The core of fundamental research deals with the source of revenue that is used by companies. It deals with why companies are producing goods and selling them to consumers. Investors who base their decisions off fundamentals have a better understanding of the financial health of a company and what factors might influence it in the future. In order to do this, you must analyze a companies cash flow, revenue, expenses, debt and other factors that might affect it in the long term. These factors are derived through financial statements that include income statements, balance sheets and cash flow statements. These are the three core documents that comprise the financial statement analysis methods which are used for fundamental research. Essentially, fundamental research seeks to answer three basic questions about an investment:
– What are the factors that will determine the investment’s future value?
– How reliable are these factors?
– What returns can be realistically expected when investing in this company or its industry?
The importance of fundamental research is one that is often overlooked and sometimes not understood by individual investors. Many of these investors rely on tools like financial news to get their information which can be inaccurate and incorrect at times. Good fundamental research is important for individuals who want to look into the future of a company based on more than just what they can see in the marketplace.
The Importance of Fundamental Research
Fundamental research is important to investors because it helps investors determine where and how much money they should be putting into a company. It can allow them to diversify their portfolio by picking out companies that are healthy and will likely see positive returns in the future. This helps them avoid picking out companies that are not doing well or do not have much room for growth which could hinder their investments if the company does poorly.
It can investors identify numbers and information about the business that will directly affect its success and what may make it seem like a better investment option than others.
How is Fundamental Research carried out?
It is important that fundamental research is conducted objectively without allowing any influence from the opinion of others affect your decision making. Look at the numbers, check your assumptions against reality, and after you’ve compared expected outcomes with actual outcomes, revisit the logical steps you took to reach your conclusion. Think carefully about alternative hypotheses or explanations of past performance and consider why or why not they were relevant?
Why? Because it’s about getting real data, nothing but data. All opinions are based on someone’s personal experience (even if that person is an investment guru). Release any bias or preconceived notions that might limit you in analyzing the facts. For example: “I don’t like this company’s CEO. I have always bought stocks in companies headed by or with CEOs I’m comfortable with.”
The first step is to take a good look at your motives. The first step of your fundamental analysis involves determining if you’re going to want to hold an investment for the very short term (weeks, months, quarters), the intermediate term (1-3 years), or even longer if it’s something you might pass onto future generations. In order to help figure out what type of investment you have, ask yourself:
In summary: If it’s something you don’t plan on holding very long, focus on how much it’s worth now. If it’s something you don’t plan on holding very long, but there is a chance that you might not be able to pull the trigger on selling, look at how much it is worth in the future. If it might be held for generations to come, then take into account how much it would be worth in the future if you’re not around to sell it. These three factors should help you decide if this investment is too risky, too narrow of an area of expertise to make money in the near future, or an interesting investment for long-term investors.
Be prepared to take off some time from other aspects of your life to do your research.
You’re going to have to do a lot of work. The investment report you’re going to create will typically be a single source document that contains a wealth of information. You’ll have to do a lot of data gathering and analysis.
In short, it might take you weeks, months, or even years from the time you decide to invest in an idea until you’ve given it some initial fundamental research.
Investors tend not to be very patient when it comes to their money, so try not to bet the farm on an idea before thoroughly researching it and examining all the facts and statistical evidence that support your key assumptions.
Investment analysis is not something you want to do in a hurry.
Don’t try to rush into making an investment decision. You need to be satisfied that all of your assumptions are correct before you make the move. Don’t reduce risk by taking too many risks too early on in your journey along the road of investing.
You need to be able to think like an investment professional or engage an expert who can when researching your investment.