Investors make money on the market when they purchase stock at a discount to its intrinsic value, or what the business would be worth if it were sold tomorrow. Fundamental investing is a process that attempts to do the (almost) impossible: calculate the correct intrinsic value of a given stock. It does so by considering basic economic factors that determine and impact a stock’s value.
It’s all about the price you pay for an asset. Is it too much? In other words, are you paying more than $1 for each $1 of value in that company? Or is it too little? Are you getting that $1 in value at a discount?
Whatever the case, determining the true value of an investment is critical in deciding how much a given asset is truly worth, and how much upside it has for you as an investor.
Fundamental investing is a great way to dip your toes and your first bit of money into the market. If you plan to try your hand at fundamental investing, here’s what to consider.
- Think about price vs. value. As an investor, having a sense for what the true value of a stock is, separate from its price, is key to success. While value is less black and white than price, it’s crucial to remember that price and value are distinct and different.
- Own your role. Fundamental analysis is a process that uses concrete information to try to determine the real value of a company’s stock. It’s not betting on a trend or looking for the big lottery-style win. When taking a fundamental approach, you play a proactive and key role in choosing stocks based on thorough research.
- Know all about the company’s financial state. In order to determine a stock’s value, investors should research a company’s revenues, expenses and income, as well as its assets and net-present value. Publicly traded companies in the US are required to file and share both a comprehensive annual financial report called a 10-K and a quarterly report, among others. In addition to the numbers, you should also understand the company’s revenue stream—that is, how it is making money— and any planned changes to it.
- Consider non-financial factors. Long-term trends and challenges to a company are considered fundamental to the company’s value. For example, has the company been facing fierce competition for many years in specific product categories? The same goes for long-term opportunities. Does the company sell technology that is primed for expansion to new markets? When doing your research, consider long-term non-financial factors.
- Don’t lose sleep over price swings. Considered a long-term investment approach, fundamental analysis doesn’t give great weight to short-term pricing and trading swings. Imagine buying a house after months of research about the neighborhood, home values, and the home’s features, only to consider selling it when its value drops slightly. Just like homebuyers might be slow to put a “for sale” sign on the front lawn because they believe that its intrinsic value is intact, investors should be slow to consider selling off their stock because of a drop in the market.
Even after a thorough fundamental analysis, it can be difficult to arrive at an accurate stock valuation. After all, none of this is easy and there are a number of different variables to consider when assessing potential investments.
When it comes to fundamental investing, remember that although it’s more like studying for a test than rolling the dice. In fact, it is both.