Behavioral finance FAQ / Glossary (Fundamental)

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This is a separate page of the F section of the Glossary.

 

Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
i: incidental

Fundamental analysis (FA), valuation, value


 


01/5i,10i,12i - 02/8i - 03/2d/3i 06/3i
+ see valuation, fair value

+ prospective analysis
+ analysis presentation
+ other kinds of stock analyses seen
in this glossary: behavioral, quantitative,
technical.

Nothing but hard facts.

Definition:

The "fundamentals" (or economic fundamentals) of an asset comprise
all important data and information on
the asset itself and on
the economy in general
.

If the asset is a stock

For a stock, such information shows what is 
the business and financial situation of:

The company itself:

  Its accounts (financial results: balance sheets, income
      statements,
for the last 5 years for example...),

They show in particular the company's profitability, solvency
and
growth.


Its current activity as well as its strategy and projects,

Its resources, competences and management,

And altogether its strengths, weaknesses, opportunities,
    threats
(what is called a "SWOT" analysis).

Its economic environment:

Its economic sector(s), and the neighboring industries that can

have an incidence on it/them.

The company's market position relatively to the other
    players
(customers, competitors, suppliers...)



The local and global economies: economic growths, monetary
    aspects...

Notably the evolution of the general "business cycle"

as well as the long term macroeconomic prospects.

Asset market information are not invited here

Market mood, please wait outside!


As seen, the elements above are strictly "endogenous" information,
which exclusively address the company life in its economic ocean.

Better stress the obvious: fundamentals do not
include
"exogenous" data about the asset's
market behaviorand performance (price,
return, volatility evolution...).

This leads to tell that fundamental analysis, however crucial for investment
decisions,
does not provide the only information that investors, even
hard core "value investors", need or use.

=> See the other kinds of stock analyses mentioned in this glossary:
      behavioral, quantitative, technical.

From fundamentals to asset valuation /
     business valuation / stock valuation

Not only a figurative painting,
but also its pro-forma invoice from the gallery.


To investigate fundamentals is normally the core part of an asset valuation.

When the asset is a stock (or more generally a business), what
is called fundamental analysis (or just financial analysis, or
security analysis or stock analysis) includes the following steps:

1a) Gather. and analyze
      fundamentals
.

1b) Make rational projections

on the company's future results.

For more details on
    what elements are
    studied, see the article
    below
"Fundamental

financial data".

 
 

2) From them, calculate what is called the

stock (or business)
"fair value"  or "intrinsic value"
(see valuation).

Estimate a theoretical /

potential price that is
supposed to reflect
perfectly the general
economic prospects
and those of the firm.

3) Take into account that valuation,
     to deem if it is opportune to

     buy the stock - if possible
     with a long term view - or sell it

Actually this is more the the decider
job
than the analyst one.
It is also up to him to determine its
buying or selling "objectives".

Another motive could
    be, before
granting a
    (*) loan to a business
    or buying its bonds to
    evaluate
its solvency.

Here the purpose is to
assess,not
the equity
investment opportunity,
the firm's future
repayment capacities.

(*) But don't forget that whatever the goal of the analysis:

* There are similarities in the aspects to investigate.
    Detectives are detectives and clues are clues.

* Knowing the company's financial strength is crucial also for
   equity investment.

EMH and fundamental) analysis

Market shopkeepers tell you that the prices on their shelves
are the fairest.

They say the market already did for you the homework to assess
the asset value.

Hmm, better dig deeper by yourself to see if they offer you a
rusty nail or a gold coin.


The EMH (see that acronym) considers that the stock market quotes always
the right price, by taking into account all available information (that
includes, even in the strongest EMH case, the unavailable information that
stay private).

If we accept this theory and see the market as a fair
wizard, there would be no opportunity of arbitrage,
no need to buy
or sell (*).

Thus, fundamental analysis - as well as any kind of analyses - would be
useless.

(*) Except maybe when the decider's risk attitude change, or when he

needs the money back, or when he has a sudden inflow of it
(congratulations!).

Moreover, the EMH assumes also that the variable factor affecting prices
and returns, and the "risk premium" (see that phrase) evolve in a
random walk (RWH, random walk hypothesis).

