Introduction to Fundamental Analysis

Main takeaways:

1. Look at how the company makes money in detail, consider all factors — including revenues earned, why are their products bought, what relation does the company have with its customers, and perhaps their behavior over time.
2. Analyse carefuly the company’s costs, as well as the partners and resources needed to produce.
3. Understand the company’s ability to maintain its competitive advantage in the long term.
4. Look at the company’s industry, its trends, and its competitors — big, small, present, and emmerging.

In the past, there were no proper valuation methods that allowed investors to conduct proper analysis. The lack of these techniques had negative impacts causing speculative bubbles such as that of 1929.

It wasn’t until 1934 when the book ‘Security Analysis’ was published and set the foundations for what we know today as value investing. Long story short, the authors told their audience to focus on buying cheap companies.

Can you guess who was behind this publication? Exactly, Benjamin Graham, Warren Buffet’s mentor. In case you live under a rock and don’t know who Mr. Buffet is, I’ll give you a bit of context.

Warren Buffet is the largest shareholder of Berkshire Hathaway which is, according to Wikipedia, ‘an American multinational conglomerate holding company.’ Buffet is also well-known by his annual letters to shareholders, where he showcases his thoughts and plenty of his knowledge.

As a good student, he took Graham’s advice and twicked it a bit. Buffet’s investment strategy is to buy ‘cheap and good companies.’

Although we could spend hours talking about Warren, let’s get into what matters: the fundamentals. These refer to each and every factor related to the economic health of a company. There are some that are obvious like revenue, profit, and debt, but also others like the market share and management’s quality (Hendriks et. al, 2020).

At this point you should be asking yourself how come are there so many profitable companies in the market. Simple question, what is McDonald’s main source of income? Not its burgers but its franchise — paying a fee for the restaurant’s holding — and its properties.

Something we need to look at when analysing a company are its revenues and costs in detail. How are the first earned, why are they bought, what relation does the company have with its customers, and perhaps their behavior over time; and for the latter, which resources and partners are needed to produce and sell these.

Do you know which other factor you definitely need to investigate? The company’s ability to maintain its competitive advantage over the long term (Hendriks et. al, 2020) Why? because it will be easier to grow and inccrease profitability. Last, do not forget about the industry, its trends, and the company’s competition. To measure these KPIs there are different frameworks that you’ve already heard about: SWOT and Porter’s Five Forces.

We will dive deeper into this in the next article.

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Reference list:

Hendriks, P., Heeringa, M., Koenraadt, J., Rikken, I., Paganini, A., Grigolini, A., Vlaming, E., Dijkstra, S., Piech, S., Kalinin, P., Quint, S., Faddegon, A. (2020) B&R Investment Guide. Second Edition August 2020. B&R Beurs, 25–27.