5 Most Important Tools For Fundamental Analysis

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To make informed investment decisions, you will need these five essential tools to conduct fundamental analysis. In this article, you will learn about these tools and how to use them.


However, before we dive into the toolbox, let’s first define a few terms.


What is Fundamental Analysis?

The term “fundamental analysis” in corporate finance refers to the art and science of business valuation.

Fundamental analysis examines various aspects of a business—the opportunities, threats, external and internal environments, current performance, and future projections.


What are the Objectives of Fundamental Analysis?


The objectives of fundamental analysis are to obtain a complete picture of a company’s performance and value; a comprehensive understanding of a company’s financial health and performance in order to inform investment and strategic decision-making.


Fundamental analysis aims to evaluate a company’s revenue, profits, assets, liabilities, growth prospects, management team, market trends, competitive landscape, and potential risks.


Also, read: Objectives of Technical Analysis


10 Key Objectives for Fundamental Analysis

The key aims and purposes for conducting fundamental analysis include the following:


1. Equity Research


Raising business capital (e.g., an IPO) and equity investment

By investigating the financial health of the business, including its revenue, profits, assets, liabilities, and growth prospects, equity researchers can determine whether to advise buying, selling, or holding a company’s stock


2. Private Equity (PE) Investments (venture capital, leveraged buyouts)


For private equity investors, fundamental analysis helps evaluate the potential of a company to generate high returns on investment. 


By analyzing the company’s financial statements, competitive landscape, management team, and market trends, PE investors can determine whether to invest in a company and at what valuation.


3. Business Combinations


In the context of business combinations such as mergers and acquisitions, fundamental analysis helps in assessing the value of a company and its potential synergies with another company.


By analyzing the financial metrics of both companies, fundamental analysis can help determine whether a merger or acquisition makes strategic and financial sense.


4. Buying and Selling a Business


Fundamental analysis is also important for buyers and sellers of businesses. It can reveal the financial health and growth prospects of a business, helping buyers determine a fair price to offer.


For sellers, fundamental analysis can help showcase the value of their business and attract potential buyers.


5. Corporate Decision-Making


Fundamental analysis within the company can assist management in making informed decisions that maximize shareholder value.


Analyzing the company’s financial metrics, market trends, and competitive landscape can help inform strategic decisions such as capital expenditures, product development, and expansion plans. 


6. Risk Management


One of the key objectives of fundamental analysis is to manage risk. 


By analyzing a company’s financial statements, you can identify potential risks such as high debt levels, declining sales, or management turnover. 


This information can be used to adjust investment portfolios or avoid risky investments altogether.



7. Long-Term Investing


Fundamental analysis is often used by long-term investors who are focused on the underlying fundamentals of a company rather than short-term market fluctuations. 


You can make informed decisions about which companies are likely to succeed over the long term and generate sustained returns on investment.


8. Valuation


Another key objective of fundamental analysis is to determine the fair value of a company. 


Through benchmark analysis (analyzing a company’s financial statements and comparing them to those of its industry peers), you can determine whether a company is undervalued or overvalued relative to its peers. 


This information can be used to make informed investment decisions.


9. Market Trends


Fundamental analysis can also help investors identify market trends and anticipate future developments,


These include new product categories, changing consumer preferences, or disruptive technologies that could impact future performance.


10. Industry Analysis


Fundamental analysis is often used to analyze entire industry trends and competitive dynamics.

So that you can identify companies that are likely to benefit from long-term growth trends or face headwinds due to changing market conditions. 


This information can be used to make informed investment decisions in specific sectors or industries.



What are the Two (2) Elements of Fundamental Analysis?


  • Quantitative Evaluation: Internal company-generated factors. Ratio analysis based on the numbers generated by the company’s financial statements


  • Qualitative Evaluation: External macroeconomic factors and other organizational metrics that cannot be quantified, such as PESTLE, brand monopoly, business model, management team, etc.


Five (5) Tools for Fundamental Analysis and Forecasting

  1. Porter’s Competitive Forces Analysis

  2. PESTLE Analysis

  3. Industry Life Cycle Analysis

  4. Ratio Analysis

  5. SWOT Analysis


Porter’s Five Competitive Forces for Fundamental Analysis


Porter’s Five Forces of Competition framework is used to examine the industry environment in which the company operates.


It is an effective tool for analyzing: 


✔ The industry’s history and dynamics

✔ The competitive structure in the industry

✔ The major competitors

✔ The competitive position of a company and 

✔ Forecasting how they will affect the bottom line of a company


PESTLE Forecasting for Fundamental Analysis


This analysis was first introduced as ETPS (later renamed PEST) in a 1967 book, “Scanning the Business Environment,” by a Harvard professor, Dr Francis Aguilar.


PEST is an acronym for the macroeconomic factors listed below. PESTEL incorporates environmental and legal factors into the analysis.


Political ForecastingLegislation, Taxation, Regulations, Government-business relations

Economic ForecastingEconomic cycle, Interest rates, Consumer spending, Government spending, Exchange rates

Socio-Cultural ForecastingDemographics, Lifestyles, Attitudes, Needs and Desires

Technological ForecastingInnovative developments, Research & Development (R&D) at the company, R&D of competitors

Legal Factors ForecastingLawsuits

Environmental ForecastingThe cost of weather changes and climate catastrophe


PESTLE is a vital framework for building expectations about the future and its impact on a business or company.



Industry Life Cycle Forecast for Fundamental Analysis


When forecasting revenues, profits, and cash flow, life cycle analysis provides a framework for making reasonable assumptions.


In other words, the financial ratio multiple to be used to evaluate a business (what multiple is most appropriate for a valuation analysis of the company) is determined by where the company is in its life cycle.


For example, the earlier a company is in its life cycle, the higher the item on the income statement used as the denominator for ratio analysis.


Financial Ratios for Fundamental Analysis


The two (2) broad categories of financial ratios are:

  • Performance Ratios
  • Financial Leverage Ratios


What Are the Two (2) Types of Performance Ratios?

The two types of performance ratios are: 

(i.) Profitability Ratios

(ii.) Efficiency Ratios


What Are the Two Types of Leverage Ratios?

The two types of leverage ratios are:

(a.) Liquidity Ratios

(b.) Solvency Ratios


SWOT Forecast for Fundamental Analysis


SWOT is an abbreviation for Strength, Weakness, Opportunities, and Threats.


It is primarily a summary of the internal and external analysis described in the previous sections.


It acts as a bridge for generating strategic alternatives by introducing opportunities available to the company.



We strongly recommend the following additional resources to continue learning and developing your knowledge of fundamental analysis:


How to Read and Decode Income Statements: The Beginner’s Guide to Profits

What is Fundamental Analysis and Its Objectives?

6 Factors That Give a Company a Wide Economic Moat

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