Fundamental analysis is an essential tool for investors.
It helps us identify what’s under the hood of the company, if you will.
Billionaire Warren Buffett subscribes to fundamental analysis, for example. And, as we all know, he’s swimming in money because of it. Using fundamental arguments, Buffett bought more than billion dollars worth of Coke (KO) in 1988.
Buffett saw consistent performance and good long-term prospects based on the nuts and bolts of Coke. He also saw bargain in the stock price after years of disaster. The stock, said Buffett, wasn’t reflective of the growth set to occur in the company’s international business. So he bought in 1988, and watched his $1 billion investment in Coke explode to $12 billion by the close of 1999.
Peter Lynch and Benjamin Graham are some other top names that come to mind, as top fundamental analysts. Fundamentals gave them a better understanding of the companies they were investing in, the health of the company, and an idea of future growth.
A fundamental analyst is trying to answer these simple questions along the way.
Is the stock overvalued / undervalued based on its price to earning ratio?
Is it trading at or below future growth, per its price to earnings growth ratio (PEG)?
Is the company making a profit?
How does the stock trade in comparison to overall sales?
Where does the company stand with regards to competition?
How much is the company making now? How much could it make in the future? Some of the key building blocks to understanding how to value a stock can be found with price to earnings (PE), price to sales (PS), price to book (PB), return on equity (ROE) and price to earnings growth (PEG) are some of the key ones to understand.
Once we begin to understand these key things, we can make a better decision to figure out if a stock is fundamentally over- or undervalued.