If we accept this, here again, there would be no need to make analyzes.

We just could decide at random, as the fabled chimpanzee that
throws darts on the newspaper stock quote page (the beast does
not use a laptop). Magic, isn't?

Between you and me, don't expect too much of that hypothesis,

and don't always take market prices as their face value!

Fundamental financial data



 

01/5i,10i,12i - 02/8i - 03/2d/3i 06/3i +
see valuation,
fair value + prospective
analysis
+ analysis presentation
+ the
other kinds of stock analyses seen in
this
glossary: behavioral, quantitative,
technical.

Looking at the horse from all sides to guess its potential value.

To do its job, a fundamental analyst collects and combines
information (called fundamental data) from:

Outdoor

1) The general macroeconomic situation (interest rates, exchange
     rates, economic growth..),

2) The economic situation of the main industries and markets,

The geographical locations' traits and economic prospects,

Situation and evolution of the customers,

Situations of the industries in or with which the firm
    operates),


Indoor

3) The firm's historical and current fundamentals:

Financial data: figures from the past and present
   income
accounts and balance sheets,


For example, analysts love to calculate financial ratios 
and to compare them

* From year to year

* Also with similar corporations.

Economic traits: organization and means, markets, growth,

profitability, solvency...,

4) Its business projects and economic and financial
     prospects and risks
(it entails scenarios and to
      estimate their probabilities)

Obviously, what are lacking here are the market attitude-making
elements.

Behavioral analysis supports fundamental analysis, as a needed effort
to start with a rational valuation, but BA adds another step:
the stock "profile" analysis and an estimate of its "image" bracket
(see those words).

More precisely, for a fundamental valuation,
    
what key expected financial data to use?

Discounting the future.

The task is complete only after a calculation gives what is considered a
"fair" value estimate.

There are various criteria for this calculation, linked to the company
performance or to investor interest, which normally would converge:

If seen from the
point of view of:

This value calculation
can be based on:

The firm's performance

and profitability

The firm's expected cash
   flows,

And / or its expected
   earnings growth


The investor's interest

The expected dividends,

Plus the expected resale
    value
of the firm / the
    stock at the end of the  

prevision period.



To compute the value, all those expected goodies are discounted with an
adequate rate of return
that includes a market risk premium
(see an example in the "expectancy" article).

Fundamental investors / traders


02/10i + see fundamental
analysis, value investing,
growth investing, PER effect

Is it worth the price?

Fundamental investors are those who base their buying / selling
decisions on fundamental analysis / fair price valuation.

Serious fundamental analysis supposes a lot of homework to scan

the firm's situations and to build prospective profit / risk scenarios.

Some narrower "fundamental" analysis /

investment schools, with their own biases

Value or growth? State your market religion!

Some investors are anchored on only some fundamentals aspects,

by using - as an heuristic - over simplified benchmarks.

This makes for narrower schools of thinking among fundamental investors,
with their own bias, such as:

1) Investors that are set on "value investing"
    (see detailed article).

They try to buy stocks that became underpriced (value stocks)

Their main criterion (*) is usually related to the current corporate
profits (**) compared to the present stock price: see PER (P/E) -
Price-earnings ratio.

(*) For "pure" value investing. In a more flexible approach
     some  future projection is also done.

(**) and/or, for some of them, on the present book value
      (see PBR - P/B).

That practice might explain what some theoreticians consider, under
the names of P/E effect or P/B effect, that a low P/E or P/B is a good
predictor of a price rise.

On the other hand, this focus on current data might also explain that
analysts stay anchored on past evolutions, while dominant investors
might bypass them to detect better the stock recovery prospects.

2) Investors looking for "growth investing"
    (see detailed article).

They focus on the past profit growth, and they extrapolate it in
expected
profit growth.

One simple tool for growth investors is to use PEG ratios
(Growth rate / PER) as stock benchmarks.

(*) To find those messages: reach that BF group and, once there,
      1) click "messages", 2) enter your query in "search archives".

Members of the BF Group, please
 vote on the glossary quality at
BF polls

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This page last update: 29/08/15  

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