Make Fundamental Analysis Work For You
Some investors lack fundamental analysis knowledge. You might know some things about the income statement and balance sheet and have a great knowledge of what’s contained in the statements. But when it comes to applying your know-how, that can be a bit trickier.
Putting fundamental analysis in action requires taking everything you know about a company and mixing in some estimates and best guesses about the future to arrive at a decent expectation of whether or not to invest in a company.
Using fundamentals as signals to buy or sell
Buying a stock at the right time is very difficult. But knowing when to sell it is even tougher. And while fundamental analysis won’t tell you the exact best time and day to buy or sell a stock, it can at least give you a better understanding of things to look out for when it comes to making decisions.
If you’re a passive investor and buy large baskets of stocks, such as those in the Standard & Poor’s 500 Index, you can afford to buy and hold the stocks as a group. Even if one company runs into big-time trouble, it’s just one holding in a large basket of stocks and not all that catastrophic. However, if you choose to invest in individual stocks, trying to pick companies you think will beat the market, monitoring the fundamentals is critical. If you start noticing a company’s trend deteriorating, you don’t want to be the last investor to get out.
The perils of ignoring the fundamentals
Blindly following a company and investing in the stock can be very dangerous — if you pick the wrong one. The dot-com bubble and subsequent financial crisis of 2008 and 2009 are still the best recent examples of how ugly things can get for investors who buy what’s popular and ignore the fundamentals. The table shows a list of a few major U.S. stocks that were worth $100 a share or more at the beginning of 2000, but saw their share prices fall to below $10 a share by the start of 2009. Ouch!
Source: S&P Capital IQ
Avoiding stock disasters like those shown is one thing that makes fundamental analysis so powerful. Losses that large are nearly impossible to recover from in a single person’s lifetime.
Using fundamental analysis as your guide
As the table shows, investing in individual stocks is very risky. Losses can be sizeable. That’s why if you’re going to buy individual stocks, you want to invest with your eyes wide open. Just as you probably wouldn’t dare fire a loaded weapon or jump out of an airplane without proper training, the same goes with investing in individual stocks.
Luckily, fundamental analysis provides investors with a host of very specific tools to help them protect themselves. And while the tools of fundamental analysts aren’t foolproof, they give investors guidance of when a stock might be getting a little dangerous or the underlying trends might be changing.