Fundamental Analysis in the Stock Market is Effective, Here’s Why

If you are new to trading and stock market investing, you may have heard of Warren Buffet and his famed value investment style. The American billionaire has perfected this means of sifting value stocks from the chaff and minting billions as a result. 

It is undoubtedly a fortune that may last generations. That’s why it is befitting to only dig in and analyze his trading methods.

TRADING STOCK CAN BE REWARDING

At the heart of value investing in the stock market is an analysis that takes the investor deep into the company’s financials. With proper application, traders can mine diamonds out of the rough, changing their financial trajectory. 

This is why traders ought to be comfortable in doing due diligence and, most importantly, know what is fundamental analysis and its application in the fast-moving financial markets.

The beauty of trading is that it rewards the patient and the emotionally intelligent. 

Sometimes, pseudo-experts and pretenders littering the otherwise clean trading space may get lucky—and won’t stop boasting of their wins in social media—even becoming influencers. However, for all we know, successful traders are tame and diligent. 

Most of them are experts in fundamental analysis and other core areas of trading like technical analysis—the art of reading charts—and sentimental analysis—expertise in figuring out the emotional stand of the market.

WHAT IS FUNDAMENTAL ANALYSIS?

In drilling down onto fundamental analysis, it becomes apparent that masters of this art are experts at predicting the price of stocks—and quite literally any other tradable asset—using a set of verified external events and facts. 

These events are wide-ranging, with most drawn from the economic calendar, where an announcement of earning reports or dividends can influence the price of a stock. 

Others include, for instance, news events and political factors, policy, seasonal factors, and quite literally any other move that directly impacts the economy. 

Many lessons can be learned from the effects of the Coronavirus pandemic and the response from governments and policy markets to stem its spread and restore normalcy.

FUNDAMENTAL ANALYSIS: ELEMENTS AND JARGON

There are three elements of fundamental analysis like economic, industry, and company analysis that may influence the outcome. 

All the same, a fundamental analyst would usually adopt a bottom-up or a top-down approach. The former looks at the global state before narrowing it down to the company level. The top-down approach works from the micro and company level to the global stage, analyzing effects that may influence stock valuation. 

In the course of their research, a fundamental analysis would check how the company efficiently uses capital through the Return on Equity (ROE) indicator, the Price-to-Earnings Ratio (P/E) to check whether the stock is undervalued or overvalued, or even its Beta—that is, the correlation of the stock with the industry or the general economy. 

Research can also drill down on dividend yield or the Dividend Payout ratio, income through the Price-Earnings-Growth Ratio (PEG), and more.

FUNDAMENTAL ANALYSIS VERSUS TECHNICAL ANALYSIS

The primary difference between fundamental and technical analysis is that the former is based on predicting a stock’s price purely on the financial and economic state of the asset in question. 

This way, it would be easy to determine whether the stock in question is undervalued—worth buying—or over-valued. 

Meanwhile, technical analysis assumes that the market is efficient and that prices are at equilibrium at any point in time. A chartist would predict a stock only using price action, usually with influencing factors like trading volumes. 

Since price action is fluid and fast-changing, this trading style is ideal for short and medium time timeframes. 

On the other hand, fundamental analysis is suitable for long-term trading since underlying factors key in the analysis may take days or even weeks before being realized.

Fundamental analysis is a trading strategy in use in stock trading and wholly in the financial markets. 

It looks at the economic side of the stock or industry. It has been proven effective, especially for long-term trading. 

Nonetheless, considering the state of the market and the tranches of economic data, a trader may sometimes miss out on opportunities. 

Therefore, analysts recommend using this style with other approaches like technical or sentimental analyses.