It suffices to say that one can hardly succeed as an investor without a working knowledge of the subject matter. This cover report is devoted to fill that knowledge gap, by taking readers through basic fundamental analysis as related to securities. Read on.
An investor with money to invest or already has invested in any business, certainly needs to be equipped with certain information that will guarantee the safety and expected returns on the investment.
Generally, this knowledge will come from the past records and his experience on the business. Since the concern of an investor is at least the safety of his fund, it is logical therefore to say that the information he would need would have to come from financial records. Analysis of financial records is therefore an important ingredient in financial decisions.
Fundamental analysis is the study of the financial affairs of a business for the purpose of better understanding the nature and operating characteristics of the company that issued the common stock. To do this, an investor would need to understand the concept of fundamental analysis, the types of financial statements that will provide him with the raw material for analytical process, the key financial ratios used in company analysis and the interpretation of the ratios.
Fundamentalists are of the opinion that, the value of a stock is influenced by the performance of the company that issued it. The prospect of a strong company is believed to be revealed in the market price of its stock and therefore will keep the price on the high point. Investors should note that, price is not the only determinant but, also the risk exposure. Fundamental analysis is not unaware of these factors and therefore conveniently incorporates them into valuation process. That is why the starting point is always the historical analysis of the financial strength of a company. The insight understanding of a company along side economic and industry figures should be used by an investor to formulate expectations about the future growth and profitability of a company.
Historical analysis is in many respect the most demanding and time-consuming and for this reason most investors rely on published reports for the needed materials. Fortunately, investors have access to various sources like the reports and recommendations of major brokerage firms, the popular financial media and consulting firms/online financial services. Historical analysis reveal to an investor the strength and weaknesses of a company from the studies of financial statements.
This study also helps to identify any underlying trends and developments, reveal operating efficiencies and the nature and characteristics of the company. It is important that an investor takes note of the following:
•The Company’s competitive position
•Its composition and growth in sale
•Profit margins and changes in company earnings
•The composition and liquidity of resources i.e. asset mix
•The capital structure of the company i.e. financial mix
A vital part of company analysis is financial statements because; they allow an investor to develop an opinion on the operating results and financial condition of a firm. Three books are therefore available for this purpose: the balance sheet, the income statement and the statement of cash flow. These books play a vital role because many financial ratios are based on them, particularly the first two, while the third book is used to assess the cash/liquidity position of the company.
The type of analysis varies according to the specific interest of the users. For example, trade creditors are more interested basically in the liquidity of a firm because their claims are short-term in nature and the ability of a firm to pay these claims is best judged by means of thorough analysis of its liquidity. The bondholders are more interested in the capital structure of the business, the major sources and the uses of funds, its profitability over time and projection of future profitability. Their interest therefore is in the cash flow ability of the firm to service debt over a long period. Common stockholders would have their minds more in the present and expected future earnings and the stability of these earnings. For this purpose, their analysis will be concentrated on a company’s profitability because of its effect on company’s ability to pay dividends and avoid bankruptcy.
The Balance Sheet
It is regarded as a statement of the results of financial management in the past and as the basis from which future progress must be made. In other words, it is a statement of the company’s assets, liabilities and shareholders’ equity. In the balance sheet, assets represent the resources of the company i.e. things the company owns. Liabilities on the other hand represent the debts, while equity is the amount of shareholders capital in the company. It is a balance of assets against debts and ownership position. For it to balance therefore, assets must be equal to liabilities and equity.
The Income Statement
It is a financial summary of the operating results of the firm. In other words, it represents the amount of revenues generated over a period of time, the cost and expenses incurred over the same period, and the company’s profits. The income statement covers activities that have occurred for a given operating period, usually a fiscal or calendar year.
The Statement of Cash Flow
It is a summary of a company’s cash flow and other events that cause changes in the cash position. Its usefulness is in the fact that it shows how a company is doing in generating cash i.e. the amount of money a company actually takes in as a result of doing business.
Financial Ratios
In financial analysis, two yardsticks are available: ratio or index. They help to relate two pieces of financial data to each other. The analysis and interpretation of various ratios should give experienced analysts a good understanding of the financial condition and performance of a company over the use of financial resources.
Ratio analysis is therefore the study of the relationship between various financial statements of account. Each ratio analysis carried out relates one item in the books to another or balance sheet to income statement. Financial ratios can therefore be grouped into five categories: (1) liquidity ratios, (2) activity ratios, (3) leverage ratios, (4) profitability ratios and (5) common stock, or market measures.
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