What is Fundamental Analysis? A Guide to Building Your Portfolio

Fundamental Analysis

The process of building a stock portfolio requires a good understanding of stock fundamentals and fundamental analysis. These fundamentals serve as indicators of a company’s financial health and provide you with the necessary information to make informed decisions about which stocks to include in your portfolio.

What is Fundamental Analysis?

Fundamental analysis is the method by which a stock’s qualitative and quantitative fundamentals are examined. Quantitative stock fundamentals refer to the financial data associated with a company. These data points are derived from a company’s financial statements, which include the income statement, balance sheet, and cash flow statement. By analyzing quantitative stock fundamentals, investors can assess a company’s profitability, debt levels, and operational efficiency, among other financial aspects.

By undertaking fundamental analysis you can assess a security’s intrinsic value (its ‘true’ value) by examining related economic and financial factors. Intrinsic value refers to the value of an investment based on the company’s financial situation and current market and economic conditions. Fundamental analysts study anything that can affect the security’s value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company’s management.

The objective of fundamental analysis is to come up with a number that an investor can compare with a security’s current price to see whether the security is undervalued or overvalued. This is achieved by conducting a thorough analysis from a macro to micro perspective to identify securities that may be overvalued or more importantly, undervalued.

Fundamental analysis is the cornerstone of any long-term investment portfolio.

Key Stock Fundamentals

There are many key quantitative stock fundamentals that investors typically consider when analyzing a company’s financial health. Here are some of the basic fundamentals:

  • Earnings Per Share (EPS)
    Earnings Per Share (EPS) is a measure of a company’s profitability on a per-share basis. It is calculated by dividing the company’s net income by the number of outstanding shares of common stock. A higher EPS can be an indicator of a company’s profitability and potential for future growth.
  • Price-to-Earnings Ratio (P/E Ratio)
    The Price-to-Earnings (P/E) ratio is a valuation metric that is calculated by dividing a company’s current share price by its EPS. This ratio provides a measure of the price investors are willing to pay for a dollar of a company’s earnings. A high P/E ratio can suggest that a company’s stock is overvalued, or it may indicate that investors expect high earnings growth in the future.
  • Dividend Yield
    Dividend yield is a financial ratio that indicates the amount a company returns to its shareholders in the form of dividends. It is calculated by dividing the annual dividend payment by the current stock price. A high dividend yield can be an indicator of a company’s commitment to returning capital to shareholders. Similarly, index funds can also distribute dividends to their investors. Learn more about how index funds pay dividends to get a broader understanding of dividend distribution across different investment vehicles.
  • Return on Assets (ROA)
    Return on Assets (ROA) is a measure of a company’s profitability relative to its total assets. It is calculated by dividing net income by total assets. A higher ROA indicates a company’s efficiency in generating profits from its assets.
  • Beta Coefficient: The beta coefficient is a measurement of a stock’s volatility in relation to the overall market and can help assess risk.
  • Equity Multiplier: The equity multiplier reveals the proportion of a company’s assets funded by shareholders’ equity. Put another way, it offers an instant overview of how a company’s debt stacks up against its equity.

How to Analyze Stock Fundamentals

The analysis of stock fundamentals involves the interpretation of these and many other financial metrics. When analyzing these fundamentals, a company’s metrics are compared with those of other companies within the same industry. This allows for a more accurate assessment of a company’s relative financial health and performance.

Thankfully, as a new investor you don’t have to undertake your own fundamental analysis of stocks. You could calculate a company’s quantitative fundamentals using publicly available information released in quarterly or annual statements and reports. But most of the time fundamental analysis can be found simply by Googling a company’s name followed by the metric in question such as “Microsoft P/E ratio”.

While quantitative stock fundamentals provide valuable insights into a company’s financial health, they are not the sole basis for investment decisions. Other qualitative factors such as the company’s business model, competitive position, and the overall health of the economy should also be considered.

Using Fundamental Analysis and Analyst Ratings to Choose Stocks for Your Portfolio

Stock fundamentals provide valuable insights into a company’s financial health and can be instrumental in assessing a stock’s potential risk and return. For instance, a company with strong earnings growth and a low debt-to-equity ratio may be seen as a lower risk investment with good return potential. Conversely, a company with declining earnings and high debt levels may be seen as a higher risk investment.

Many financial analysts have already undertaken fundamental analysis on most stocks, and you can get an understanding of the analyst ratings of a stock by googling, for example, “Microsoft analyst rating”. Analyst ratings are assessments given by financial analysts about the potential performance of a particular stock or security. These ratings are typically issued by investment banks or other financial research firms, and they are used to provide investment advice to the public, their clients, or their firm’s clients.

Analyst ratings usually come in the form of “buy,” “sell,” or “hold” recommendations. Here’s what each rating generally means:

  • Buy: The analyst believes that the stock has a good potential for price appreciation and it could outperform the market or its sector in the near future.
  • Hold: The analyst believes that the stock is fairly valued and it will likely perform in line with the market or its sector. Investors who already own the stock are advised to retain it, but new investors may not be advised to buy it at the current price.
  • Sell: The analyst believes that the stock is overvalued or that its future prospects are poor. It is expected to underperform the market or its sector.

