Fundamental Analysis: Finding the Real Value

Fundamental analysis is a common phrase in conversations about a company’s value, health, and liquidity. What makes up this analysis style and how do you go about assembling it?  Reda Farran, Global Markets Analyst at Finimize joins Cassidy Clement to discuss.

Summary – Cents of Security Podcasts Ep. 93

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement 

Welcome back to the Cents of Security podcast. I’m Cassidy Clement, Senior Manager of SEO and Content here at Interactive Brokers, and today I’m your host for the podcast. Our guest is Reda Farran, Global Markets Analyst at Finimize. Fundamental analysis is a common phrase in conversations about a company’s value, health, and liquidity—but what exactly makes up this analysis style, and how do you go about assembling it? 
In this episode, we’re going to explore all of that and more. Welcome back to the program, Reda. 

Reda Farran 

Sure, nice to be back. Thank you for having me again. 

Cassidy Clement 

Of course. We have touched on technical analysis in our episodes here on Cents of Security in the past—a little bit more in-depth—but it’s about time we go into fundamental analysis. So what exactly is it, and are there certain elements or maybe fundamentals—no pun intended—that make up this analytic strategy? 

Reda Farran 

Yeah, sure thing. There are many ways to go about analyzing a particular investment. You touched on technical analysis. I’m sure you’ve had some experts come up to your show and explain what that is. And fundamental analysis is basically another particular way or method of looking and analyzing a particular investment. 
I’m sure we’re going to focus a lot on stocks in this podcast. You can apply fundamental analysis really to almost any investment. What does it involve? From the name, it involves analyzing the underlying fundamentals. So if you are looking at a particular stock—what is the stock at the end of the day? A piece of paper that gives you partial ownership in a company. 
So if you wanted to analyze, using fundamental analysis, a stock, what you’re going to end up doing is basically analyzing the underlying company. So you will be looking at factors such as its financials, its management team, its competitive position, the wider industry, and so on—trying to analyze these underlying factors and ultimately trying to come up with some kind of view on the intrinsic value of the stock. 
So basically, what you think the stock is actually worth, regardless of what the stock price tells you—but what you think the stock is actually worth based on the company’s, like I said, underlying profitability, cash flows, its position within the wider industry, and so on. 

Cassidy Clement 

Yeah. Really what it seems to come down to is: we’re looking for what value would accurately be attributed to this stock or item because of a change in price, whether it’s up or down—and then, of course, wider market trends. 
So when we compare this to technical analysis—and it’s a common thing where somebody says they’re for technical analysis over fundamental analysis or vice versa, or sometimes a mix—what exactly is the difference? And the age-old question: is one actually better than the other? 

Reda Farran 

That’s a great question, and I will get to that—but maybe just to explain the differences. So I already explained what fundamental analysis is, right? So you’re analyzing the underlying fundamentals of the investment. If you’re looking at a stock, it’s the company in question. 
If you’re looking at a government bond, then you’re really looking at the underlying finances of the country or the government in question, and so on. So you’re doing this kind of deep analysis, trying to come up with a view of whether you think the stock is undervalued or overvalued. 
So is the stock price above where you think the intrinsic value is and you should avoid it? Or is the stock price meaningfully below where you think intrinsic value is? 
So you’re trying to come up with a view on what you think the stock is worth. 
Now, fundamental analysis, I would say, is more long-term focused. Because just because you find an undervalued stock, it doesn’t mean—hey, tomorrow, suddenly, the stock price is going to go up to where you think the intrinsic value should be. 
In the long run, stock prices do trend or converge toward intrinsic value. In the short run, you have these crazy kind of whipsaws—volatility, prices can be very overvalued, very undervalued, and so on. 

Technical analysis doesn’t really care much about underlying fundamentals. The argument the technical analysts make is that the stock price captures all of the underlying fundamentals—and there’s a certain element of truth to that, right? 
If you have a particular company that’s growing its earnings consistently every year and so on—so its earnings are going up like that—you’re going to probably find its stock price also going up, reflecting that growth. 
So the underlying argument, or the big argument they make—which has a lot of truth, to be quite honest—is that the stock price already captures a lot of the fundamental information. And because they believe that, technical analysts say, “Look, the most important thing to analyze is the stock price and volume attributed to that,” and so on. 

