Using Fundamental Analysis to Invest

How one investor stays ahead of the crowd with old-fashioned principles.

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When it comes to investing, I'm not as experienced as some other folks. For years, I've relied on keeping things simple and going with index funds from Vanguard. Lately, I've been getting more interested and one of the most basic things about buying stocks is understanding the underlying business.

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While it's not easy to boil a huge company into a bunch of facts and figures (and then making decisions on those), what you need to consider before making any investment is well known and well understood. So, how do you do a proper business valuation?

There are a number of business valuation models, and stock evaluation models, that you can use. One of the most basic ways to evaluate an investment is to make use of fundamental analysis and it's the cornerstone of a lot of analysis approaches.

What is Fundamental Analysis?

As you might imagine, fundamental analysis deals with looking at the fundamentals of an investment. Technical analysis, on the other hand, deals mostly with looking at the numbers associated with an investment, considering the technical aspects of the price action and looking for patterns. With fundamental analysis, though, you are looking at a slightly bigger picture and considering the basic aspects of a stock or other investment.

Some of the items to consider in your fundamental analysis of a company include:

  • Company management
  • Potential for growth
  • Place as an industry leader
  • Whether or not regular profits are achieved
  • Profit margins
  • Business model
  • If a company has a strong business model, and has been showing stable growth under competent management, it might be a good indication that the company is fundamentally sound, and worth considering as an investment.

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    You can also use fundamental analysis when looking into other investments. Consider the underlying fundamentals of a currency: Does the country have a growing economy? Is the country on solid financial footing? Are their political issues that could derail progress or cause instability?

    You can also apply fundamental analysis to commodities, real estate, bonds and other investments. The key is to look at the big picture of the investment, and make decisions based on whether or not you think that those fundamentals will change.

    During the stock market troubles following the financial crisis, and during the recession, many people, panic-stricken, sold investments that were still, in the long-run, fundamentally sound. Now those stocks have been recovering, and even thriving. A dip in any market overall is not an indication that something has changed fundamentally with an investment.

    Deciding When To Sell

    Of course, there will be times when it becomes necessary to to sell an investment. You can use fundamental analysis to help you make that decision. Rather than following the herd, or listening to a bombastic media personality (Jim Cramer!), look at the big picture of the investment. Have the fundamentals changed? In the case of a stock, you might find that the power structure of the company is changing.

    Or, perhaps the company is losing market share. These types of fundamental shifts might mean that it is time to sell an investment. If you have receive solid returns up until now, there's no harm selling an investment and putting the proceeds into a high-yield savings account until you find the next opportunity.

    In the end, though, there is no way to completely predict the future, or to know what will happen next with any market or any investment. You can use various tools to help you evaluate an investment, and decide whether or not it would work for you. Fundamental analysis can be one way to examine the merits of an investment.

    Jim Wang writes about personal finance at Bargaineering.com. When he's not tackling money issues, he's usually looking forward to his next vacation and writing about it at Wanderlust Journey.