FUNDAMENTAL ANALYSIS- STRENGTHS AND WEAKNESSES
Fundamental analysis is done to evaluate securities by analysing its intrinsic value with the help of economic, financial, qualitative and quantitative factors. Also, fundamental analysts study microeconomic and macroeconomic factors. The aim of fundamental value is to provide a quantitative value so that an investor can use it to compare with security’s current market price and hence analyse whether security is overvalued or undervalued.
Fundamental analysis aims to determine the stability or performance of the companies by going through key numbers and economic indicators. Fundamental analysts focus on identifying fundamentally strong companies and fundamentally weak companies so that they can decide whether to go long, that is, purchasing stocks and expecting its value to rise in future or companies that are strong or short, that is, to sell the stock and re-buying them when prices will be low for the companies that are weak.
However, as every aspect has two sides, fundamental analysis too has its own strengths and weaknesses that are discussed in brief below:
Fundamental analysis proves to be beneficial for long term investments pertaining to long term trends, hence viable to be used by long term investors. However, investors need to be patient in long term investing and while adapting to fundamental analysis, it assists in prediction and recognition of economic, demographic, and technological trends that make the patience of long term investors worthwhile.
Since long term investors believe in value investing, fundamental analysis looks out for best in companies and help investors in identifying those with a good value. With a thorough understanding of fundamental analysis, an investor can find companies that lead in valuable assets, have stability and strong balance sheets, strong financial performance and stable earnings.
Fundamental analysis provides a thorough understanding of the business to an investor. After going through the overall process of research, understanding, and analysis, an investor gets aware of the revenues, expenses, and profits of the company. Investors can discover earning potential and expectation of a company and identify those companies that are expected to deliver desired return on the investments and neglect those that may pertain to shortfalls. Fundamental analysis also assists investors in identifying opportunities by analysing the key value drivers of a company in an industry. Since a stock’s price pertains to its industry group, investors tend to grab opportunities by thoroughly understanding these groups that may be high-risk, low-risk, growth-driven, income-oriented, etc.
It is crucial to know a company’s business for investors to get a better hold on categorizing stock within their relevant industry group as stock tends to move in groups. As it is known, fundamental analysis makes an investor get through with a company’s business and since business tends to change frequently, it helps investors to place it in a group so that relative valuations are well considered of.
As fundamental analysis is related to a deeper understanding of all aspects of any company, it becomes a time-consuming process for investors. Time-consuming process thereby may provide valuations that are contradicting to the current level of prices in the market and hinder the end goal of investors, that is, to receive better returns on their investments.
As each industry group and company vary, different valuation techniques need to be adopted while evaluating specific companies. An investor would need to adopt different technique and model for different industries and companies which may create hassle and often lead to a time-consuming method. Also, diving into different techniques and models frequently can limit the understanding and research of a particular company and can provide confusing results.
False or Biased Information
Since all information during fundamental analysis come from the direct source of companies itself, it may be hampered or biased to attract investors. Companies are capable of manipulating figures in financial statements that can mislead the investors.
In conclusion, fundamental analysis is a valuable tool for investors looking for long term investments, however, only if dealt with caution. Investors need to be aware of strengths as well as the weaknesses of fundamental analysis to take charge and control of weaknesses and deal with them according to their own perspective to increase the chances of returns on their investments and succeed as an investor.