If you’re interested in investing in companies for the long-term on your own, then you need to learn how to do fundamental analysis. But to protect yourself from feeling overwhelmed, you need to first understand what it is about and where you can start.

I promise that after these basics of fundamental analysis below, you will know what approach will suit you best and become confident in going into more depth.

I will also give you an overview of what you will be using to perform fundamental analysis so you’re mentally prepared.

Sounds good?

Let’s get started…

Choose your approach

Alright, first things first. You need to understand that fundamental analysis has some angles of approach that many analysts choose to use a combination or just one of them according to their experience and needs.

But don’t worry; I will help you decide which ones are for you…

Analysis on a Relative Basis

Analysis on a relative basis or simply relative valuation allows you to value a stock based on how it fares when compared to other stocks (in the same industry or the market as a whole).

For example, take the P/E ratio, a metric that shows you how many times the earnings of a company its stock price per share are. You can calculate it by dividing the price of the stock by the earnings per share. The lower it is, the more undervalued a company is considered.

Now, the argument that relative valuation analysts make is very simple; how can you know what P/E ratio is too high or too low if you have nothing to compare it with? So, they insist on comparing data like this to that of other companies in the same industry or with the market.

This is actually the most friendly approach to valuing a company and since you’re a beginner it’s a great way to start analyzing stocks.

So, you definitely want to approach the matter in this way.

Analysis On An Absolute Basis

Now, analysis on an absolute basis or absolute valuation is about analyzing a stock based on your own understanding of what is high and low, good and bad. But comparing a company’s present financial performance and condition to its past (or forecast future) also falls into the absolute valuation category.

For example, some analysts who have a lot of experience have developed a sense of what P/E ratio is low and high and they don’t need to compare it with the market; although most will do that too. They mostly use this sense to screen stocks; if some metrics seem good to them by themselves, they will go forward with comparing them with other companies’ metrics.

They can also compare some key metrics that highlight the present performance of a stock with those of the past to see if the stock is undervalued or not.

With that being said, absolute valuation analysts will mainly try to estimate a stock’s fair price by taking into consideration the expected cash flows in the next few years. This is perhaps what defines analysis on an absolute basis best.

If this is interesting to you then you will benefit from this approach, but if it’s intimidating right now, it’s better to leave it until you become more experienced.

Qualitative Analysis

Till now, all of the approaches we talked about include precise data and fall into the category of quantitative analysis.

Qualitative analysis, on the other hand, concerns itself with information that cannot be measured using metrics. For example, anything from managerial competence to competitive advantages, customers’ opinions, quality of products, etc.

This may seem easy to apply at first but it’s actually harder to pull off well. Qualitative factors are hard to assess correctly and they require the experience of someone who has a mind for business.

This approach isn’t completely necessary if you are looking to adequately diversify but it provides something that others cannot; an assurance that good financial health and performance will continue in the future.

If you are looking to basically “marry” a company, meaning that you want to stay invested in a stock indefinitely, you should apply it. After all, qualitative analysis creates the greatest degree of familiarity with a company.

But for starting, it’s not that necessary if you have a widely diversified portfolio.

Read Financial Statements

After you choose your approach(es) you will be ready to see what kind of tools you will be using as you learn how to do fundamental analysis of stocks.

Fortunately, you won’t need multiple monitors and software subscriptions for this; the only thing you will be paying for is your internet connection. Nearly all of the information you will need to apply fundamental analysis is in financial reports like 10-Ks and 10-Qs.

Let’s go over what you will be specifically reading in those…

The Balance Sheet

The balance sheet is the first thing that appears in any publicly-traded company’s financial report. It basically outlines all of the assets a company has.

The information there and, therefore, the total assets are split into two distinct categories: total liabilities and equity.

The total liabilities are simply all of the debt a company has (long-term loans and short-term obligations). The equity is what remains after you subtract the total liabilities from the total assets and it includes things like cash, investments, manufacturing plants, patents, etc.

Key financial health metrics like debt to equity (D/E), current, and quick ratio are derived from the data in the balance sheet so you’ll definitely be using it for your analysis.

The Income Statement

After the balance sheet comes the income statement which shows what remains after subtracting from the revenue figure all of the producing costs, the operational expenses, the interest on loans, and the tax.

Metrics like the P/E ratio (which we talked about earlier) and profit margin are calculated using the information in the balance sheet.

The Cash Flow Statement

Now, the last report is the cash flow statement which shows how much cash comes in.

The difference from the income statement here is that the cash flow statement doesn’t account for non-cash expenses like depreciation and amortization.

These two types of expenses are based on the fact (and sometimes hypothesis) that factories, machinery, patents, trademarks lose their value over time. So, accountants usually subtract such expenses from the revenue even when no cash has gone out of the company.

The metrics that make use of the cash flow statement are free cash flow growth, price to free cash flow, etc.

Conclusion

In conclusion, fundamental analysis isn’t so intimidating once you understand your options and that you can learn while practicing.

The trick is to start from somewhere and you can use this article as a reference point whenever you want to explore other approaches.

Now, I hope these fundamental analysis basics helped you get started and I want to encourage you to share this article with others if you think it was useful.

Also, please ask me anything you like in the comments and I will get back to you as soon as possible.

Take care and good luck with analyzing stocks!

Disclaimer: This information should not be viewed as financial advice. You should consult a financial advisor or do your own due diligence before you invest. The owner of this website and author of this article are not to be held liable for any undesired result by anyone who uses this information that is provided here in any way.