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What Is Fundamental Equity Analysis?

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  • Written By: Geri Terzo
  • Edited By: Shereen Skola
  • Last Modified Date: 19 November 2016
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In fundamental equity analysis, financial analysts and investors focus on the core financial components of a business to determine the future outlook for the value of the stock. Fundamental factors include earnings, which are a representation of profits at a company, in addition to revenues, which are sales, as well as any dividends that are distributed to shareholders. While other methods of analysis might consider broader investment conditions, fundamental equity analysis focuses on the merits of a business to determine whether or not a stock is a solid investment.

A helpful way to examine the process of fundamental analysis is to consider its limitations. One of the key factors in the fundamental approach is that it suggests insight can be obtained by reviewing the financial items at a company. It bases future business forecasts on the most recent performance at the organization. Fundamental analysis does not consider other items without a monetary value tied to them, such as the management style of executives, which shapes the direction of a business. It also limits the analysis to one business as opposed to viewing that entity in light of its market share versus any rival firms.

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Fundamental equity analysis presumes that investors are not valuing a stock precisely according to the available information surrounding a business. The approach suggests that there is greater insight to be gleamed from reviewing the major financial components at the organization and that further stock value may be unlocked in the process. For instance, by forming future business forecasts on the business fundamentals at a company, investors might recognize new potential in that security that they did not fully comprehend before. The analysis can work in the opposite direction, and investors may decide that the fundamentals prove a stock is too risky to own.

Financial statements include the data that is used throughout fundamental equity analysis. Among these components are net income are earnings per share. They are revealed on a quarterly and yearly basis, and financial analysts often measure a company's results based on whether or not these profits met some consensus estimate. The analysis is not limited to simply reviewing the results but also forming a ratio to determine what level of profitability makes a stock attractive and a worthwhile investment.

When profits in a period are more than sufficient, managers may decide to return some of that income to investors through dividend payments. This type of distribution is included in fundamental equity analysis, and contributes to the overall return on an investment. Some companies reinvest profits into the business instead of making dividend distributions. Investors may buy a stock because of the company's tendency to pay dividends based on a fundamental analysis.

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