 Personal Finance PowerPoint Presentation Fundamentals of Stock Prepare to Get Financially Fit by Practicing Personal Finance Most of this information comes from Investopedia. What are stock fundamentals, which you can find online. Take a look at the references, resources, continue your research from there. This by Ben McClure updated December 12, 2021 in prior presentations. We've been taking a look at investment goals, investment strategies, investment tools, keeping in mind the two major categories of investment. Fixed income, typically bonds, equities, typically stocks. We're focused on the stock side of things here. Also, no quick recap of what stocks are. Corporations, separate legal entity, breaking out ownership into stocks, which are going to be equal in unit. They're all the same representation of ownership of the corporation. The corporation often going public. When we're thinking about the stocks here, we're usually talking about publicly traded corporate stocks. That means they're going to be on an exchange, the exchange making it easier for the corporation to issue the stocks to more people like individual investors, giving the individual investors the ability to buy the stocks. Now, we've also talked about other tools, which are often applied for individual investors such as mutual funds and ETFs, which can then help us to diversify with smaller amounts of money, putting money into the ETFs and the mutual funds, allowing us to get access to more stocks in general, possibly using things like index funds. Now, if we're going to be investing in individual stocks, note that we're going to take different strategies in terms of a way to determine which stocks we want to be investing in. That's what our focus is going to be here on. So what are stock fundamentals? Stock fundamentals are key metrics for a company such as cash flow and return on assets, ROA. So note that assets for the company, those are on the balance sheet. Those are things that they're holding onto, not because they just like to have a pile of cash on the balance sheet, but because they want to be able to use those assets in order to generate revenue in the future. So how well are they using those assets in order to generate revenue? Because if they're not generating revenue, then we can put our money elsewhere where revenue is being generated. So analysts often perform fundamental analysis to analyze a stock by looking at its fundamentals. This involves looking at any data which is expected to impact the price or perceived value of a stock. So in theory, if you look at an individual stock, you would think that you could look at their financial statements, which should represent where they stand at a current point in time and their performance. That being the balance sheet and the income statement, we should be able to perform some ratio analysis to see where they stand. Do they have good liquidity? Can they pay basically their bills? What's their performance been in the past? And then we're also going to take into consideration factors in the economy at this point in time and possible projected future factors that we think are going to happen in the market. So those factors you would think would be driving on a market basis supply and demand the price of the stock. So how stock fundamentals work and the broadest terms fundamental analysis involves looking at any data which is expected to impact the price or perceived value of a stock. So obviously anything that's going to be impacting the price which is determined on the market basis are things we would want to take into consideration. So this is of course anything aside from the trading patterns of the stock itself as the name implies, it means getting down to basics. So we're going to do some analysis. Some good old, this is like the detective work, good old just getting down to the details. So fundamental analysis focuses on creating a portrait of a company. So we want to get a picture of where they stand, what they've done, identifying the fundamental value of its shares and buying or selling the stock based on that information. Some of the indicators of commonly used assessed company fundamentals include, so we can look at things like their cash flow, return on assets. Remember assets are kind of like investments for the company. When you hear the term investment, you can use that for a lot of different ways. When we use it here, we think stocks and bonds we're investing in, but a company is really investing in, all their assets are investments because the company is there to use those assets to generate revenue. So how efficiently are they doing that? Conservative gearing and history of profit retention for funding future growth. So are they trying to grow in a somewhat conservative way or a very aggressive type of growth strategy? For example, are they able to fund their growth with the current earnings that they have, reinvesting those earnings, purchasing things like buildings and equipment, other assets in order to generate and grow more revenue in the future, or are they funding their growth through aggressive debt strategy, leverage strategy? Not that debt and leverage are necessarily bad, but there's going to be debate in terms of how much leverage, how much debt is too much debt. So the soundness of capital management for the maximization of shareholder earnings and returns. So is the management sound? Are they able to take the resources that they have, use them efficiently to generate returns on them? So fundamental analysts have a stead approach to analyze stock performance. They look at a variety of factors that they believe influence a stock's performance. These include the industry as a whole. So we're going to obviously look at what industry the company is in in general, the competition within the industry. So oftentimes when you're looking at an industry, the question is, is this an industry where everybody's kind of the same and they're competing on price? Therefore you're looking for like the most efficiently priced company? Or do they have some differentiating strategies that are involved within the industry and possibly then looking at things that would differentiate them? So a company's management structure, its income and revenue of course, as well as its growth potential, example of stock fundamentals. All of the data is public and readily available generally through a company's financial statement. So if it's a publicly traded company traded on an exchange, one of the benefits of that is to be on the exchange, they have to report their financial information and they have to do it in such a way that it complies with whatever the standards are of the exchange. So that should make it easier for comparability. The goal is to ultimately identify which stocks are priced correctly and incorrectly by the market. Now of course this is not an easy thing to do for like a layman person to be doing. To kind of specialize in these areas but you can, these are really good kind of tools using like ratio analysis to determine whether a price looks like it's going to be fairly priced or not. So to help you visualize it, let's use the following analogy. Think of the stock market as a shopping mall where stocks are the items for sale and the retail outlets. Their sites are set solely on the products in the mall. Shoppers are dismissed as an unreliable, emotional herd with no inkling of real value of the goods for sale. Fundamental analysis moves slowly through the store seeking the best deals. So in other words if you think about a shopping analogy, a lot of people just go through the store and might buy on like an impulse kind of fashion instead of methodically going through the store and picking deals. And if you think about it that way and you use analysis you can start to think, well maybe I could have an advantage over other people that are basically shopping and not really thinking that way. So there's debate in terms of how much value you can really generate. And if you think that you can't really beat the market and that way you still want to invest