So they’re looking at the stock price, they’re looking at stock graphs, they’re computing different indicators, they’re looking for trends and patterns in the stock chart—and trying to take buy or sell decisions based off of that. 

Now, which is better? 
Look, personally, I really don’t like when certain investors who are hardcore fundamental analysts completely dismiss technical analysis—and vice versa. 
Some people who are really into technical analysis say, “Hey, fundamental analysis is useless.” 
The truth is—or perhaps my truth, what I believe—is that both are really useful. 
At the end of the day, these are two tools—not mutually exclusive, quite complementary—two tools that you have at your disposal as an investor to take good investment decisions. 
Why just say, “This one is correct,” and completely dismiss the other? 
Why don’t you try to utilize both of these tools in your own investment decision-making? 
It’s completely fine to have a stronger preference for one of the two. 

Personally, because I spent the bulk of my career as an equity analyst, I like fundamental analysis more—but that does not mean I dismiss technical analysis. I actually still use it. 
For me, fundamental analysis tells me what to buy. 
So basically, if I find stocks are cheap, trading below where I think their intrinsic value should be— 
But then technical analysis tells me when to buy. 
So it helps me as a timing tool, essentially. 

And I think that’s really reasonable, because even if you’re correct about a particular stock—you think it’s undervalued— 
But then if you look at the chart, and you look at the technicals, and it’s just in this massive downtrend— 
Perhaps that’s not the right time to buy it. 
But perhaps there’s what technical analysts call a “trend reversal.” 
So basically, you’re seeing this big downtrend, you think the stock is undervalued, and then something happens—maybe a catalyst kicks in, some rumors of a takeover attempt because the company is too cheap, etc. 
Suddenly the stock price jumps up, and then you get this uptrend. 

It’s fine—I’d rather miss out on the first 10–20% of the stock rebounding, but then capture the rest of the upside, as opposed to buying a stock in a downtrend and continuing to hold it as it falls. And Cassidy, I’m going to ask you a question. What’s the difference between a stock that’s gone down 80 percent and a stock that’s gone down 90%? 

Cassidy Clement 

Depends on who you’re asking. Somebody might say it’s undervalued, so they have the potential to buy more on the downtrend at 90, while others may say, “I want to get out fast,” and it leads to a panic. 
I hate that was my answer, but all of my years of finance content—I feel those are the two viewpoints I hear the most. 

Reda Farran 

It’s a really good answer. I’ll tell you perhaps a funnier, but even truer, answer. A stock that’s gone down 80 percent has gone down 80%. A stock that has gone down 90% has, first of all, gone down 80%—and then halved. 
Think about it. If you had a stock at a hundred, it goes down to 20—that’s an 80% drop. Then you halve the 20, and it goes down to 10. So it’s gone down 90%. 

What I mean by that—so even though a stock has gone down 80%—okay, it’s gone from a hundred to 20—you’re like, “Cool, this is now undervalued. I’m gonna buy it at 20.” And then it halves and it goes to 10, and you lost 50 percent of your money. 

So I guess what I’m trying to say is: look, technical analysis can go hand in hand with fundamental analysis in the sense that you can use fundamental analysis to try to discover undervalued stocks, but then you can try to use technical analysis as a timing tool—when to jump in, when to buy it—as opposed to buying in too early if a stock is in a massive downtrend and then losing a lot of money. 
Ideally, you want to buy a stock when it’s in an uptrend and ride it. And you want to try to avoid those stocks that are just perpetually going down. 

Cassidy Clement 

I think those were really great points, because really when it comes down to it, you have to think about—before you go and apply an analysis style or strategy—A) do you have any background or education on the matter, if it’s you actually initiating this strategy? 
There’s a chance that you may have an advisor or someone else who helps you with your financials. 

The other elements, of course, are: what is your risk tolerance? Your financial goals? Is there any type of trading style that you utilize because you either have to, or because that’s the type of trader you are? 
All of that goes into what elements you can pick and choose from either of those strategies. And also, if you tend to favor one over the other—which, as you mentioned, it’s really dependent on what type of trader you may be. 

