How to Do Fundamental Analysis

Introduction to Fundamental analysis

Fundamental analysis is an investment method based on evaluating the internal factors of a company, such as financial situation, business operations, and management, to determine the stock’s value. Fundamental analysis contrasts with technical analysis, an investment method based on analyzing stock price and volume charts to determine price trends.

Fundamental analysis has several benefits:

• Helps investors determine the true value of a stock.
• Assists investors in minimizing investment risks.
• Aids investors in finding better investment opportunities.

The basic analysis consists of three main steps:

1. Macro research: Researching economic, political, and social factors that can influence stock prices.
2. Micro research: Studying the internal factors of a company, such as financial situation, business operations, and management.
3. Comparison with similar companies: Comparing the company under analysis with similar companies to determine whether the stock is undervalued or overvalued.

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Additional Information

Fundamental analysis is a complex investment method that requires knowledge and experience. To perform effective fundamental analysis, investors need to master the following:

• History of fundamental analysis: Fundamental analysis is a long-standing investment method. Early investors used it to evaluate companies and determine stock values.
• Types of fundamental analysis: There are two main types: quantitative analysis and qualitative analysis. Quantitative analysis uses figures and data to evaluate a company, while qualitative analysis considers immeasurable factors such as the company’s reputation and leadership quality.
• Economic, political, and social factors affecting stock prices: Important economic factors include GDP, inflation, interest rates, and exchange rates. Key political factors include government policies, such as taxes and regulations. Important social factors include consumer trends and demographic changes.
• Important financial indicators: Important financial indicators include ROE, ROA, P/E, and free cash flow.
• Important business operation indicators: Key business operation indicators include revenue growth, profit growth, and market share.
• Important management factors: Important management factors include experience, capability, and ethics of leadership.

Step 1: Macro Research

Macro research is the first step in fundamental analysis. In this step, investors need to analyze economic, political, and social factors that may impact stock prices.

Economic Background Analysis

The economy is the most crucial factor affecting stock prices. When the economy is growing, businesses tend to expand and profit, leading to an increase in stock prices. Conversely, during an economic recession, businesses may experience reduced growth and profit, resulting in a decrease in stock prices.

Important economic indicators to analyze include:

• GDP: The total value of goods and services produced in a country during a specific period. Growing GDP indicates economic development and potential investment opportunities.
• Inflation: The overall increase in prices of goods and services over a specific period. High inflation may devalue currency, making investors more cautious and potentially leading to a decrease in stock prices.
• Interest rates: The central bank’s cost of borrowing money. High interest rates may increase capital costs for businesses, leading to reduced profits and stock prices.
• Exchange rates: The value of a country’s currency compared to other currencies. A high exchange rate can reduce the value of stocks of export-oriented companies, as their revenue is converted into the domestic currency at a lower value.

Additional Information on Economic Indicators

Real GDP

Real GDP measures the total value of goods and services produced in a country during a specific period, adjusted for inflation. Real GDP is commonly used to gauge economic growth.

Nominal GDP

Nominal GDP measures the total value of goods and services produced in a country during a specific period, without adjusting for inflation. Nominal GDP may be distorted by inflation, so real GDP is often considered a more accurate measure of economic growth.

Per Capita GDP

Per capita GDP is GDP divided by the population. Per capita GDP is an important indicator to assess the standard of living in a country.

Unemployment Rate

The unemployment rate is the percentage of the labor force within the working age that is unemployed. A high unemployment rate can reduce consumer income, affecting demand for goods and services and, consequently, impacting business revenue and profits.

Inflation Rate

The inflation rate is the rate of price increase for goods and services over a specific period. High inflation can devalue currency, making investors more cautious and potentially leading to a decrease in stock prices.

Prime Interest Rate

The prime interest rate is the interest rate set by the central bank. A high prime interest rate can increase capital costs for businesses, leading to reduced profits and stock prices.

Real Exchange Rate

The real exchange rate is the exchange rate adjusted for inflation. A high real exchange rate can reduce the value of stocks of export-oriented companies, as their revenue is converted into the domestic currency at a lower value.

