Warren Buffett says:
"Only buy something that you'd be perfectly
happy to hold if the market shuts down for ten years"
If you could perform Stock Market Fundamental Analysis like Warren Buffett What would it feel like?
We can't promise you that, but we can promise that by the time you've devoured this section, you'll be a lot wiser than you were before you started.
To be like Warren Buffett and his sidekick - Charlie Munger, would take a lifetime of study.
So let's open up this topic called Stock Market Fundamental Analysis, some would regard as boring, and try and turn it into something "almost" exciting.
After all, if it's going to make you a lot of money so there must be some enjoyment in it. Right?
Stock Market Fundamental Analysis will be the cornerstone of your Retirement Investing.
Stock Market Fundamental Analysis is, as the name implies, analysing the basic parameters of a company's shares.
Here's the dictionary definition of each word:
Fundamental: 1. basic,
2. an essential part of something
Analysis: 1. close examination
2. assessment or explanation of something
From those definitions we like to think of Stock Market Fundamental Analysis as a basic, yet essential close examination of something. In this case, we want to assess a share's financial performance, over time. Detailed, but keeping it as simple as possible.
It might be called "fundamental" but knowing where to start is not that easy.
We think we'd all like to emulate Warren Buffett, and a lot of what you'll read on this website is modelled on his principles.
But we're not Warren Buffett. We're simple, private investors who are investing for our retirements using tried and proven principles. Just following the work done by others because we haven't got the skills, time, or inclination.
Now here's the good news.
You don't need to pore over a company's financial stuff (but you can if you want to), all that grunt work has been done for you. But you do need to have a little understanding of what's what: 'Financial Statements', 'Financial Ratios', etc. are.
What we like to do, and we would suggest you do the same, is look at 'Financial Ratios'. They're easy to understand which is what we're sure you want to hear.
A good understanding of 'Financial Statements', without any jargon, will help you piece it all together.
You don't need a degree in accountancy. You just need the "30,000 foot view".
Start with the basics.
There are two sorts of Stock Market Fundamental Analysis. Quantitative and Qualitative.
Sounds like just two words that are hard to pronounce. We might have trouble saying them late on a Friday night!
As always, we like to break these somewhat unknown words down, so that we really understand what they mean. Back to our trusty dictionary then.
1. relating to quantity, based on the amount or number of something
2. measurable, capable of being measured or expressed in numerical terms.
Relating to, or based on, the quality or character of something
The Holy Grail of Stock Market Fundamental Analysis is finding what a share is really worth.
The price that you see in the markets for a company's shares is not necessarily its "real" value. What you see is known as the Market Value.
The "real" value is sometimes known as its Intrinsic Value.
This may be best explained with a simple example. Suppose the value of a company you are researching is 300p but in the market it is trading at only 260p. The 300p tag is the Intrinsic Value (or "Fair" value).
As a value investor you would want to buy this stock (if everything else looks favourable) at a price which is lower than this Intrinsic level. Which in the above example it is, (260p is lower than 300p).
There are two problems here though. One, you don't know for sure if your Intrinsic valuation is accurate and two, you don't know how long it will take for the market price to catch up with your valuation.
This section of the website will detail lots about Intrinsic Value. For now, just accept that if a share is below Intrinsic Value it could be cheap (but maybe get cheaper) and if it's above its Intrinsic Value it could be expensive (and maybe get even more expensive).
But as mentioned many times on this website, we use Fundamental Analysis to identify what shares to buy, and then we use Technical Analysis to tell us when to buy (and sell).
But right now, we're just looking at some basic Fundamental Analysis.
In the above paragraph, we just looked at the "quantitative" part of Fundamental Analysis. Analysis that attempts to value a company's shares by concentrating purely on its financials. e.g. is the company growing, does it make a profit, can it pay its debts, etc.
Now we're going to look at the "qualitative" part of Fundamental Analysis. Analysis that attempts to value a share on less tangible items. e.g. quality of management, brand awareness, etc.
When analysing a company's shares most amateur investors only look at things like its Dividends, Earnings per Share, Price/Earnings Ratio, etc. but a total analysis means looking at everything a company does.
One of Warren Buffett's biggest concerns is understanding a company. He wants to know what the company does, how does it earn its money. He likes to know everything about a company if he's going to invest.
He hardly ever invests in tech companies. Why? Because he reckons he doesn't understand them.
He therefore looks at financial aspects of a company, but also the other aspects of a company. He looks at its management, its brands, its patents, its production methods and, and, and ...