Your example is very good, and I think it may be a little complex for those who are just getting into the area, but that’s the exact point. These strategies are not hard and fast and proven for thousands of years to be better than the other. 
There’s a lot of elements to it, and the market’s unpredictable. So when we go to fundamental analysis, though, there’s a lot to still consider. 

Reda Farran 

Yeah, absolutely. You said it really well. I think, look, there’s no secret sauce. 
To me, if you ask me what’s the secret to investing, it’s having a good investment process and sticking to it. 
But that second part—sticking to your investment process—you’re only more likely to do that if your investment process is tailored to your own investment style and your own kind of personality. 

If you happen to be more of a short-term trader—that’s your particular style—then perhaps technical analysis is better geared toward you, because technical analysis is more short-term in focus. 
If you happen to be a long-term investor, then fundamental analysis will perhaps be better geared to you. 

So if you adopt a particular process that’s more aligned with your style and personality, you’re more likely to stick to it. 
But that doesn’t mean you have to completely disregard the other particular method. 
You could be a fan of fundamental analysis, utilize it heavily, but still back it up with some technical analysis. 
Like I said at the start—these are two tools. They’re not mutually exclusive; they’re complementary. 
If you want to be a good investor, it doesn’t matter if you think theoretically this method is better than that. 
What matters is to make money. 
And you’re more likely to make money by using many different tools to arrive at a smart investment decision. 

Cassidy Clement 

Yeah. There’s definitely the question of: does this actually fit what I need when it comes to your application? 
But when we actually look at technical analysis and fundamental analysis, there are elements that go into each of them that—some people may say, “Okay, I get it in the example, but where do I actually find these metrics to help initiate my strategy?” 

And what I mean by that is—it’s a common lesson in business school or economics—which is finding certain statements or filings from a public company to be able to utilize in different ratios or formulas to bring you to different fundamental metrics, performance metrics, etc. 
So for fundamental analysis, where would someone go for the elements? 

You would initially think, “Okay, if you’re calculating earnings per share, there’s a certain formula,” but where would you find those numbers? 

Reda Farran 

So the good news is that it’s honestly never been easier to find this kind of information in this day and age. 
And also—and we can touch on this as well later—but also thanks to AI, it’s also never been easier to arrive at summaries of big annual reports and so on. 

So in terms of where you find this information: every single publicly listed company has a dedicated investor relations website, where they have their annual reports, investor presentations, financial statements, and so on. 
Those are a great place to start—particularly the annual report—because the first X amount of pages in any annual report is a very in-depth overview of the business. 

You cannot invest in a stock if you’re using fundamental analysis—if you’re doing technical analysis, it’s fine. You hear a lot of analogies of people buying and selling things they don’t even know what company it is. 
But if you’re doing fundamental analysis, and you’re trying to understand the company and value the company, you need to have a really good understanding of what this particular business does. How does it make money, exactly? 

So the very first section of an annual report has a very in-depth overview of the business—it’s called “Business Overview.” 
They tell you what they do, who their customers are, who their suppliers are, and so on. 

Also, the annual report is really good in the sense that it lists all the big risks facing the particular company—or that could impact a company. 
I think that’s something really important—something very overlooked with beginner investors. They focus a lot on the upside, not so much on the downside. 

And what I mean by that is—everyone’s trying to find the next big winner, focusing on how much money they can make in a stock—but they don’t think enough about the risk. What could go wrong? And how much they can potentially lose in a particular stock. 

And I can tell you one thing about investment success: it’s not so much about how many winners you have, but it’s about avoiding catastrophic losses. 
If you concentrate your portfolio in a few stocks that end up going down 50%, it’s going to be very hard for you to recover from that. 

So the annual report is a great place to start. 

They also, in the annual report, obviously have financial statements. You can find summary financial statements on the website and so on. Investor presentations are a really great resource—I would encourage any investor to look at those. 
So these are PowerPoint presentations done by company management teams that, again, provide very nice summaries and overviews of the business. They provide outlook—you know, their future outlook, where they expect, let’s say, their revenues, their profits to go, and so on. 
Very useful source of information. 

Now in terms of particular financial metrics that you mentioned—earnings per share—and in fundamental analysis, there are hundreds of ratios you can compute, from profit margins to return on equity, and so on. 
The good news is, you don’t have to sit down and calculate all of these yourself. I think it’s good if you have an understanding of how these ratios are calculated—because only if you understand how a ratio is calculated and what it tells you can you actually interpret it—but you don’t have to sit there and manually calculate all these ratios for a company you’re interested in. 

