Investors use fundamental analysis is to determine the value of a stock and predict its likely future market performance.
The process can be carried out on three levels: macro, sector and individual stock analysis.
Examines the global and domestic economic factors and overall market trends to determine likely directions for stock markets as a whole. Factors such as GDP, economic growth, inflation, interest rates and energy prices will be considered. The analyst will then move on to:
Identifies which sectors of the economy will outperform in the current macro economic conditions. This may be based on regional or industry specific factors. Finally, the focus moves to:
Which business within the selected region or industry will show the best performance?
The method of starting with macro economic factors and working down to individual businesses is called the top-down approach. If the order in which the research is done is reversed, that is the bottom- up approach.
Once the analysis is focused on individual stocks the financial and business health of that company will be considered and compared to its peer group. The assumption behind fundamental analysis is that markets can incorrectly price a security in the short term, but in the longer term these anomalies will be corrected and the stock re-priced. The goal is to identify these situations and exploit them.
A selection of the ratios and measures used to determine the comparative value of different securities is discussed in the article; How to Read a Stock Quote
The main alternative to fundamental analysis is technical analysis, which is discussed here.
The ratio found by dividing a stock's price per share by its cash flow per share (This ratio, similar in type to the price-earnings ratio, serves as a measure of investors' expectations on a firm's future financial success.) continue reading