Stock Market - How to Use Fundamental Analysis to Make Trading Decisions

Stock Analyzing

Investors come in many shapes and forms, so to speak, but there are two basic types. First and most common is the more conservative type, who will choose a stock by viewing and researching the basic value of a company. This belief is based on the assumption that so long as a company is run well and continues turning a profit, the stock price will rise. These investors try to buy growth stocks, those that appear most likely to continue growing for a longer term.

The second but less common type of investor attempts to estimate how the market may behave based purely on the psychology of the market's people and other similar market factors. The second type of investor is more commonly called a "Quant." This investor assumes that the price of a stock will soar as buyers keep bidding back and forth (often regardless of the stock's value), much like an auction. They often take much higher risks with higher potential returns-but with much higher potential for higher losses if they fail.

Fundamentalists

To find the stock's inherent value, investors must consider many factors. When a stock's price is consistent with its value, it will have reached the target goal of an "efficient" market. The efficient market theory states that stocks are always correctly priced since everything publicly known about the stock is reflected in its market price. This theory also implies that analyzing stocks is pointless since all information known is currently reflected in the current price. To put it simply:

• The stock market sets the prices.
• Analysts weigh known information about a company and thereby determine value.
• The price does not have to equal the value. The efficient market theory is as the name implies, a theory. If it were law, prices would instantly adapt to information as it became available. Since it is a theory instead of law, this is not the case. Stock prices move above and below company values for both rational and irrational reasons.

Fundamental Analysis endeavors to ascertain the future value of a stock by means of analyzing current and/or past financial strength of a particular company. Analysts attempt to determine if the stock price is above or below value and what that means to the future of that stock. There are a multitude of factors used for this purpose. Basic terminology that helps the investor understand the analysts determination include:

• "Value Stocks" are those that are below market value, and include the bargain stocks listed at 50 cents per dollar of value.
• "Growth Stocks" are those with earnings growth as the primary consideration.
• "Income Stocks" are investments providing a steady income source. This is primarily through dividends, but bonds are also common investment tools used to generate income.
• "Momentum Stocks" are growth companies currently dow jones index coming into the market picture. Their share prices are increasing rapidly.

To make sound fundamental decisions, all of the following factors must be considered. The previous terminology will be the underlying determining factor in how each will be used, based upon investor bias.

1. As usual, the earnings of a particular company are the main deciding factor. Company earnings are the profits after taxes and expenses. The stock and bond markets are mainly driven by two powerful dynamisms: earnings and interest rates. Harsh competition often accompanies the flow of money into these markets, moving into bonds when interest rates go up and into stocks when earnings go up. More than any other factor, a company's earnings create value, although other admonitions must be considered with this idea.