You have plenty of websites online—Yahoo Finance, CNBC, Koyfin, Atom Finance, etc.—so basically cheaper versions of the Bloomberg Terminal that calculate all these ratios for you. So you don’t have to waste a lot of time doing it yourself. You can go to these platforms, go to these websites, look at the key financial ratios for a particular company. 
It can be very telling. 

One thing to keep in mind: looking at a particular financial ratio—let’s say a company’s profit margin or return on equity—is okay, good in isolation, but it becomes a lot more informative if you can compare that company’s ratios to other companies in the industry, or if you compare it to the company’s own history. 
So, for example, you see this year, this company’s profit margin is 20%. 
Okay—is that good or bad? It depends, right? 
If its profit margin five years ago was 50%, then you’re like, okay, that’s really bad, right? Its profit margins have gone down. 
But if its profit margin was 5% five years ago, then that kind of tells you, okay, this company’s becoming more cost-efficient, becoming more profitable, and so on. 

Going back to that 20% example—you need to take that within the context of the industry. 
If you’re looking at a company in the software industry—software is well known to have high profit margins because you’re selling software, not physical products—then perhaps that 20% suddenly doesn’t look that good. 
You look at similar companies in the industry selling similar software—they have profit margins in the 40% range. And then you’re like, okay, this particular company is not so good relative to its peers. 

So what I’m trying to say—or the key takeaway from all of this—is that it’s really important to look at financial ratios, but it’s also really important to put those ratios in context. Compare them to the company’s own history, and compare them to other companies in the wider industry. 

So that’s where you get the statements, that’s where you can look at and get those financial ratios, and you compare them with other companies. 

And then the last thing I want to touch on—it’s again a relatively new development—is AI. 
And I said, it’s never been easier these days to not only access information, but to try to understand and interpret information. 

Look, I am not telling you—and this is completely wrong—to rely on AI to make investment decisions. No. 
But AI can be a really useful tool to make your research process faster, more efficient, and perhaps more informed. 
Right now, you can literally open ChatGPT, upload a PDF—so upload an annual report of a company—and have a conversation. 
And basically ask ChatGPT to summarize the company’s business model. Ask it to summarize the key risks facing the company. 
You can even ask ChatGPT to calculate some of the financial ratios we mentioned, give you some interpretations, and so on. 

So basically now, you can use—there are plenty of AI tools out there—to help you with this process of fundamental analysis. 
Again, don’t rely on an AI tool to conduct all the analysis and come up with investment decisions, but use it as a tool to help you make your process more efficient, faster, and perhaps more informed. 

Cassidy Clement 

I think that’s a really good point, because for a long time—at least within, let’s say, the past 10 to 15 years—while we did always have Yahoo Finance and other additional financial websites, the large-scale idea was: you need to have large-scale data in order to look at this from a broader picture. 

And what I mean by that is: the idea almost was, unless you had access to humongous data sets—like a Bloomberg Terminal—your fundamental analysis was limited and potentially flawed. 
We’re at the point now where you have all of these presentations and elements and investor relations websites that are pretty robust. 
You have some tools that involve AI or larger databases really at your disposal—where you can look at these ratios and not look at them in a vacuum. 

And you came up with the competitive analysis—well, not came up with—but mentioned it; it’s a common one. 
And I think it’s really important to look at things in the view of the sector itself, because some example you might have is—maybe you look at Tesla and think of it as an automotive company and not necessarily an innovative technology company. 
If you look at it in relation to the rest of the automotive market, those ratios can be incredibly different from those of a standard American, we’ll say, automotive company—because they’re not as focused, we’ll say, on the technology and innovation as much as they are more of a blue-chip type of company. 

And it’s important to keep those things in mind, and that’s where you need to utilize maybe an AI or some type of larger data assistant—because there may be, in some cases, a hundred years’ worth of data now as we’re getting closer to 2029. For Ford, that would be about a hundred years, if I believe so. 

