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At some point, you are likely to want to move beyond just investing in an all-market index fund or ETF, and start making other additions to your investment portfolio.As you prepare to evaluate investments for inclusion in your plan, it’s a good idea to learn about fundamental analysis.
What is Fundamental Analysis?
When analysing an investment, it can help to look at the underlying fundamentals, the numbers that make a company (and its stock) tick.
Fundamental analysis is more about analysing firm-specific data and big picture factors, rather than looking at technical aspects of an investment’s market chart.
Unlike technical analysis, where you focus on price action, looking at today, yesterday, 52-week averages, and then looking for patterns that can help you try to predict the next move up or down, what fundamental analysis requires you to look at items that are a little more qualitative Some of the items that should be considered in fundamental analysis of a company include:
- Profit margins
- Place in the industry/sector
- Growth potential
- Balance sheet
- Business model
- Political situation, and how it might affect the company
- Scandals related to the company or its management
It’s even possible to use fundamental analysis on investments other than companies. You can consider global supply when thinking about the fundamentals related to commodities like oil or copper, or look at the global political picture when considering currencies.
Weather events, geopolitical situations, and economic factors are all items that can fundamentally impact an investment. These types of big picture factors can provide you with insight that you might not receive if you look at price action alone.
When Should You Sell?
Knowing when to sell is one of the biggest issues you have to deal with when it comes to your investments. Knowing when to sell is as important as knowing when to buy. And you should also know when not to sell.
Looking at the fundamentals can help you decide whether or not it’s time to sell an investment. A company stock makes a good example. At times when the market is down, it’s easy to get caught up in the panic and sell. But, before you follow the herd, step back and think about the fundamentals.
Is the company still headed by competent management? How did the company handle the last big stock market downturn? Is the business model still solid? Have profit margins remained the same?
In many cases, the drop to the company is a result of the broader market. A company that is fundamentally sound is likely to recover over time, and possibly even thrive.
Indeed, even during the recession following the financial crisis of 2008, there were companies that continued to pay dividends, and maintained fundamentally sound business practices.
They saw lower share prices when the rest of the market dropped, but as the stock market has recovered, many of these fundamentally sound companies have thrived. Selling low in a panic would have meant lost opportunities.
Yes, there are times to sell. However, selling shouldn’t be based on fear. Instead, you should look at the fundamentals of the investment. What’s changed about the basics?
If you are concerned that new management is headed in the wrong direction, that is a good reason to sell. If you see shrinking profit margins and a business model that isn’t adapting to the new realities of the industry, that’s a good reason to sell before things get worse.
Carefully think about your situation, and the big picture. Use fundamental analysis to make better decisions about investments, and choose investments that are likely to remain strong going forward.
Miranda is a freelance contributor to several investing and personal finance web sites. She also writes for her own blog, Planting Money Seeds.