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Financial Versus Fundamental Analysis - What Is The Difference?

Aug 17, 2007
The examination of key ratios and viewing the performance of a certain company is one of the many ways in which an investor can decide to invest in stocks. This form of investment is known as fundamental analysis.

A simple description of fundamental analysis would be, the determination of how much money a company is making from this deciding how much earnings can be expected in the future. A good way of predicting future earnings is look at the past performance of the company.

Earnings are reported by companies usually on a quarterly or annual basis and from these figures the expected growth levels of the company can be predicted. The value of the company on the stock market is to a large degree set by how well the company is performing.

There is a large variety of ways of determining a company's earnings. Information on earnings can come from financial statements provided by the company. The financial statement which is required to be provided by all publicly traded companies, and in the statement is included a balance sheet, auditor's report, statement of cash flow, description of business activities and the expected revenue for the financial period.

The information provided in the financial statement makes it possible for fundamental analysis to reveal information on the value of the company, its competitive advantage, and the ratio of management to outside investor's ownership.

Fundamental analysis applies a variety of tools to the financial data in order to extract important information on the company. For instance the earnings per share can be found out. This is a very useful piece of information to any investor and is far more useful to know than, for example, total company profits. Although the earnings per share is a good way of comparing the performance of two companies in the same industry it should not be used as a deciding factor when choosing what shares to invest in.

The price to earnings ratio (P/E) shows the relationship between the stock price and company earnings. If a company has a high P/E then it is possible that the company is overpriced, it could also mean however that the company is expected to continue to grow and yield more profit. A low P/E may indicate that investors are sceptical about the company's future performance, however it could also indicate that most investors have failed to see the opportunity that the company holds.

Other ways fundamental analysis can be used through its ability to discover the price to sales ratio for companies with no earnings, or the price to book value for investors who are interested in long term investments. Another indicator of whether or not an company is a good investment is its dividend yield. This is the percentage return a company pays in the form of dividends.
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