Fundamental Analysis: Analysing Companies

Submitted by Sharemarket News on 13 May, 2011 - 17:55

Learn about analysing companies.

Calculations can put off the beginner trader or stock market student. It's good to remember that calculations are a way to distill raw market data into a manageable value. Think of numbers as a way to simplify rather than complicate things. In case you get scared off by balance sheet analysis, you can always employ the services of a stockbroker or a professional analyst. Before crunching numbers, list the facts you are trying to learn.

  • Growth. Is growth from mergers and acquisitions or is it organic?
  • Profit margin. Is profit margin growing? Is it too high or too low against competitors? Can profits be
    maintained for a long period or only for the short term?

Quantitative vs Qualitative

Let's break up the "fundamentals" to see the big picture. Quantitative factors can be measured numerically, for example by looking at a company's financial statement. Financial statements show revenue, assets, and profits. Qualitative factors are related to characteristics as opposed to numerical value, like a company's brand name recognition, and the quality of the company's board members.

Quantitative factors and qualitative factors are usually studied together by analysts before jumping in a certain direction. Let's take Microsoft. To measure the company's worth, analysts need to look beyond annual dividends and earnings per share. The Microsoft brand name is recognised by billions of people around the world, and contributes to the company's "value."

To evaluate Miners R Us, trader X will need to crunch the numbers as well as analyse the company "story" (what does MRU do besides drill for gold? Does it plan to expand into the explosives business in the future?).

Qualitative Factors

Qualitative factors is all about the company. Start by asking how the company makes money. Does it sell burgers or is it really an underground loan seller? Avoid being blindsided by knowing where you are sinking your money. Savvy investors invest in what they know.

Next, check for competitive advantage. Company A stays competitive by doing different activities from Company B or by doing the same thing but in different ways.

Knowing who runs the company is a no-brainer. Management leads the company into profit gains or losses, so its important that you get to know who's who in the business. Unfortunately, as an ordinary investor, you cannot easily set up a lunch with the top brass. What you can do is participate in quarterly conference calls, read management discussion and analysis (MD&A) in the annual report, check past performance and bone up on ownership status.

Lastly, find out how the company is being run. What are the policies in place for stakeholders? What are your rights?

Quantitative Factors

Now we come to the industry in which the particular company functions. Know who your company's customers are. Will the company be branching out in the future and adding new customers? A company with a small number of customers providing the majority of revenue is usually a bad sign. If one of the customers transfers his or her business to another company, revenue drops significantly.

Other quantitative factors are market share and competition. Is the company the sole provider of a particular product or is it only one among hundreds? A major player can pass on costs to its customers, thus setting the market price that its smaller competitors will follow.

Regulation also affects a business' bottom line (net income). Even if profit making potential is unlimited, the actual earnings can be limited with highly regulated companies (like drug companies and utilities providers). For example, drug companies have to go through a lengthy (and expensive) process to get a drug approved before it hits the public. These costs can add up.

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