The Balance Sheet
   
* The Income Statement
    * The Cash Flow Statement
    *  Shareholders' Equity
        Statement

 


Introduction to Fundamental Analysis

Fundamental analysis involves the in-depth study of a company in order to determine values and future trends. While the main focus is on a company’s financials, it’s also critical to analyze the economic environment and the industry in which a company operates. The focus of this section is to find values, by using “bottom up” financial analysis; economic and industry analysis will be left for another day. The goal is to help bring financial concepts “alive.”

 Knowing the numbers is critical in spotting values.

Start by reviewing a company’s business model, which is the company’s method for generating revenues, costs, and profits.

 This is not as abstract as it may seem. I once met with a high-level executive who described that her company was having a great year. They were able to raise more money from investors then the company spent. When I asked about revenues, she mentioned that their revenues were how much they raised from investors, not from actual sales. As a CPA, my outlook was completely different. While they viewed themselves as having a good year because they raised capital, I viewed them as a start-up, without a proven business model. At the time, they were not transitioned and were not positioned, to generate sales or profits. While they were promoting their technological prowess, their true skill was at raising money. This example demonstrates, moreover, that a company’s business model needs to coincide with investors’ goals and objectives.

Investors first need to thoroughly understand a company’s revenue stream, by finding out what actual products or services the company offers. Dig deeper than vague general categories; identify the specific products made and how are they used. Determine their selling prices and try to estimate their profit margins. Ascertain who the company’s customers are. In many cases, the ultimate purchaser of a company’s products may not be the company’s customer. Companies may sell to distributors, wholesalers and retailers, but not to the final customer. Investors also need to determine where the customers are located, and how the products or services are delivered to them. Know exactly where the cash is coming from to pay the bills.

Don’t ignore the cost side of the profit equation (revenues minus expenses equal profits). Go beyond the costs to sales ratio trends. Investors need to consider facts such as: how large is the workforce, and where are they located?  Does the company design and manufacture its products? Do they outsource manufacturing or service departments and if so, where are they located and what are the risks? What are they purchasing and who are the suppliers? Are just-in-time inventory practices utilized?

If the company is a service organization, how is it structured, where are its offices, how many employees does it have, and how much does it pay its billable employees? Are there “costs plus” billing arrangements?

One must also get a handle on research and development expenses. Go beyond the typical “R&D as a percentage of sales” calculation. What exactly are the scientists and engineers researching, what types of returns are expected, and what are the time frames of the potential payoffs?

Understand the company’s organization and reporting structure. What are its main divisions, subsidiaries, and profit centers; every company slices the pie differently. Does it have a centralized or decentralized organization? Is it structured correctly to make acquisitions, or could it be the acquired?

The goal is to understand how a company operates; and what are its special qualities that make it a sound investment.

Most of this information is contained in the company’s SEC form 10K, which is filed annually, normally within 75 days after the company’s year-end. The quarterly 10Q statements are normally not as comprehensive as the annual report and are more of an update to the annual report. They are due 45 days after the quarter-end, except the last quarter, which is incorporated into the annual filing.

While fundamental analysis is time consuming, I rather think of it as potential wealth building.

After understanding the company’s business model, one must then determine if the company’s strategy is profitable and is it a good investment choice for you. Is the stock valued at a price on which you can make a good return? After all the analysis, it still comes down to price versus expected return.

Click below for more information on "the numbers":

  - The Accounting Process
 - The Postulates and Principles of Accounting:
     * Postulates of Accounting
     * Principles of Accounting
 - The Financial Statements
     *  The Balance Sheet
     *  The Income Statement
     *  The Cash Flow Statement
     *  The Shareholders’ Equity Statement

 

 

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