Fundamental analysis involves analysing the underlying forces that affect the well being of the economy, industry groups, and companies. Most often, the aim of company analysis is to derive a stock's current fair value and forecast future value. If fair value is not equal to the current stock price, fundamental analysts believe that the stock is either over or under valued and the market price will ultimately gravitate towards fair value. By believing that prices do not accurately reflect all available information, fundamental analysts look to capitalize on perceived price discrepancies.

My objective is to find fundamentally healthy, low risk companies and profit from future price movements using technical analysis. Fair value is important but I make no attempt to ever forecast the future.

At the company level, fundamental analysis may involve examination of financial data, management, business concept and competition. This article will focus on financial data. Before reading further, I suggest you work through the free online course from ASX Investor Education called  Analysing and Selecting Shares found in the MyASX section of the site.

A company’s vital statistics and financial performance are used to determine the financial health of a company and to then compare it to other companies. Some of the more popular ratios are found by dividing the stock price by a key value driver.

Below is a list of potential inputs into a financial analysis:

The list can seem quite long and intimidating. However, after a while, an investor will learn what works best and develop a set of preferred analysis techniques. 

Sources of information

The key sources of information on fundamental analysis are the Australian Stock Exchange (ASX), stockbrokers, the media and the internet.

The growth of investment information on the internet has been phenomenal. Statements of financial position and ratio analysis can be obtained from websites of stockbrokers, and financial services providers and some companies provide research on their own website. Below is an example of a company’s vital statistics and financial performance that might be viewed on the internet:

This financial information could help an investor determine whether a company is healthy and low risk and how it compares to other companies. As part of the analysis process, it is important to remember that all information is relative. Usually, companies are compared with other companies in the same sector. For example, a media share (Fairfax) would be compared to another media share (Rural Press), not to a retailing company (Coles Myer).

Fundamental information is important but is very time consuming to access, particularly on a share by share search. The Ninemsn website has some fundamental research tools that could save investors a lot of time in finding healthy, low risk companies. You will need a hotmail email address to sign in. From hotmail, go to ninemsn, Finance & Business, Investor, Tools, Share Finder. The Investment Finder has nine basic predefined searches by independent research company Aspect Financial.

Here’s an example of how I use the “Aspect Ranks for all companies” search. I highlighted the search and selected FIND. The result listed 1721 companies with their Aspect rankings for Value, Risk, Growth, and Income. Rankings are numbered 1 to 5 with the lower the ranking the better. I copied the rankings list into an Excel spreadsheet, sorted the list by Risk and deleted all companies with a risk rating greater than 2. I next sorted the list by Growth and deleted all companies with a Growth rating greater than 2. I then deleted all companies with a market capitalization less than 100 million and with low liquidity, as they could be difficult to trade. I was left with 24 shares that I could put into a watch list and monitor for entry signals generated from technical analysis. The total percentage price increase over the previous 12 months for the 24 shares was 705 %. See list below:

Top Down Analysis and Advanced Finder

Top-down analysis starts with the overall economy and then works down from industry sectors to specific companies. Depending on the expectations for the economy, certain sectors are likely to benefit more than others. An investor can narrow the field to those sectors that are best suited to benefit from the current or future economic environment.

The individual company is important but its industry group often exerts just as much, or more, influence on the stock price. When stocks move, they usually move as groups.

Once an Industry Sector has been selected as likely to benefit from the current economic environment or meets specific technical analysis criteria, it is necessary to find the healthiest, lowest risk companies in that sector. Fundamental software packages will do this task as will the Advanced Finder on the ninemsn website, both at a cost.

Advanced Finder allows the investor to search a sector for all shares meeting specific fundamental criteria. My sector search finds shares meeting the following criteria:

• Market Capitalisation greater then 100 million
• P/E Ratio less than 25
• Return on Equity greater than 5%
• Earnings per Share Growth greater than 5%
• Risk Rating less than 4

What I am left with is a handful of companies that stand out from the pack in a favoured sector. Specific entry and exit signals are generated with technical analysis.

Fundamental analysis can be valuable tool, but it should be approached with caution. Research written by an analyst who is selling advice is stating an opinion and often has some sort of bias. As investors, we are putting our faith in company accountants and auditors to present accurate figures reflecting the true state of a company’s financial position. Corporate statements and press releases offer valuable information, but are often part fact and part spin. Like every other analysis tool, investors need to take the good aspects of fundamental analysis and combine it with the good aspects of other forms of analysis to make common sense investment decisions.

About Jim Berg

Jim Berg, author of The Share Trader’s Handbook, is a former broker, private trader and lecturer with over 20 years experience in the investment industry. He’s appeared on CNBC Asia and Market Wrap and is a regular guest speaker at the Traders and Investors Expo, ASX, SFE and the Australian Technical Analysis Association.

Jim is a well respected Financial Market figure who has educated thousands of clients in Australia and abroad. His successful proven strategies are detailed in his home study course, "Trading Strategies With MetaStock".

Using the tools and trading strategies demonstrated in his investment workshops and seminars, Jim won the 2002 Personal Investor Magazine Trading Competition. 

(c) All rights reserved 2005. This article has been prepared by a third party and licensed to ASX. The views are those of the author and not necessarily of ASX. This material is educational and it is not intended to constitute financial advice. It has been prepared without taking account of any person's objectives, financial situation or needs and because of that, any person should, before making an investment decision, consider the appropriateness of the advice having regard to their objectives, financial situation and needs.

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