Factors Influencing Economic Indicators

Factors influencing economic indicators can be categorized into two types:

Internal Factors:

Internal factors are events occurring within the economy that can be controlled by the government or businesses. These factors can directly affect economic indicators such as GDP, unemployment rate, and inflation.

Economic Policies

• Economic Policies: Government economic policies, including fiscal, monetary, and trade policies, can impact the economy. For example, increased government spending on public investment can stimulate economic growth.

Production and Business Operations

The production and business operations of companies are essential internal factors that can influence the economy. The performance of companies can be reflected through indicators such as output, revenue, and profit.

• Output: The total value of goods and services produced by companies during a specific period. Increased output can stimulate economic growth.
• Revenue: The total value of goods and services sold by companies during a specific period. Increased revenue can lead to profit growth for companies.
• Profit: The remaining income of companies after deducting expenses. Increased profits can lead to increased investment by companies, promoting economic growth.

Consumer Spending

Consumer spending is another crucial internal factor that can impact the economy. Consumer spending constitutes a significant portion of the GDP in most countries. Increasing consumer spending can stimulate economic growth.

Consumer spending can be influenced by factors such as income, prices, and consumer confidence. When consumer income increases, they are more likely to spend. When prices rise, consumers may spend less. When consumer confidence increases, people are more likely to spend.

External Factors

External factors are events occurring outside the economy, beyond the control of the government or businesses. These factors can indirectly affect economic indicators by influencing internal factors.

The economic situation of other countries is a crucial external factor that can influence the economy. When the economic situation of other countries is positive, it can promote international trade, potentially boosting economic growth.

Unexpected events such as natural disasters, pandemics, etc., are also external factors that can impact the economy. These events can disrupt production, trade, and consumption, potentially slowing economic growth.

Therefore, investors need to understand both internal and external factors that can influence economic indicators to analyze them effectively.

Calculation of Economic Indicators

The calculation of economic indicators may vary depending on the specific indicator. However, in general, economic indicators are calculated based on data collected from various sources, such as statistical data, accounting data, and survey data.

Explaining the Significance of Economic Indicators

The significance of economic indicators can be explained based on the factors influencing these indicators. For example, if real GDP shows strong growth, the economy is expanding and developing. When the economy grows, the demand for goods and services increases, which is favorable for businesses. Therefore, the stock prices of companies in that economy may rise.

Example 1: Strong Growth in Real GDP

If the real GDP of Vietnam grows by 7% in 2023, investors may expect the stock prices of Vietnamese companies to increase. This is because strong real GDP growth indicates economic growth and development, creating potential investment opportunities.

Example 2: Decrease in Unemployment Rate

The unemployment rate is the percentage of the labor force that is unemployed. A decrease in the unemployment rate indicates a healthier labor market. When the labor market is robust, consumers are more likely to spend, benefiting businesses. Therefore, stock prices of companies in the consumer sector may increase.

For example, if Vietnam’s unemployment rate decreases from 3% to 2.5% in 2023, investors may expect the stock prices of Vietnamese consumer companies to rise.

Example 3: High Inflation

Inflation is the general increase in prices of goods and services over a specific period. High inflation can devalue currency, potentially reducing the profits of asset-income companies. Consequently, stock prices of asset-income companies may decrease.

For example, if Vietnam’s inflation increases from 2% to 3% in 2023, investors may anticipate a decrease in the stock prices of Vietnamese real estate companies.

Example 4: Increase in Prime Interest Rate

The prime interest rate is set by the central bank. An increase in the prime interest rate can raise the capital cost for businesses, potentially reducing their profits. Hence, stock prices of companies with high capital costs may decrease.

For example, if Vietnam’s prime interest rate increases from 5% to 6% in 2023, investors may expect a decrease in the stock prices of Vietnamese manufacturing companies.