A good analyst will look deep into a company. The accounts are but one aspect (the quantitative side) the other aspect is the qualitative side.
This involves looking at a company's business model. What do they do? How do they do it? To be able to invest in a company with confidence, an analyst needs to be thorough in his research.
Has the company got a Durable Competitive Advantage? Like Coco-Cola with its strong brand name. Or Microsoft's dominance of the PC market. Or GSK's brand and dominance in pills and potions.
Warren Buffett calls these "economic moats." What he is referring to is companies that build a fortress and surround themselves by impregnable waters. Hence the term economic moat.
They are companies that have a strong foothold in particular markets. Markets that are difficult for others to replicate.
It can be quite tricky assessing a company by Qualitative Analysis. Armed with information such as brand names, patents, and methods of production, professionals have to make their best judgement. As amateurs we can only make educational guesses.
Look on the corporate websites of companies that are of interest, they are publicly available. Find out as much as possible about the people running the company.
We like to see who's buying their company shares and who's selling them. Those selling may be doing so for a good reason. We kinda don't take too much notice of director sales (unless the shares look like a sell on other grounds).
But we do take notice of directors buying. It shows confidence that they have in their company.
This information is readily available and you should take note.
Another thing we look for, is how many customers a company may have. Those with only a few customers could be vulnerable.
Companies with a large market share have Warren's Economic Moat. That market share will protect future earnings, in good times and bad.
And will that market share continue to grow? Probably.
As you can see then. It's not just about numbers. The qualitative aspect of share analysis can be just as important.
You now know that you need to observe two aspects of Fundamental Analysis - Quantitative and Qualitative. You also understand that using Qualitative Analysis reveals the other side of a company that you should investigate.
Using Quantitative Analysis can result in finding the "Fair Value" for a share.
The Holy Grail of investing. If you can ascertain the "Fair Value" of a share, at any given time, you can make money over and over again. It's a big "IF" but well worth the effort.
Sidebar: Joel Greenblatt wrote: "Value Investing is figuring out what anything is worth and paying a lot less for it."
To begin, we'll outline the first steps to finding this Holy Grail - 'Financial Statements'.
There are three 'Financial Statements' to look at.
1. 'The Balance Sheet'
2. 'The Income Statement'
3. 'The Cash Flow Statement'
And towards the end of this article, we'll give you a brief introduction to 'Financial Ratios'. We like them, they are understandable. And we like anything that's simple and understandable.
So how do the three 'Financial Statements' relate to one another?
1. 'The Balance Sheet'
'The Balance Sheet' represents a record of a company's assets, liabilities, and equity at a given point in time.
It is called a "Balance" sheet because the company's finances have to 'balance' as in the equation below:
Assets = liabilities + shareholders' equity
Assets represent what the company owns or controls: cash, inventory, machinery, buildings etc.
The other side of the equation represents the total value of financing the company has used to acquire the assets.
Liabilities represent debt (which has to be repaid).
Equity represents the total value of money that the owners have put into the business. This includes retained earnings (profit from previous years).
Sidebar: Warren Buffett just loves the type of company that ploughs money back into itself. His company, Berkshire Hathaway, has never, ever, paid a dividend for this reason.
2. 'The Income Statement'
Whereas the 'Balance Sheet' is a snapshot of the company's finances at a given time, the 'Income Statement' is a measure of the company's performance over a specific time period (usually quarterly or annually).
'The Income Statement' represents information about a company's revenues, expenses, and profit that were generated over that period.
3. 'The Cash Flow Statement'
'The Cash Flow Statement' represents a record of the amount of cash a company has coming in and a record of the amount of cash a company has going out.
A 'Cash Flow Statement' can be important because it is difficult for a company to "fudge the figures". Earnings figures can be manipulated by "creative" accountants but it's nigh on impossible to manipulate what's in the bank.
We'd like to think that we've come across all the 'Financial Ratios' that there are, but alas, we keep seeing new ones. We know of 30+ ratios and you'll find them all in this section of the website.
The most common ratios we're sure you've already come across: the likes of 'Price/Earnings (P/E) Ratio', 'Price Earnings Growth' (PEG) ratio, 'Dividend Cover', 'Price to Sales Ratio', 'Return On Capital Employed', etc. etc. etc.
It's useful to know what these ratios are. They will keep cropping up and you will need a basic understanding of what they are.
Besides, one or more of these ratios may well decide what company you'd like to invest in.
There are many, many books on the subject of Stock Market Fundamental Analysis, we can only list here the few that we have consumed.