It’s helpful to utilize that for a larger trend. While trends may lean themselves more toward a technical analysis, fundamental analysis elements will absolutely bleed into that. 
That kind of leads me into my next question, which is: the way that fundamental analysis is used outside of just ratios itself—are there certain ways that it’s used for a larger scale of analyzing liquidity, or maybe overpriced or underpriced sectors, or maybe just broader company health or industry health? 

Reda Farran 

100%. You touched on quite a few there. 
And fundamental analysis is not purely looking at ratios. Actually, if you say “looking at ratios,” that’s assuming that fundamental analysis is purely quantitative—which it isn’t. 
There’s a big qualitative element to fundamental analysis. 
Companies don’t operate in a vacuum, as you rightfully said. Companies operate in a wider industry. 
So a big part of fundamental analysis that’s very qualitative in nature is analyzing the particular industry that this company operates in. 
So: how competitive is the industry? Who are the competitors? 

How cutthroat is the competition? Who are the key suppliers, the key customers of this particular industry? What are the regulations for this particular industry? 
Some industries are heavily regulated—like utilities, for example—so you cannot just sit down and invest in utilities purely quantitatively, because you need to understand qualitatively the quality of regulations in different states, because utility regulation differs from state to state, and so on. 

As you also mentioned—things like liquidity—trying to understand: is this company financially solvent? Can it actually meet its debt obligations or not? Or is it on the verge of going bankrupt? 
That particular form of fundamental analysis is really done by shorting analysts—so people who are looking at companies and stocks to bet against. 
So basically betting that the stock price will decline. 
They’re not interested in profitability ratios as much—they’re more interested in things like debt, and so on. 
Is this company on the verge of going bankrupt? Is this in a declining industry? And so on. 

So there are many different ways to use fundamental analysis. It’s really important to stress—it doesn’t have to be, and it shouldn’t just be, quantitative. There’s a big qualitative element to it. 

We touched on industry. I think quality of the management team is another really important thing to consider—very qualitative in nature, but something really important. 
You can have a phenomenal company, and then you put in a really bad management team in there, and they’re going to drive the company to zero, right? 
And vice versa—you can have a very troubled company, bring in an external kind of new management team that has a really strong background in turnarounds, and then they manage to turn the company around. And there’s a lot of money to be made in these kinds of situations. 

So qualitative analysis is equally as important as quantitative analysis. 

You touched on things such as liquidity, profitability, and so on. I said at the start, when I was explaining what fundamental analysis is, there are many different things and different ways to do it. 
But one of the main end goals is to arrive at a valuation of the company—so basically arrive at what you think the intrinsic value of the stock should be. 
That involves basically doing a valuation on the company. 

And there are different ways to do that. You can use shorthand, shortcut methods—like looking at price-to-earnings ratios of that particular stock, comparing it to its peers, and so on—to more very detailed methods, such as doing a discounted cash flow model. 

And on that kind of detail, that takes me to an important point—which is that fundamental analysis can be time-consuming sometimes. 
Perhaps that’s why it’s not for everyone. 
If you’re a casual investor, a bit time-constrained, you have a full-time job—deep fundamental analysis might not be the best approach for you, because it is rather time-consuming. 
But that’s the end goal at the end of the day—to have that in-depth understanding of the company in question and arrive at some kind of view on the valuation level of the stock. 

And to try to buy undervalued stocks that you think are undervalued, and then to avoid—at the very least—stocks that you think are overvalued. 
Or, if you happen to be confident enough to implement shorting strategies, even short stocks you think are very overvalued. 

Cassidy Clement 

You mentioned a little bit about the time consumption if you do fundamental analysis traditionally—fully doing your own calculations, etc. 
My last question is really about the limitations and strengths of incorporating fundamental analysis into your research for financial strategies. 
Could you speak a little bit on that—for maybe some rules or ideas to keep in mind before people just jump into it, and then they find themselves a month later with two new calculators and Excel spreadsheets that are a thousand lines deep? 

Reda Farran 

Absolutely. So the pros and cons—let’s perhaps start off with the cons, because I led into—we drifted into this by me talking about one of the cons of fundamental analysis, which is that it is quite time-consuming. 
That is the truth. Look, you can do shorter, simpler fundamental analysis in a shorter amount of time, that’s fine. 
But if you think about these professional equity analysts who are studying stocks for a living—they conduct really in-depth fundamental analysis, which is very time-consuming. 