Example 5: High Real Exchange Rate

The real exchange rate is the exchange rate adjusted for inflation. A high real exchange rate can reduce the value of the domestic currency, impacting the profits of export-oriented companies. Thus, stock prices of export-oriented companies may decrease.

For example, if Vietnam’s real exchange rate increases from 1.1 to 1.2 in 2023, investors may anticipate a decrease in stock prices of Vietnamese export-oriented companies.

However, investors should note that economic indicators are just one factor in determining stock price trends. Other factors, such as specific business factors, political and social factors, and market psychology, can also influence stock prices.

Therefore, analyzing economic indicators is a crucial tool for investors to identify stock price trends and make more informed investment decisions.

Step 2: Micro Research and Financial Analysis

Financial Statement Analysis

Financial statement analysis is a crucial tool for investors to assess a company’s financial health. The three main financial statements include the income statement, cash flow statement, and balance sheet.

Key Financial Ratios

There are various financial ratios that investors can use to evaluate a company. Some common financial ratios include:

• ROE (Return on Equity): Measures the efficiency of using shareholders’ equity. A high ROE indicates the company is generating substantial profits from its equity.
• ROA (Return on Assets): Measures the efficiency of using assets. A high ROA indicates the company is earning significant profits from its assets.
• P/E (Price-to-Earnings Ratio): Measures the stock’s valuation. A high P/E suggests investors are willing to pay more for each unit of the company’s earnings.

Utilizing Financial Ratios Effectively

Each financial ratio carries its significance. Investors need to comprehend the meaning of each ratio to use them effectively.

Example: Return on Equity (ROE)

High ROE indicates that a company is earning substantial profits from its shareholders’ equity. However, a high ROE could also signal potential risks. A company with a high ROE may be using significant financial leverage, which can pose risks when interest rates rise.

Understanding the nuances of financial ratios is crucial for making informed investment decisions.

Other Financial Ratios

In addition to the common financial ratios mentioned earlier, investors can also utilize other financial ratios to assess a company. Some of these ratios include:

1. Gross Profit Margin: The gross profit margin is the percentage of revenue that a company retains after deducting the cost of goods sold. A high gross profit margin indicates that the company has a competitive advantage in pricing or costs.
2. Operating Profit Margin: The operating profit margin is the percentage of revenue that a company retains after deducting costs of goods sold, selling and administrative expenses, and interest expenses. A high operating profit margin suggests that the company is effectively managing its costs.
3. Pre-tax Profit Margin: The pre-tax profit margin is the percentage of revenue that a company retains after deducting all expenses, excluding tax expenses. A high pre-tax profit margin indicates that the company is generating significant profits.
4. Debt-to-Equity Ratio: The debt-to-equity ratio is the ratio of a company’s net debt to its equity. A high debt-to-equity ratio suggests that the company is using significant financial leverage.
5. Free Cash Flow to Equity Ratio: The free cash flow to equity ratio is the ratio of a company’s free cash flow to its equity. A high ratio indicates that the company is generating substantial free cash flow, which can be used for dividends, share buybacks, or growth opportunities.

These additional financial ratios provide further insights into a company’s financial health and performance.

Analysis of Operational Activities

Operational activity analysis is the process of evaluating factors related to the business operations of a company, such as products or services, market, and competitive opponents.

Products or Services

The products or services of a company are crucial factors determining its success. Investors need to assess whether the company’s products or services meet market demands.

• Product or service characteristics: Do they meet market needs? What competitive advantages do they have?
• Quality of the product or service: Is it of high quality? Is it well-regarded by customers?
• Pricing: Is the pricing competitive?

Market

The market a company serves is also a critical factor to consider. Investors need to evaluate if the market has growth potential.

• Market size: Is the market large or small?
• Market growth rate: Is the market growing or declining?
• Market characteristics: Is the market highly competitive or not?

Competitive Opponents

Competitive opponents are other companies providing similar products or services. Investors need to assess the strength of a company’s competitive opponents.

• Size and scale of competitive opponents: Are they large or small?
• Financial status of competitive opponents: Do they have strong financials?
• Products or services of competitive opponents: How do their offerings compare in terms of quality and pricing?
• Competitive strategy: What is the business strategy of competitive opponents?

