Fundamental Analysis

Fundamental analysts focus on information and macroeconomic factors that are affecting the true value of a financial security.


Fundamental analysis is a commonly used method for measuring the intrinsic value of a financial-traded asset based on the observation of economic and other 'hard' data.

1. Learn the Basics of Fundamental Analysis

Investment Analysis Framework

There are two forces forming an overall framework of investment analysis:

(i) Technical Analysis, and

(ii) Fundamental Analysis

The Goals of Fundamental Analysis

The main goals of fundamental analysis are:

(a) to identify the fair market value of a financial-traded security

(b) to identify and measure the impact of risks associated with an investment decision (risk identification is essential for managing your portfolio in an efficient way)

Fundamental Analysis Framework

A fundamental analysis framework consists of all major internal and external factors that can affect the future cash-flows of your investment.

(1) Internal fundamental factors

(2) External factors (business, macroeconomic, etc.)

2. Investment Risk

There are two major categories and ten individual sources of investment risk. Portfolio risk may adversely affect future cash-flows of an investment and even lead to a total loss of the initial capital.

(I) General Categories of Risk Separated by their Fundamental Nature

Identifying Investment Risk -TradingCenter.orgIn order to deal with the investment risk, we must first identify its origin. We can distinguish risk into two general categories: systematic and non-systematic risk. Systematic risk is unpredictable, and therefore, it can not be identified and managed. This category includes mainly risk deriving from 'black swan' events. For example, financial collapses, war, or the nationalization of local companies by the force of state law.

(II) 10 Categories of Risk

Here are the 10 major categories of investment risk:

1. Business Risk

2. Market Risk

3. Credit Risk or Default Risk

4. Liquidity Risk

5. Interest Rate Risk

6. Financial Risk

7. Inflation Risk

8. Currency or Foreign Exchange Risk

9. Political Risk or Country Risk

10. Systemic Risk

 More on Investment Risk


3. Major Categories of Financial Ratios

The financial ratios are used for the evaluation of particular companies or industries. The financial ratios can provide a tool for comparing different companies and industries in several aspects such as profitability, debt, book value, and many others.

Here are the categories of financial ratios:

1) Balance Sheet Ratios –Measuring Financial Stability

i) Debt-Equity Ratio

ii) Current Ratio

2) Operating Ratios - Measuring Performance

i) Operating Profit Margin

ii) Net Profit Margin

3) Efficiency Ratios – Measuring Efficiency

i) Total asset turnover ratio

ii) Return on Equity

4) Valuation Ratios – Measuring Effectiveness

i) P/E Ratio

ii) P/E/G Ratio

 More on Financial Ratios


4. Valuation of Stocks & Industries

Been able to evaluate the true value of a company is very important towards making profitable investment decisions. Here are the five most important evaluating methods:

(1) Revenue-Based Valuations

(2) Earnings-Based Valuation

(3) Cash Flow-Based Valuation

(4) Equity-Based Valuation

(5) Empirical Valuation

 More on Investment Valuation Methods


5. Commitments of Traders (COT)

The Commitments of Traders (COT) is an important report issued by the CFTC that shows the aggregated long and short positions in the futures market regarding all major asset classes including Forex currency pairs. The COT is considered an important indicator for analyzing market sentiment and future market conditions, especially as concerns the positions of non-commercial traders. The COT report is available for all actively traded Futures contracts such is stock indices, interest rates, and currencies.

■ The Commitments of Traders includes a breakdown of the total futures positions of 3 different market participants:

(1) Non-Commercial traders / large speculators

(2) Commercial Forex traders / hedgers

(3) Small speculators (too small to be reported)

■ There are COT reports for many different asset classes including:

(a) Stock Futures (equity investors)

(b) Commodity Futures (precious metals, energy, etc)

(c) Currency Futures (including US Dollar against Euro, Japanese Yen, British Pound, Canadian Dollar, Swiss Franc, Australian Dollar, Mexican Peso, Russian Ruble)

 More on Commitments of Traders Report (CFTC)


6. Treasury Bills (T-Bills) and their Correlation with Equity and Forex Markets

All investors must keep a close eye to what happens in the bonds market. Significant changes in the pricing of government and/or corporate bonds can be used as an indicator of upcoming economic transitions. In this context, significant changes in the yield of government bonds or changes in the spread between different-maturity bonds may forecast what is about to happen in the real economy, in the equity markets, and in the Forex markets. Actually, there is an important factor linking every financial market and that factor is the level of interest rates.

Government Bonds Classification

Government bonds, in general, are classified according to their maturity. There are three (3) main categories:

■ Bills –Maturing in less than one year

■ Notes –Maturity in 1 to 10 years

■ Bonds -Maturing in 10 years, or more

The marketable securities are issued as Treasury Bonds. Based on the length of their maturity they are called Treasury Bonds, Treasury Notes or Treasury bills (T-bills).

 More on Treasury Bills (T-Bills)


Fundamental Analysis

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