What does fundamental analysis mean and how do you measure a stock that way?
You’ve probably heard of one of the most famous fundamental analysts, Warren Buffett. He is a value investor who looks at fundamental analysis because he evaluates a stock based on its underlying fair value and future earnings power. Put more simply, and according to Buffett, “The key to investing is . . . determining the competitive advantage of any given company and, above all, the durability of that advantage.”
Fundamental Analysis attempts to determine the health of a company by looking at Earnings, Revenue, and other metrics the company reports on a quarterly or annual basis, and the company’s Balance Sheet at any given time. These are the types of things that indicate a company’s current strength and where it’s headed in the future.
Key metrics in fundamental analysis include things like revenue, expense, assets and liabilities, and cash flow. For stock investors, fundamental analysis helps determine value by focusing on underlying factors that affect a company’s worth (as opposed to technical analysis which primarily looks at stock prices and patterns).
For example, here’s how financial criteria like this are broken up in the Chaikin Power Gauge Rating:
Some of the most important factors in the Financials component are Price to Book (current price divided by book value per share, latest quarter) and Free Cash Flow (net free cash flow relative to Market Cap, latest quarter). Chaikin‘s research has shown a strong correlation between a company’s net Free Cash Flow – how much extra cash it spins off – and its likelihood of outperforming the market over the next 3-6 months.
A Research Analyst might know a typical Free Cash Flow value for a Tech company versus an Insurance company, but how can an average investor get that specialized knowledge? Fortunately, the Chaikin Power Gauge takes this into account, so you don’t have to.
As part of financial metrics, quarterly earnings reporting is another important part of fundamental analysis. What a company reports in its quarterly earning report (usually defined as its net income during that period) can have a big effect on its stock price, especially if something unexpected is reported. This is because analysts and investors use earnings report trends to make predictions about whether a company will be profitable and successful long-term.
Here’s how the the Chaikin Power Gauge Rating breaks down earnings into measurable data: