What It Is:
How It Works/Example:
Fundamental analysis observes numerous elements that affect stock prices such as sales, price to earnings (P/E) ratio, profits, earnings per share (EPS), as well as macroeconomic and industry specific factors.
Fundamental analysts use either top-down or bottom-up methods of analysis, or sometimes both.
A top-down analysis might function in the following manner:
1) The entire market is analyzed, including global and macroeconomic indicators
2) The specific sector, such as Technology
3) The industry, for example semiconductor manufacturers
4) The specific stock, for example company ABC
Conversely, a bottom-up analysis starts by investigating specific stocks first.
The fundamental analyst observes trends, market and price movements, company financial statements, interest rates, return on equity (ROE), and numerous other indicators with one goal in mind: buying or selling stocks that will provide a high return on investment (ROI)
Why It Matters:
Fundamental analysis, like technical analysis, attempts to predict which stocks are valuable and which are not. According to its proponents, fundamental analysis offers a fuller picture of the possible movements of both the stock market and individual stocks because as many elements as possible are investigated. Technical analysis, on the other hand, only looks at past data of stock prices. Perhaps the greatest argument in favor of fundamental analysis can be made by observing the success of one of its most famous proponents: Warren Buffett.