In addition to these three, some analysts use ratings like “outperform” (expecting the stock to do slightly better than market averages), “underperform” (expecting the stock to do slightly worse), or “strong buy” and “strong sell” to indicate a particularly bullish or bearish outlook.

TipRanks.com MSFT Analyst Ratings

It’s important to note that analyst ratings are based on the analyst’s research and opinion, and they are not guarantees of a stock’s future performance. Different analysts may also have different opinions on the same stock. Therefore, while analyst ratings can be a useful tool for investors, you should review a range of ratings from more than one analyst, and they should be used as part of a broader investment research strategy.

Diversification is a key strategy in portfolio management, and understanding stock fundamentals can aid in achieving a diversified portfolio. By analyzing the fundamentals and analyst ratings of different companies across various sectors, you can select a mix of stocks that helps to spread risk and potentially enhance returns.

Case Study: Microsoft (MSFT)

Let’s conduct a basic analysis of Microsoft Corporation (MSFT) using five core fundamentals:

  • Cash Flow: Cash flow is a key indicator of a company’s financial health. Positive cash flow means the company is adding to its cash reserves, allowing it to reinvest in the business, pay back investors, reduce debt, or save for future challenges. Even with substantial investments in growth and trends in emerging markets, Microsoft maintains a robust free cash flow (FCF) balance. With a 5-year average exceeding US$50B, Microsoft demonstrates fundamental business health, possessing the financial capacity to allocate the necessary resources to ensure sustained revenue growth over the long term.
  • Return on Assets (ROA): Microsoft’s ROA is 4.814% as of March 31, 2023. This indicates that Microsoft is fairly efficient at using its assets to generate earnings. A higher ROA indicates a company is more efficient in generating profits from its assets.
  • Conservative Gearing (Debt to Equity Ratio): Microsoft’s debt to equity ratio is 0.2942 or 29.42% as of March 31, 2023. This indicates that Microsoft has a relatively low level of debt compared to its equity, suggesting a conservative financial position. A lower ratio means the company is using less leverage and has a stronger equity position.
  • Profit Retention (Retained Earnings): Microsoft’s retained earnings are $108.2 billion as of March 31, 2023. This is a substantial amount of retained earnings, indicating that Microsoft has been retaining a significant portion of its profits, potentially for reinvestment in the business. A higher level of retained earnings can be a good sign as it might mean the company is profitable and growing.
  • Price to Earnings Ratio (P/E): Both novice and seasoned investors often turn to P/E ratios as a straightforward method to assess a stock’s value and determine if its price is reasonable. At present, Microsoft’s trailing twelve-month P/E ratio is 37.48, a bit above the S&P 500 industry average of 26.37. This could suggest that investors anticipate Microsoft to outperform its peers in terms of growth, or it might imply that Microsoft’s stock is overpriced when compared to its benchmark index.

Based on these stock fundamentals, Microsoft appears to be a financially healthy company with strong profitability, efficient use of assets, conservative financial leverage, and significant reinvestment in its business. These are just a few of the many financial metrics you can use to evaluate a company’s financial health and investment potential.

Limitations of Stock Fundamentals

While stock fundamentals are a vital part of investment analysis, they are not the only factors to consider when choosing stocks for your portfolio. Qualitative factors such as a company’s strategy, industry trends, and macroeconomic factors also play a significant role in its potential for success.

For instance, a company may have strong quantitative fundamentals, but if it operates in a declining industry or faces significant regulatory challenges, its future performance could be at risk. Similarly, macroeconomic factors such as economic growth rates, inflation, and interest rates can impact a company’s profitability and stock performance.

Other Tools for Stock Analysis

In addition to fundamental analysis, other tools such as technical analysis and qualitative analysis can provide valuable insights. Technical analysis involves studying price patterns and trends to predict future price movements. It can complement fundamental analysis by providing insights into market sentiment and potential turning points in stock prices.

Qualitative analysis, on the other hand, focuses on non-quantifiable factors such as the quality of a company’s management team, its competitive position, and the strength of its brand. These factors can have a significant impact on a company’s long-term success and can provide important context to the numbers revealed in fundamental analysis.

While stock fundamentals are a crucial part of the investment decision-making process, they should be used in conjunction with other tools and considerations to build a well-rounded view of a company’s potential for success.

Frequently Asked Questions


  • Marcus Anderson

    Marcus Anderson is a seasoned investment specialist and a key contributor to MoneyMaver. With a passion for making investing accessible to everyone, Marcus has dedicated his career to simplifying the world of finance and helping people make informed investment decisions. Marcus holds a degree in Finance from the University of Pennsylvania's Wharton School and has over a decade of experience in the financial sector. He started his career as an investment analyst for a major Wall Street firm, where he honed his skills in financial analysis and investment strategy.

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