The analysis essentials / 02
Fundamental analysis,
made understandable.
Understand the business behind a stock, read the key numbers, and judge the price in context.
01 / Understand the business
Start with how the company makes money.
Fundamental analysis examines a business, its finances, and its prospects to assess what an investment may be worth. A strong company can still be a poor investment at too high a price.
Follow the revenue.
What does the company sell, who pays, and why do customers choose it? Check whether sales depend on a few customers, one product, a region, or the economic cycle.
Look for staying power.
Consider competition, pricing power, costs, and the investment needed to maintain the business. A popular product or fast-growing market does not automatically produce durable profits.
Read the original filings.
For U.S. public companies, use annual 10-K and quarterly 10-Q reports. Read the business description, risk factors, management discussion, financial statements, and notes. Management’s explanation is a starting point to evaluate.
Which financial statements should I read?
Income statement: revenue, expenses, and profit over a period.
Balance sheet: assets, liabilities, and equity at a date.
Cash-flow statement: cash from operations, investing, and financing over a period.
Statement of equity: changes in owners’ interests.
Read them together; profit and cash flow are different measures.
How is this different from technical analysis?
Fundamental analysis focuses on the business and valuation. Technical analysis focuses on market data such as price and volume. They answer different questions, and neither removes uncertainty.
Start here: SEC’s guide to reading a 10-K ↗ · Financial statements explained ↗
02 / Read the numbers
A ratio needs a comparison and an explanation.
Compare a company with relevant peers and its own history. Match reporting periods and definitions. There is no single P/E, margin, or debt ratio that makes every company a good investment.
Same share price. Different P/E.
Fictional company · $60 per share
Price-to-earnings (P/E) divides share price by annual earnings per share (EPS). Change the earnings to see why the denominator matters:
At $3 of annual earnings per share, the price is 20 times earnings.
The $60 price, in blocks of yearly earnings
Illustrative figures, not market quotes. Trailing P/E uses past earnings; forward P/E uses estimates. With zero or negative earnings, the usual positive P/E comparison is not meaningful.
Profitability: how much is retained?
Operating margin is operating income divided by revenue. Net margin uses net income instead. Ask why margins changed, and compare businesses with similar economics rather than applying one threshold to every industry.
Growth: what is driving it?
Compare revenue and earnings across consistent periods. Separate demand growth from acquisitions, currency effects, or price increases. Check per-share results too: new shares can dilute gains for existing owners.
Financial strength: can it meet obligations?
Review cash, borrowing costs, debt maturities, and cash generation. Debt-to-equity and the current ratio can help, but asset quality and industry structure matter. A high ratio is not automatically good or bad.
What can ROE and ROIC tell me?
Return on equity compares net income with shareholders’ equity, commonly using average equity. Return on invested capital compares after-tax operating profit with invested capital; definitions vary. Debt, buybacks, or a small equity base can distort ROE. Compare consistent calculations across time.
What about P/B, P/S, and EV/EBITDA?
P/B compares equity market value with book equity; accounting values may differ from economic value.
P/S compares equity market value with sales, but ignores profitability.
EV/EBITDA compares enterprise value with earnings before interest, taxes, depreciation, and amortization. EBITDA is not cash flow and excludes important costs.
Use measures suited to the business.
Is free cash flow more reliable than earnings?
It offers another perspective, not automatic proof of quality. A common definition is operating cash flow minus capital expenditures, but definitions differ. Timing, working capital, and investment needs can change the result. Check the calculation and any adjustments.
03 / Build your view
Separate the evidence from the assumptions.
“What must go right for today’s price to make sense—and what happens if it does not?”
Build a consistent comparison.
Choose relevant peers and several years of results. Note the source, date, fiscal period, currency, and accounting basis. Reconcile company-adjusted figures with reported results.
Consider more than one outcome.
Explore weaker, middle, and stronger cases for growth, margins, and financing needs. A valuation estimate depends on those assumptions. Use a range rather than treating one price target as a fact.
Write down what would change your mind.
Summarize the business case, valuation, major risks, and missing information. Identify developments that would challenge the idea, then revisit them when new filings arrive.
Does a low P/E mean a stock is cheap?
Not necessarily. Earnings may be temporarily high, the business may be shrinking, or risk may justify a lower multiple. A high P/E may reflect growth expectations that later disappoint. Investigate the reason for the price.
What is discounted cash flow?
A discounted-cash-flow model estimates future cash flows and converts them to a present value using a discount rate. Small changes in growth, discount rates, or long-term assumptions can materially change the estimate. Match cash-flow definitions to the valuation method.
What mistakes should I watch for?
Comparing unrelated industries, mixing forecast and historical figures, annualizing an unusual quarter, and ignoring debt or dilution can mislead. Favor evidence over a persuasive story, and remember that careful analysis can still be wrong.