Management Analysis

The leadership of a company, responsible for its operations, needs evaluation. Investors need to assess the competence and ethics of the company’s leadership.

• Experience and skills of leadership: Do they have suitable experience and skills?
• Leadership commitment: Is there a long-term commitment to the company?
• Ethics of leadership: Are they ethical in their practices?

Specific Example:

Company A is a smartphone manufacturing company. They produce high-quality products that meet market demands. The smartphone market is experiencing strong growth. However, Company A faces intense competition from other companies such as Apple, Samsung, and Huawei.

From this analysis, investors can recognize that Company A has growth potential but also faces risks due to fierce competition.

Thus, micro-level research is a crucial step in fundamental analysis. By analyzing the internal factors of a company, investors can determine the true value of stocks and make more informed investment decisions.

Step 3: Comparison with Similar Companies

After conducting a micro-level analysis of a company, investors need to compare it with similar companies in the same industry. This comparison helps investors determine whether the company is currently priced reasonably or not.

Value Comparison

There are two ways to compare the value of a stock:

• Comparison with its intrinsic value: The intrinsic value of a stock is the value that a company is worth. Various methods, such as discounted cash flow (DCF), net asset value (NAV), and comparative methods, can be used to estimate the intrinsic value of a stock.
• Comparison with the prices of similar companies: Comparing the price of a stock with the prices of similar companies can help investors determine whether the stock is undervalued or overvalued.

Specific Example:

Assuming Company A has an intrinsic value of 100,000 VND per share, while its market price is 120,000 VND per share. Thus, the stock of Company A is currently overvalued by 20%. Investors may consider selling the stock or wait for the stock price to decrease to a more reasonable level.

Prospects Comparison

In addition to value comparison, investors also need to compare the prospects of a company with the prospects of the industry and similar companies. This comparison helps investors determine whether the company has growth potential or not.

• Comparison with the industry’s growth prospects: If the industry a company operates in is growing rapidly, the company is likely to have growth potential.
• Comparison with the growth prospects of similar companies: If a company has better growth prospects than similar companies, it may be priced higher.

Specific Example:

Assuming the smartphone industry is growing at a rate of 20% per year. Company A, a smartphone manufacturing company, has growth prospects of 30% per year. Therefore, Company A has better growth potential compared to the industry and similar companies, which could result in a higher valuation of its stock.

Conclusion

Fundamental analysis is a process of evaluating the true value of a stock based on the internal factors of a company, such as financial situation, business operations, and management.

Summary of fundamental analysis steps:

1. Macroeconomic research: Study economic, political, and social factors that may impact stock prices.
2. Microeconomic research: Examine internal factors of a company, including financial situation, business operations, and management.
3. Comparison with similar companies: Compare the company with similar ones in the same industry to determine if it is priced reasonably.

Considerations when conducting fundamental analysis:

• Investors need to use reliable sources of information, including company financial reports, securities analysts’ reports, and financial news websites.
• Investors need analytical skills to understand and evaluate the collected information, including financial analysis, business operations analysis, and management analysis.
• Investors need to have patience, as fundamental analysis is a time-consuming process that requires thorough research before making investment decisions.

Specific Example:

Assume an investor is considering investing in Company A’s stock. The investor has conducted a fundamental analysis and gathered the following information:

• Macroeconomic research: The economy is experiencing strong growth.
• Microeconomic research: Company A has a strong financial position, with consistent profit growth over several years. The company also has high-quality products meeting market demands, and experienced leadership.
• Comparison with similar companies: Company A has a higher intrinsic value compared to similar companies.

From the collected information, the investor may conclude that Company A is a good company with growth potential. However, the investor should also be aware of potential risks, such as intense competition from other companies.

In conclusion, fundamental analysis is a crucial tool for investors to make informed investment decisions. However, investors need to use reliable information sources, possess analytical skills, and exercise patience to effectively conduct fundamental analysis.