As we devour more, we will list them here, so keep coming back to this web page.
The Intelligent Investor by Benjamin Graham
Benjamin Graham was, arguably, regarded as the greatest investment advisor of the 20th. century. His philosophy of "value Investing" taught investors, such as Warren Buffett, the virtue of long-term investing.
The Intelligent Investor is regarded as the stock market bible.
It is essential reading, even if you do not agree with some of Graham's philosophies.
The fact that it is one of Warren Buffett's top three recommendations is a good enough testimonial to its usefullness.
Click the link below to reserve your copy:
Summary of The Intelligent Investor published by Business News Publishing
We love summary books. We don't read them instead of the full work but in addition to.
The Summary adequately covers Graham's 6 principles of Value Investing and although only 40 pages in total it will:
We just love the work that Benjamin Graham put into this volume. Any work by him is worth consuming and this is one of his best. You can get it right here:
If you prefer a quick read, and still get the gist, click the link below for a summary of Ben Graham's classic:
Value Investing From Graham to Buffett and Beyond by Bruce Greenwald
Benjamin Graham taught Value Investing to all of his students - Warren Buffett being one of his stars. In fact, the final Part (III) of this resource details how 8 successful value investors put the principle into practice. Among these eight are: Warren Buffett, Mario Gabelli, Walter and Edwin Schloss, and Paul Sonkin.
The book is ideal for private investors. Part I starting with the basics and Part II detailing sources of value.
If you want to emulate the Warren Buffetts of this world, this is an ideal resource for you.
Get your copy of this must read book for the private investor by clicking the link below:
You Can Be a Stock Market Genius by Joel Greenblatt
Joel Greenblatt is a genuine pro investor. He has achieved 50% annual growth for over a decade.
This book is a practical and easy reference with plenty of case studies. It also contains all the tools that you will need.
Chapter 2 details seven basic rules for successful investing. The author reckons that all it takes is a little extra time and effort.
To quote Greenblatt directly from his book:
idea behind this book was to let you know about a snowball sitting on
top of a hill, to provide you with a map and enough rope and climbing
gearso that you can reach the snowball. Your job - should you choose to
accept it - is to nudge it down the hill and make it grow."
Order your copy now by clicking the link below:
Warren Buffett and the Interpretation of Financial Statements by Mary Buffett and David Clark
The dynamic duo are at it again.
This book is loosely based on Benjamin Graham's work of a similar name and is ideally suited for the private investor. It provides insights into how Warren Buffett pulls apart a company's accounts looking for those Economic Moats.
Who would have thought that a resource about company accounts would be readable? But Mary Buffett and David Clark have successfully done just that.
If you want to understand how Warren Buffett values a company, and you definitely should, then this resource should be very near the top of your shopping list.
Click the link below to reserve your copy now:
The Tao of Warren Buffett by Mary Buffett and David Clark
I don't normally rave about any one particular resource because I find most of the books on my bookshelf infomrtive and/or entertaining.
But this book is both informative and entertaining. And very, very readable. I don't normally read a book in one sitting, but this is one of those rare times when I did just that.
Warren Buffett didn't write too many books himself, this one was co-written by his ex-daughter-in-law and noted journalist DAvid Clark.
Warren Buffet's quotations are legendary and you will find his best ones here in this publication together with wise explanations. All 125 of them.
A must have for your investing bookshelf, click below to get your copy now:
We'd like to think that you now look at 'Stock Market Fundamental Analysis' as a lot less stodgy a subject as you did before.
The idea is that you do not become a financial genius, rather just a good understander of the basics - without any of the jargon.
You are not expected to do any of the number-crunching yourself, all that has been done for you. The end game is to be able to find "forever" stocks that you can buy and keep for years or longer (if you want to).
N.B. The term "forever" refers to individual shares that are a always a buy, in rising markets. You would NOT even want to be invested in these shares in a severe Bear Market.
You want to be able to buy and sell these "forever" stocks over and over and get your portfolio performing even better. Stock Market Technical Analysis will show you how to do that.
But you have to have something to buy first. Use the techniques given in this section to ensure you invest in good, solid companies. Companies that have that 'Durable Competitive Advantage'. Over time, they will make you a lot of money.
Remember, it's Stock Market Fundamental Analysis that will tell you what to buy.
If you really are new to investing, or if you lack confidence or even success, read a series of articles that cover a lot of how Warren Buffett invests his money. He has made his fortune, and others fortunes, by weeding-out Undervalued Stock.