Fundamental analysis is a synonym for stock analysis, that is, the study of a company’s prospects as an investment.
Investors who choose to purchase stocks can choose to buy broad index funds that own many stocks or to buy stocks individually.
The investor who elects to buy individual stocks thus must choose to purchase one stock over another. Doing that requires research.
Fundamental analysis is research that attempts to understand how a given stock will fare in the future.
For instance, is the company in a good position compared to its competitors? Is the intrinsic value of the company fully reflected in the current share price?
Furthermore, is the economic sector in which the company operates likely to lead to increased revenue and profitability, thus increasing demand for that stock?
Investors who rely on fundamental analysis rely on public data provided by the companies via regulated information releases, as well as data about its competitors and the economic niche in which those companies operate.
Consider going to buy a car. You’ve decided on the general type and features (a sedan with four doors, ample trunk space, and good highway mileage), so now you have decide make and model.
A broad way of narrowing down the field is to consider just mileage data or just resale values or sticker price. The fundamental analysis approach, however, would lead you deep into the actual cars that fit your initial qualifications.
Exactly what size engine? How much interior room? Cost to insure and maintain the car? These are questions that might produce widely divergent answers from car to car.
All of these answers, in aggregate, could affect your decision to buy or not buy. A low-priced that cars an arm and a leg to maintain is not a good deal, right?
Fundamental analysis of stocks is just like getting under the hood on a car purchase. Doing such an analysis requires some expertise and experience with car ownership, and the same happens with stocks.
Is the company in good financial shape? Does it have the cash flow necessary to grow and compete? Are their new products and markets in the pipeline? Is it fairly price now?
You have to be ready to make a decision based on multiple factors that are hard to compare, any one of which could be a dealbreaker, up to and including the price.
Fundamental analysis is not easy to do, so many investors rely on research from big banks and brokerage houses. Others prefer to do their own research and, they hope, to gain an edge by understanding the investment better than most others.
In the end if a stock turns out to be a lemon despite your best efforts at research, you have to be ready to get out of it and go buy something else.