Fundamental Analysis

Reading a company’s financial report card

Understanding how to research stocks by looking at the business numbers
Modified

September 7, 2025

Category: Analysis & Research
Difficulty: Beginner

Definition

Looking at a company’s financial numbers to decide if the stock is a good deal. Like checking a company’s report card before buying their stock.

The Basic Idea

Stock prices change every second based on emotions and news.

But businesses change slowly based on actual performance.

The opportunity: Sometimes stock prices don’t match business reality.

Your job: Figure out what the business is really worth.

What You’re Looking For

Is This a Good Business?

  • Does it make money consistently?
  • Is it growing or shrinking?
  • Does it have advantages over competitors?
  • Is management smart and honest?

Is the Stock Price Fair?

  • Are you paying too much?
  • Could you get a better deal elsewhere?
  • What are similar companies selling for?
  • Does the price make sense given the profits?

Three Things to Check

  1. The Company: Financial health and business strength
  2. The Industry: Is this a growing or dying business area?
  3. The Economy: Are conditions good for this type of business?

The Company Report Card

Every public company releases quarterly “report cards” called financial statements. Here’s what to look for:

Income Statement (The Profit Report)

Shows how much money the company made: - Revenue: Total money coming in - Expenses: Total money going out - Profit: Money left over (revenue minus expenses) - Growth: Is revenue growing each year?

Balance Sheet (What They Own)

Shows the company’s financial position: - Assets: What they own (cash, buildings, equipment) - Debt: Money they owe to others - Equity: What’s left for shareholders - Debt-to-equity: How much they owe vs. own

Cash Flow Statement (Actual Money Movement)

Shows real cash in and out: - Operating cash flow: Cash from running the business - Free cash flow: Cash left after necessary expenses - Cash generation: Is the company generating or burning cash?

Simple Ways to Value Stocks

Price-to-Earnings (P/E) Ratio

What it means: How much you pay for each dollar of profit - Formula: Stock price á annual profit per share - Example: $100 stock with $5 profit = P/E of 20 - Good or bad?: Compare to similar companies - Rule of thumb: P/E under 15 might be cheap, over 25 might be expensive

Debt-to-Equity Ratio

What it means: How much debt vs. ownership - Low debt: Company is safer but might grow slower - High debt: Company is riskier but might grow faster - Red flag: Debt much higher than equity

Profit Margins

What it means: How much profit from each sale - Gross margin: Revenue minus direct costs - Net margin: Revenue minus all costs - Higher is better: More efficient business - Compare to competitors: Are margins improving or declining?

Does This Company Have Advantages?

What Makes a Business Strong?

  • Brand power: Do people prefer this company? (Apple, Coca-Cola)
  • Network effects: Does it get better with more users? (Facebook, eBay)
  • Low costs: Can they make things cheaper than competitors?
  • High switching costs: Is it hard for customers to leave?
  • Patents or licenses: Do they own something competitors can’t copy?

Warning Signs

  • Lots of competition: Many companies doing the same thing
  • Easy to copy: No special advantages
  • Declining industry: Newspapers, brick-and-mortar retail
  • Dependent on few customers: Risk if they leave

What Fundamental Analysis Can’t Do

It’s Not Perfect

  • Takes time: Need to read lots of reports and numbers
  • Past performance: Looking at old data, not future guarantees
  • Subjective: Two people might value same company differently
  • Market timing: Stock might stay cheap or expensive for years

Markets Are Emotional

  • Good companies can have bad stock prices: Market doesn’t always care about fundamentals
  • Patience required: Takes time for market to recognize value
  • No guarantees: Even great analysis can be wrong

Getting Started with Fundamental Analysis

For Beginners

  1. Pick companies you understand: Start with businesses you know
  2. Read the annual report: Company’s own description of their business
  3. Check basic ratios: P/E, debt levels, profit margins
  4. Compare to competitors: How do they stack up?
  5. Look at trends: Are things getting better or worse?

Red Flags to Avoid

  • Consistent losses: Company loses money every year
  • Too much debt: Debt much higher than yearly profits
  • Declining revenue: Sales shrinking year over year
  • Management changes: Lots of executives leaving
  • Accounting issues: Anything that seems fishy

The Bottom Line

Fundamental analysis is like being a detective. You gather clues from financial statements to figure out if a company is worth buying.

Key point: It works best for patient investors who can wait for the market to recognize good businesses at fair prices.