Fundamental Analysis For Dummies

Matthew Krantz

• Publisher: For Dummies
• Year: 2016
• ISBN:
  9781119263609
• Edition: 2
• Topic: Business
• Subtopic: Trading
• Index: Business

Determine the strength of any business with fundamental analysis

Have you ever wondered the key to multibillionaire Warren Buffet's five-decade run as the most successful investor in history? The answer is simple: fundamental analysis. In this easy-to-understand, practical, and savvy guide, you'll discover how it helps you assess a business' overall financial performance by using historical and present data to forecast its future monetary value—and why this powerful tool is particularly important to investors in times of economic downturn.

It's more important than ever for investors to know the true financial stability of a business, and this new edition of Fundamental Analysis For Dummies shows you how. Whether you're a seasoned investor or just want to learn how to make more intelligent and prudent investment decisions, this plain-English guide gives you practical tips, tricks, and trade secrets for using fundamental analysis to manage your portfolio and enhance your understanding of shrewdly selecting stocks!

• Predict the future value of a business based on its current and historical financial data
• Gauge a company's performance against its competitors
• Determine if a company's credit standing is in jeopardy
• Apply fundamental analysis to other investment vehicles, like currency, bonds, and commodities

With the help of Fundamental Analysis For Dummies, you just may find the bargains that could make you the next Warren Buffet!

Part 1

What Fundamental Analysis Is and Why You Should Use It

IN THIS PART …

Find out how understanding the way a company makes money can help you make money.

See how fundamental analysis compares with other ways of investing.

Check out how some successful investors put fundamental analysis to work.

Understand the accounting procedures companies use to record their fundamentals for all to see.

Chapter 1

Understanding Fundamental Analysis

IN THIS CHAPTER

Getting a solid overview of why fundamental analysis is worth your time

Stepping through some of the main concepts that are critical to fundamental analysis

Understanding the ways that fundamental analysis can fit into many investment strategies

Grasping how to use this book to further your understanding of fundamental analysis

Before you gulp down that neon-colored energy drink or pour yourself a bowl of super-sweetened cereal that looks like it was made by Willy Wonka himself, you probably do something first. It’s probably not a bad idea to take a glance at the nutrition label that spells out what ingredients are in the box.

You might not know what guar gum, guarana, or other ingredients that often show up on the labels of such processed foods are, but you can get a pretty good idea of what’s good for you and what’s not. If a bottle of apple juice, for instance, has a list of ingredients longer than your arm and is filled with stuff you can’t pronounce, you know you’re not drinking squeezed apples. Being aware of what’s in a food may or may not sway your decision to eat it, but at least you know what you’re putting into your body.

Companies and stocks, too, come with similar labels. All companies that are publicly traded, or that take investment money from the public, are required to disclose what they’re all about. Just as food processors must list all the ingredients that go into their products, companies must tell investors what they’re composed of.

Unfortunately, all the information investors need to know about a company doesn’t fit inside a tiny rectangle — like it does on a food label. Instead, the key elements that make up a company are broken down at length in a series of financial statements and other sources of fundamental data.

Reading these critical financial statements and gleaning insights from them are the most basic goals of fundamental analysis. Fundamental analysis is the skill of reading through all the information companies provide about themselves to make intelligent decisions. Just as you’d want to know what’s in that Frankenfood you’re about to bite into, you want to know what’s in an investment you’re thinking about adding to your portfolio.

Why Bother with Fundamental Analysis?

You might wonder why you need to hassle with fundamental analysis. After all, at every family picnic there’s undoubtedly the loudmouthed relative who’s filled with all sorts of can’t-go-wrong stock tips. Why bother with technical things like net income or discounted cash flow analysis when you can just turn on the TV, write down a couple of stock symbols, buy the stocks and hope for the best?

You might also figure learning how companies operate is just needless information. After all, you don’t need to know about fuel injection systems, suspensions, and car battery technology to drive a car. And you don’t need to know what’s going on behind the curtain to enjoy a play. Some investors figure they can just pick a couple of hot stocks, buy them, and drive off to riches.

