Fundamental analysis in regard to the sharemarket is a method of assessing whether a company is a good investment using various sources such as financial statements, company announcements, disclosures and economic and industry reports.
It involves an academic approach and considers the overall economy, the industry in which the business operates and the Financial Health (see Lincoln Indicators, no affiliation) of the company. Fundamental analysis looks at both ‘quantitative’ data (eg. revenue growth, margins and financial ratios) and ‘qualitative’ data (eg. management strength, market position, patents and proprietary technology).
Using this method, the company’s valuation is based on past performance, industry trends, growth potential management and competition. Unlike the Efficient Market Theory (EMT), which says that all information is already reflected in current prices and therefore cannot be predicted, fundamental analysis believes that an intrinsic value may be derived and that investors can profit by buying ‘undervalued’ shares and, where short selling is allowed, selling ‘overvalued’ shares. There are varying ideas on intrinsic value. See our post https://superbenefitnews.wordpress.com/2011/03/30/prof-john-price-taught-about-value-of-shares-on-20-march/.
Shares that are undervalued are those that have a higher intrinsic valuation compared to the current market price. Whereas, overvalue shares are those with intrinsic valuations less than the current market price. The assumption here is that in the long run, shares will move towards the intrinsic valuation or the ‘correct price’.
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