When trying to decide what investments to add to your portfolio, it can be easy to become discouraged. How do you know which are likely to have staying power, and which are just fads?
One way that you can choose solid stocks (and other investments) is to make use of fundamental analysis. This type of evaluation can help you identify stocks that have good underlying value, and that are more likely to recover and perform well over time.
Fundamental Analysis: Look at the Big Picture
The hallmark of fundamental analysis is that you use it to determine which companies are in a good position in terms of the big picture. Instead of buying shares based on current prices, or falling prey to the current fads in the market, you base your decisions on the underlying factors that point to a solid future for the company.
Fundamental analysis goes beyond the numbers of daily share price and attempts to decode recent price trends. Instead, it looks at the overall health of an investment, based on factors that change at a much slower pace than what you see with daily stock market volatility.
What Should You Look At?
When analyzing a stock by looking at its fundamentals, there are a few factors to take into account. These are items that look at the general health of the company, by considering the foundation — or the fundamentals — on which it is based:
- P/E Ratio: The price to earnings ratio gives you an idea of whether or not the price is where it should be, in relation to the earnings of the company.
- Company Management: You can learn a lot from the way a company is managed. You should consider whether or not those leading the company make good decisions, and think about how they have helped the company in the past — and whether the plans for the future are likely to pan out.
- Profit Margins: Take a look at the profit margins. Are they the same over time? Are they growing? Or are they shrinking? Shrinking profit margins can be a red flag.
- Balance Sheet: The balance sheet lets you look at the types of liabilities the company has, and compare it to assets. Every company is going to have liabilities and debt of some sort; the key is to make sure these liabilities don't overwhelm the company.
- Growth Potential: Is there potential growth? Where does the company sit in relation to its competitors? Pay attention to these aspects of the company. You want to invest in shares that reflect a solid potential.
- Scandal and Politics: How do politics affect the company? Is there a scandal brewing? Have there been big changes in management?
If the fundamentals of a company have remained fairly stable over a long period of time, and nothing has changed recently, there is a good chance that the company will do well. Even if market factors mean that the stock is losing value right now, solid fundamentals mean that it is likely to weather the storm… and maybe even turn out better in the end when it's time to sell shares.