| Fundamental Analysis the Easy Way - Part 3 |
| Tuesday, 03 March 2009 00:00 Written by John Jagerson | ||||||||||||||||||||||||||||||||
Fundamental analysis will not perfectly predict the future of any stock. This is true of all types of financial analysis, however it will provide a very specific benefit. The primary benefit of fundamental analysis is that it removes some of the unknowns. For example, in the stock market some of the most dangerous unknowns are those that surround a stock or company that has yet to provide profits, income or has not done so in a long time.  
A stock like this is driven exclusively by trader expectations about the future since the company has not proven that it can perform in the past. Trader expectations are extremely volatile and can lead to large amounts of concentrated risk. This series of articles on simplified fundamental analysis builds on the concepts discussed in the Understanding Financial Statements article series. Fundamental analysis can also help identify companies that are operating at extremes. Too often those with unusually high or low ROE numbers will also be very sensitive to the market and can be quite volatile. As a general rule, I have found that it is acceptable to look for stocks with an ROE measure 10-40% greater than their industry group or sector. Doing this simple analysis removes many of the unknowns and creates a large selection of companies to choose from when building a diversified portfolio of stocks. In the next section I will show you some easy ways to search for this information through free and widely available search tools. To see the first article in this series on fundamental analysis, click here. To see the second article in this series on fundamental analysis, click here. Author's Note Redux: You will notice that several times within the video and text of this section I qualify statements with the phrase "diversified portfolio." This is not by accident. Almost all analysis breaks down when you only apply it one trade at a time or one stock at a time. This is because there is an unavoidable randomness within stock price changes, which is also known as unsystemic risk. Therefore, fundamental and technical analysis really only adds value when used on a group of stocks where the benefits of diversification can reduce exposure to unsystemic risk. This is a big subject and one we have already spend a lot of time on. Next, go to Fundamentals the Easy Way Part 4
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3.25 Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved." |
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