When I was an equity analyst at Fidelity, on average, it took me about two full weeks of work to do an in-depth kind of analysis on a company, build a valuation model, and produce a report. So two weeks on a particular stock—as a full-time job. 
So that gives you the idea on the amount of work involved. 

Another con of fundamental analysis is: garbage in, garbage out. 
And what I mean by that is that when you’re conducting your fundamental analysis, you’re relying on information provided to you by the management team—the financials, the investor reports, and so on. 

And these could be prone—and have been, as we’ve seen in many episodes in the past—prone to manipulation. 
So basically, management teams can fudge some of the accounting numbers, make things look better than they seem, and so on. 
In investor presentations—remember I mentioned that the companies can give their outlook—they say, “We expect to grow earnings by 10 percent a year for the next five years.” 
Those could end up being extremely optimistic and not true at all. 

So, garbage in, garbage out. 
If the underlying data you’re relying on to do fundamental analysis is bad or fudged or manipulated accounting data, then you’re going to come up with bad, fudged, or manipulated conclusions at the end of the day. 

And then perhaps one third and final con of fundamental analysis is that sometimes it cannot be universally applied to any particular kind of investment. 
Fundamental analysis is much more easily understood and applicable to investing in stocks—because you can analyze the underlying company and try to arrive at a stock valuation. 

But Cassidy, if I told you—what’s the intrinsic value of the Mexican peso? 
What’s the intrinsic value of a particular cryptocurrency? 

It’s really hard, right? These are particular investments or asset classes where it’s really hard to come up with a concept of intrinsic value. 
Currencies, cryptocurrencies, and so on—there’s not necessarily underlying cash flows. 
There’s not necessarily a physical underlying asset, like a business, that you can suddenly value. 

So what I mean by that is: sometimes fundamental analysis is a lot harder to apply on certain types of investments where it’s hard to think of fundamentals, or think of a concept of intrinsic value. 

Again, it’s very easy to understand when you’re thinking about stocks, but much more arcane and harder to understand and utilize when you’re thinking about some non-traditional asset classes. 

That’s why, actually, if you look at the Forex space—or currency traders—they rely a lot more heavily on technical analysis. 
Not necessarily because they think that’s the better approach, but because they don’t really have an alternative. 
There’s only so much fundamental analysis you can do on the Mexican peso—but at some point, you have to look at charts of how it’s trading relative to another currency, and then try to formulate a buy or sell decisions based off that. 

In terms of the pros of fundamental analysis—and, excuse the pun—but it’s a fundamentally sound process. 
If you think about it, trying to find stocks that are undervalued and buying them, trying to find stocks that are overvalued and avoiding them—that’s fundamentally sound. That’s logical. That’s a sound investment process. 
Buying something cheaper than what it’s really worth is fundamentally sound. 

And many of the best investors—the investing legends that we talk about, like Warren Buffett and so on—one of the most well-known investors out there, is purely a fundamental analyst. 
His approach is trying to find undervalued companies, buying them, and holding on for a really long time. 
So fundamental analysis is a fundamentally sound investment strategy. 

There are many examples of successful investors using it to make money. 
It has a strong track record, and it can be applied to almost anything. 
I mentioned a few asset classes where it’s hard to apply, but you can apply it to real estate, you can apply it if you’re analyzing bonds—corporate bonds, government bonds, and so on. 

So it’s a really sound approach. I think that’s the biggest thing fundamental analysis has going for it. 

Cassidy Clement 

Yeah, if you have the access to those additional metrics to help you paint a picture of the value—I think you’re right. 
Outside of stocks, it gets a little bit weird, just in the sense of—you’re going to have a lot of blank variables. 
But it does help understand—or give the user an understanding—of how the price point has gotten to where it is today, and how the value’s been established. 

But you brought up some awesome points today, Reda. Thanks for joining us. 

Reda Farran 

Pleasure as always. Thank you, Cassidy. 

Cassidy Clement 

Yeah, sure. So, as always, listeners can learn more about an array of financial topics for free at interactivebrokers.com/campus. Follow us on your favorite podcast network, and feel free to leave us a rating or review. Thanks for listening, everyone.