If the vicious bear market that began in 2007 taught investors anything, it’s that blindly buying stocks just because you might “like” a company or its products was hardly a sound way to tune up a portfolio. Chasing hunches and personal opinion about stocks is often not a great way to invest, as you’ll find out in Chapter 20. The financial crisis is now becoming a distant memory for many investors who might again think fundamental analysis doesn’t matter. Investors have taken to chasing stories and hype again in the bull market that kicked off in 2011 — and most or certainly many of those “can’t-go-wrong” investments will meet a poor fate as the fundamentals catch up to reality.

Some of the real values of fundamental analysis

Ever notice how there’s always a new wonder diet promising to make you skinny, and a new pill to make you healthier? More times than not, though, it seems these things never work. Getting healthy comes back to the basics — a balanced diet and exercise.

The same goes with investing. Believe it or not, investing can be somewhat full of fads. There’s always a new investment pundit or economist with a novel way to pick winning stocks. And just as an hour on the treadmill will do you more good than a bottle full of miracle pills, successfully choosing stocks often comes back to fundamental analysis.

Fundamental analysis is the classic way to examine companies and investments for a variety of reasons, including the fact it is:

• Based on fact, not opinion: It’s easy to get caught up in general enthusiasm about what a company is doing or the products it’s selling. Fundamental analysis blinds you to this investment hype and gets you focused on cold-hard business realities. It doesn’t matter if all the kids in your neighborhood are buying a company’s products if the company isn’t making any money at selling them.
• Good at pinpointing shifts in the business’s health: If a company’s success is starting to fade, you’ll see it show up in the fundamentals. No, there won’t be a giant sign saying “Sell this stock.” But there are clues if you know how to look, as you’ll discover in Chapter 18. Companies are required to disclose key aspects of their business, so if there’s a problem, a fundamental analyst will often be early at spotting some trouble.
• All about execution: Companies’ CEOs are usually good at getting investors focused on the future and how things are going to get better next quarter. But fundamentals are based in reality — right now. Just think of children who say how hard they’re working at school. The report card is still the tangible evidence of how things are actually going. The numbers don’t lie — if you know where to look.
• A way to put price tags on companies: What’s a painting worth? What’s a used car worth? The price of an asset with a subjective value is generally what someone else is willing to pay for it. The stock market, an auction of buyers and sellers, does a good job putting price tags on companies. But fundamental analysis gives you another way to see just how much investors, by buying or selling stock, are paying for a stock.

Driving home an example

One of the best recent examples of how fundamental analysis can help you and your portfolio is General Motors. For decades, GM represented the might of U.S. industriousness, know-how, and creativity. GM commanded a massive market value of $3.5 billion in 1928, says Standard & Poor’s. I’ll step you through what market value means in more detail in Chapter 3, but for now, just know that GM was the most valuable company by far in 1928.

For decades, investors figured a dollar invested in GM was money in the bank. The company slugged through upturns and downturns and was a lasting power that helped drive the U.S. economy. The company kept paying fat dividends and kept powering profits higher. There was even an expression: “As GM goes, so goes the nation.”

But investors who blindly bet GM would remain a lasting force and ignored the fundamental signs of trouble suffered a brutal blow on June 1, 2009. On that day, which will forever remain one of the lowlights of capitalism, GM became the fourth-largest public company to seek bankruptcy protection, according to BankruptcyData.com. Shares of GM stock collapsed to just 75 cents a share, down 97% from their level just three years before.

Fundamental analysis may not have helped you predict just how shocking GM’s fate would be. But concrete elements from the company’s financial statements could have tipped you off to just how challenged GM was well before it became a penny stock and was liquidated. GM was ultimately reborn when a new company was created and bought many of the old company’s assets, including the GM name. You can be sure that investors in the new GM paid much closer attention to the fundamentals.

GM VERSUS FORD

Even months before GM filed for bankruptcy protection, fundamental analysis could have served you well.

Back in January 2009, seeing both GM and Ford facing intense financial strain, many investors wondered if either one was worth taking a bet on. Some helpful fundamental analysis tools, including an analysis of the statement of cash flows, could have determined whether you lost a fortune or enjoyed a big gain.

I’ll show you how to read the statement of cash flow in detail in Chapter 7. But for now, I’m just giving you a real example of why fundamental analysis matters to whet your appetite. At the beginning of 2009, both Ford and GM were constantly in the news. Both faced a tough business climate and both had depressed stock prices: Fo...