There are three components to fundamental analysis of a stock: financial statement analysis, valuation and qualitative factors. Each of these is important for a different reason and no factor can stand alone to support an investment decision. Financial statements help identify how strong a company is, compare it to peers and help forecast future earnings. The valuation analysis determines what price an investor should pay for those future earnings. And, qualitative research is probably the most important in that it provides a range of important information that factors into both the financial statement analysis and valuation. It also often identifies the important catalysts for the stocks upward or downward movements in the future.
Company level Qualitative Research
First there are different factors to identify at the company level that have a significant bearing on fundamental analysis: the business model, competitive advantage, customer base and management as well as corporate governance.
- Business model: Understand what the company does and how it generates value for its customers. For some firms, this is easy because they sell food or manufacture something simple. Other times, it is more complicated. For example, some firms that lease long-lived assets such as railcars make on a modest amount on the lease above the cost of capital. The real profit comes from remarketing the assets and selling them later in their lives. It is important to dive in and understand this. Discussions with people in the industry can help which is why channel checks are an important part of your market research.
- Customers and Geographic exposure: Identify if the firm has a few large customers or a very fragmented customer base. Also, know how the firm is viewed by these customers, as value or premium brand, consistent quality product, on time delivery, fairly priced etc. Second, know the geographic sales breakdown, each economy has different growth rates and critical factors that may require additional research.
- Competitive Advantage: This is important because without a competitive advantage competition increases and profit margins decrease or disappear. For Intel, their R&D and size is their advantage and for Wal-Mart it’s their industry leading logistics along with size that provides them leverage over suppliers.
- Management: A good management team can make a big difference especially when a business is in a challenging environment or still developing industry. Checking conference calls and management comments in the financials can reveal if a team is hitting targets and has had successful strategy in the past.
Industry level research
These are the important internal factors but there are also key external and industry qualitative factors that are part of stock analysis.
- Industry growth & cycle: If an industry is expected to decline by 5% it is hard to forecast a company in it to grow 10%. Knowing the industry trends and cycle are critical factors in modeling company growth. Look at historic data along with forecasts from competitors and trade groups.
- Market share: A company could be the largest player in an industry, a small, up and coming firm or a niche player. Gaining or losing market share is a growth factor to consider, know what trends are driving the stocks gains or losses. Good market research help uncover these trends.
- Competition: Identifying the closest competitor is important. Often times the competitive position determines pricing power and margins. Also, conduct market research to track competitors and search for actions that are disruptive such as a new product launch, discounting or strategic shift.
- Regulatory authorities: External regulators are impactful for some firms. Knowing who plays key roles and may issue critical legislation or rulings is critical. For example, FDA oversight is important to understand if the analysis is on a pharmaceutical firm.
The research on these factors is addressable through comprehensive reading, market research and analysis. Already mentioned important resources are conference call transcripts, industry associations and financial filings. Also, news releases, investor power points and market research all provide further insights. Market research can really shorten the research process by identify competitors, competitive position, market share, industry trends, pricing power and a host of other critical points of understand. Research Optimus can help investors dive in deep and understand these important components.
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