your money. Of course you might be going and investing in sectors of the market by investing like index funds, mutual funds and ETFs for example. So once the crowd moves on from say the personal computers, the PCs, they will take a closer look at ones that were passed over. Fundamental analysts, analysts may take a stab at determining the scrap value of the PC stripped down to its hard disk, memory cards, monitor and keyboard. So they're actually going to piece it together and say what's the actual value of this thing if I was to take it apart. Of course when you put it together there's the synergy man of all the pieces together. So this whole is worth more than the sum of its part. But in any case and the stock market this is akin to calculating the book value or liquidation price of a company. Liquidation price meaning what would happen if they went out of business and they sold everything. So if they liquidated then what would they sell for? They'd have to sell all the assets, pay off all the liabilities and the rest would go to the owners generally. That would generally be the equity in the company that's your starting point. Assets minus liabilities equal the equity but that's on like a book value. So if you took into all the factors involved, if you actually liquidated, it would be a little bit more complicated than that quite a bit. So these analysts also take a very close look at the quality of the PC. It is going to last, is it going to last or will it break down within a year? The fundamental analysts will pour over the speculations, scrutinize the manufacturer's warranty and consult consumer reports. Similarly equity analysts check a company's balance sheet for financial stability. Then the fundamental analyst may try to understand the performance of the PC in terms of say processing power memory or image resolutions. These are like the forecast earnings and dividends identified from a company's income statement. Finally the fundamental analyst will put together all the data and come up with the intrinsic value or value independent of the current sale price. If the sale price is less than the calculated intrinsic value, the fundamental analyst will buy PCs. If not, they will either sell the PCs they already own or wait for prices to fall before buying more. Special considerations. Performing fundamental analysis can be a lot of hard work but that is arguably the source of its appeal. By taking the trouble to dig into a company's financial statements and assessing its future prospects, investors can learn enough to know when the stock price is wrong. These conscientious investors are able to spot the market's mistakes and make themselves money. At the same time, buying companies based on intrinsic long term value protects investors from the dangers of day to day market fluctuations. However, the fact that fundamental analysis shows that a stock is under value does not guarantee it will trade at its intrinsic value at any time soon. So clearly when you do an analysis like that, even if you basically break everything down and you say, hey look this is what I think the actual true value of it is, I think the market price is over or under that, we have to take into consideration the market price is driven by other factors such as emotion and whatnot as well. So you would think that then if your calculation was right in the long run, then things would play out and tend towards the actual intrinsic value of the stock. But in the short run, you would think that it could be fluctuating based on other things as well. So things are not so simple. In reality, real share price behavior relentlessly calls into question almost every stock holding and even the most independently minded investor can start doubting the merits of fundamental analysis. There is no magic formula for figuring out intrinsic value. So clearly finding the intrinsic value and taking into consideration all the factors can be difficult to do, but you could do some basic analysis and use those tools and that does give you a good sense and an ability or capacity to do some comparisons to other stocks as well. When the stock market is booming, it is easy for investors to fool themselves into thinking they have a knack for picking winners. So again, you really have to kind of keep this in mind because oftentimes if we start to do fundamental analysis and start doing stock picking for example, then if we don't have a long track record of doing so, then we can't really gauge how good we are and that's the same for another kind of investor as well. If they show you their track record even for the last 5 or 10 years, it's quite likely that the big cycles in the market last 5 to 10 years. So you might have been working with someone who's just the way they tend to be, whether they be aggressive investors or non-aggressive investors on the most basic level, might simply just happen to match the way the market currently is at this point in time and if the market changes, the question is do they have the flexibility to change or is it just so happened that whatever their innate tendencies are for trading happen to line up with the market at that point in time. So you want to be of course quite careful and make sure that you're still using diversification tools and so on even if you're going into more rigorous picking of individual stocks. But when the market falls and the outlook is uncertain, investors cannot rely on luck. They actually need to know what they're doing. So fundamental analysis versus technical analysis. Fundamental analysis is much different from its cousin technical analysis where fundamental analysis focuses on measuring a stock's intrinsic value. Technical analysis concentrates solely on the trading and price history of a stock by looking at trading signals and other analytical tools to evaluate the strength or weakness of a stock. So you can look at the past performance in terms of trends on the trading. Note that if you're doing the trends on the trading those are trends that you can look at and try to guess what's going to happen in the future but you're not really looking at the fundamentals to drive that decision. You're looking at the behavior of the market, the rise and falls which could be again a more emotional kind of thing than looking at trying to find the intrinsic value of the stock through looking at the financial statements. Technical analysis believe that a stock's past performance, its price and trading activity can help determine where it will go in the future. In essence, the theory of technical analysis is rooted in the fact that the movement in price is not random. Instead, it believes that patterns and trends are identifiable and repeat over time. To demonstrate, let's go back to the analogy above. Technical analysis analysts ignore the goods for sale. Instead, they keep an eye on the crowds as a guide for what to buy. So if a technical analyst notices shoppers congregating inside a computer shop they will try to buy as many PCs as possible betting that the growing demand will push PC prices higher. So they're not really digging into the PC here in this analogy. They're just looking, hey, that's the popular thing. You're following the trends at this point in time and trying to get a pattern or see the pattern of the trends even though they don't seem to align possibly with the underlying value of whatever's going on. And we know, of course, that trends and fads can last for quite some time even if they don't seem to be lining up with the fundamental values of the stock. And so we could be picking stocks based on that. However, the person that's doing the fundamental analysis is trying to figure out what they believe the fundamental worth of the stock is and make their investment decisions on that. And the theory there would be that at some point in the long run the trends and the fads will come and go but things will, you know, if you look at the long-term trend tend towards to everything else equal and if the markets were working efficiently in the long run the fundamental value of the stock.