Security Analysis: Part 3- Fundamental Analysis

Investment success is pretty much a matter of careful selection and timing of stock purchases coupled with impeccable matching to your individual risk tolerance. In order to carry out selection, timing and matching actions an investor must conduct deep security analysis. The first two steps in security analysis are Economic Analysis and Industry Analysis which have been covered in the first two installments of this three part series. The third step is Fundamental Analysis which is the in-depth study of the finances and operating outcomes of a company.

We believe the value of common stock is determined in large measure by the performance of the firm that issued the stock. If the company is healthy and can demonstrate strength and growth, the value of the stock will increase. When values increase then prices follow and returns on an investment will increase. However, just to keep the savvy investor on their toes, the mix is complicated by the risk factors involved. Fundamental analysis examines all the dimensions of risk exposure and the probabilities of return, and merges them with broader economic analysis and greater industry analysis to formulate the valuation of a stock.

Look at the company from inside and outside to identify their strong points and how they are taking advantage of them. Identify weaknesses and how they guard against them and seek to overcome them. Assess the speed and effectiveness of actions to fend off threats and take advantage of opportunities. Financial statements are the heart of company analysis and no undertaking of security analysis is complete without in-depth scrutiny of the balance sheet, the income statement and the statement of cash flows.
• The Balance Sheet gives a snapshot of a firm’s assets, liabilities and shareholder equities at a specific point in time.
• The Income Statement gives the history of the operating results over a specific period of time, generally a year.
• The Statement of Cash Flows is a record of the money in and the money out, plus any other events that cause changes in the company’s fiscal position.