Fundamental analysis
How does fundamental analysis work
Rather than having one prescribed, universal method, fundamental analysis can be conducted in a number of ways. However, many analysts tend to use a top-down approach. This begins by considering the wider picture before progressively drilling down into the detail surrounding each market.
Let's have a look at how you might do this. Suppose you're thinking of trading on UK shares - here are some steps you could follow to analyse the market for potential opportunities:
Consider overall economic performance
Assess which sectors will be affected
Select a sector to focus on
Narrow it down
- Which companies have the largest shares of the market?
- Who is the recognised market leader?
- Are there any new and disruptive players in the market?
- Are there any imminent changes or developments that might shake up the hierarchy in the industry?
- Will any current competitive advantages soon be under threat?
It's worth noting that when you conduct fundamental analysis like this, you should always be 'comparing apples with apples' at each stage. In other words, when looking at a country's economy, you compare it with other countries' economies. When assessing industry sectors, you view them alongside other sectors. And when you come to individual companies, you contrast them with other companies in the same sector. For example, if you were looking at Barclays you'd compare it to another bank, such as HSBC, and not to a retailer like Tesco.
Lesson summary
- Fundamental analysts generally use a top-down approach
- First they consider the overall economic picture
- Then they assess the performance of different sectors and select one to focus on
- Finally they look at companies within the sector to identify those with potential
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1
What is fundamental analysis
4 min -
2
How does fundamental analysis work
7 min -
3
Analysing an individual company
4 min -
4
Evaluating a company's management
6 min -
5
Understanding balance sheets
8 min -
6
Analysing cash flow statements
4 min -
7
Understanding the income statement
7 min -
8
The pros and cons of fundamental analysis
5 min -
Quiz
10 questions