Fundamental analysis of stocks is the process of studying a company’s business, financial health and growth prospects to estimate what its shares are really worth. If technical analysis asks what the chart is doing, fundamental analysis asks whether the company is a good business at the current price. This guide covers the key statements, ratios and steps.
What Is Fundamental Analysis?
The goal is to estimate a stock’s intrinsic value, meaning what the business is worth based on its earnings, assets, debt and growth. If the market price is well below your estimate, the stock may be undervalued. If it is well above, it may be overvalued.
Quantitative vs Qualitative Analysis
- Quantitative: numbers such as revenue, profit, debt and cash flow.
- Qualitative: factors such as the business model, competitive advantage, management quality and industry outlook.
The Three Financial Statements
- Income statement: shows revenue, expenses and profit over a period.
- Balance sheet: shows assets, liabilities and shareholders’ equity at a point in time.
- Cash flow statement: shows how cash moves through operations, investing and financing.
New to company reports? Read our guide on how to read an earnings report.
Key Ratios in Fundamental Analysis
| Ratio | What it measures | How to read it |
|---|---|---|
| EPS (earnings per share) | Net profit divided by shares outstanding | Higher and growing is generally better |
| P/E ratio | Share price divided by EPS | Compare with the company’s peers and its own history |
| P/B ratio | Share price divided by book value per share | Useful for banks and asset-heavy firms |
| ROE (return on equity) | Net profit divided by shareholders’ equity | Shows how efficiently the company uses investor money |
| Debt-to-equity | Total debt divided by shareholders’ equity | Lower usually means less financial risk |
| Current ratio | Current assets divided by current liabilities | Above 1 suggests it can cover short-term bills |
| Profit margin | Net profit divided by revenue | Higher margins suggest pricing power |
A Step-by-Step Process
- Understand the business. How does the company make money?
- Check growth. Look at revenue and profit over the last 5 to 10 years.
- Check financial health. Review debt, cash flow and the current ratio.
- Compare valuation. Compare the P/E and P/B with competitors in the same industry.
- Judge the quality of management and the competitive advantage.
- Decide on a margin of safety. Buy only if the price is comfortably below your estimate of value.
Limitations
Fundamental analysis does not tell you when to buy, and a good company can still be a poor investment at a high price. Many investors pair it with technical analysis for timing. If you invest for income, see dividend investing for beginners.
Frequently Asked Questions
What is the difference between fundamental and technical analysis?
Fundamental analysis values the business using financial data. Technical analysis studies price and volume patterns on charts.
Which ratio is the most important?
No single ratio is enough. Use several together, and compare them with companies in the same industry.
Is fundamental analysis for long-term investors only?
It is most useful for long-term investing, but short-term traders also use it to avoid weak companies.
Disclaimer: This article is for educational purposes only and is not investment advice. Investing involves risk, and you can lose money.
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