How fundamental analysis can help you select valuable companies. 3 reports to follow.

In our previous article, we looked at technical analysis - a method that focuses on price movements on charts. It's like a driver's speedometer: it gives you information about speed and direction, but says nothing about the state of the engine. The other main method of analysis, fundamental analysis, does the opposite. It's like a thorough technical inspection of a car, where all the important components are assessed: engine, gearbox and bodywork.

Fundamental analysis is a methodology that aims to find the true value of a company, which often differs from its current market price. The main objective of this approach is to find undervalued (or overvalued) stocks by examining all the factors that influence the value of a company. Investors using fundamental analysis ask themselves: "Is this company worth investing in over the long term, and why?"

This article is the second in our series and focuses on the fundamentals of fundamental analysis, looking at what data and reports should be analysed and how they should be interpreted in the European market context.

Fundamental principles of fundamental analysis

Fundamental analysis is based on the belief that market prices may fluctuate in the short term, but in the long term they reflect the true value of a company. This is a long-term investment strategy. The most famous pioneer of fundamental analysis was Benjamin Graham, whose ideas were further developed by Warren Buffett.

The main focal points of the fundamental analysis are:

Company financial data: Reports are the backbone of fundamental analysis.
Economic conditions: The state of the economy as a whole and its impact on the business.
Industry analysis: The company's position within its competitors and the industry.
Quality of leadership: How is the company run and who are the decision-makers?

Financial statements: the "passport" and "history" of a company

The company's financial data is the main source of information. Every publicly traded company, including those in the European Union, is required to publish three main financial reports on a regular basis. Reading them is the be-all and end-all for any fundamental analyst.

1. Income Statement

The profit and loss account gives an overview of a company's income and expenses over a given period, showing whether the company is profitable or not. Key indicators to monitor:

Revenue: Total company revenue.
Gross Profit: Income after deduction of direct costs.
Operating Income: Profit after deduction of administrative and selling expenses.
Net Income: Final profit after all costs, including taxes, have been taken into account.

2. Balance Sheet

A balance sheet is like a snapshot of a company's assets, liabilities and equity at a particular point in time.

Assets: What the company owns (e.g. sularaha, buildings, machinery).
Liabilities: What the company owes (e.g. loans, debts).
Equity: The difference between a company's assets and liabilities.

3. Cash Flow Statement (Cash Flow Statement)

This report shows how the company has earned and spent cash. This is important because profits may not always reflect cash flows. Cash flow is divided into three categories:

Operational cash flow: Cash flow from operating activities.
Investment cash flow: Cash flow from the purchase and sale of assets.
Financing cash flow: Cash flow from loans and equity issuance.

Financial ratios: putting numbers in context

Just looking at raw numbers does not give the full picture. It is important to compare them with the average of other companies or industries. This is done using a financial ratio.

P/E ratio (Price-to-Earnings Ratio): One of the most common. It shows how much investors are willing to pay for each euro of profit for a company. A lower P/E may indicate an undervalued company.
EPS (Earnings Per Share): Earnings per share, which shows how much profit was earned per share.
ROA (Return on Assets) and ROE (Return on Equity): They show how effectively a company uses its assets or equity to generate profits. Higher ratios usually indicate strong management.
Debt-to-Equity Ratio: It shows how much debt a company has compared to its equity. Too much debt can indicate financial risk.

Understanding management and the economy: qualitative aspects

Fundamental analysis is not just about numbers. It is just as important to assess the "non-quantifiable" factors.

Quality of leadership: Is the management competent and honest? Do they have a long-term vision? Do they own shares in the company (which would motivate them to act in the interests of shareholders)?
Macroeconomic factors: How will inflation, interest rates, political stability and European economic growth affect your business? For example, increases in the European Central Bank's interest rates can affect a company's borrowing costs.
Competitive advantage: Does the company have a "moat" against competitors? This could be a unique brand, patents, economies of scale or a network effect. For example, some European luxury brands have a strong competitive advantage because of their reputation and heritage.

Real-life example: a German car manufacturer

Let's say you're interested in buying shares in a German car manufacturer. Using fundamental analysis, you would investigate the following:

Profit and loss account: See if the company's profits have grown steadily over the last 5 years. If turnover has increased, but net profit has fallen, find out the reason (e.g. increased costs, higher payments, etc.).
Balance sheet: You control your company's debt burden. Is it able to repay its loans? Does it have sufficient liquid funds?
Macroeconomics: Analyses of how a car manufacturer will be affected by a rise in energy prices or a recession in Europe.
Management: Read reports and interviews with the CEOs to assess their strategic vision for the electric vehicle transition.

After a thorough analysis, you conclude that the company is well-managed and has good prospects for the future, but the market price is currently low as investors are concerned about the global supply chain crisis. This is a classic "value investor" scenario, where fundamental analysis gives you the knowledge and the courage to invest when others are hesitant.

Assessing the business environment: a picture that goes beyond financial statements

While the numbers give us an important insight into the health of a business, they do not always fully reflect its future potential. Successful fundamental analysis also requires a deeper understanding of a company's business and competitive environment. Ask yourself: In which market does the company operate? What is the business market? What is the market in which the company operates? What are the potential growth drivers and risks? For example, the future prospects of European energy companies are closely linked to the green revolution and regulation, while the success of technology companies depends on innovation and their ability to respond to new trends in the global market. It is important to understand whether a company has a sustainable competitive advantage that is difficult for others to replicate. This could be a strong brand (e.g. a well-known European luxury brand), a unique technology or a cost advantage that allows products to be offered at a lower price. This 'protective wall' gives the company stability and potential for long-term growth, which is critical for a value investor.

Technical vs. fundamental analysis

Technical analysis:

Focus: Price movements, graphs, indicators, patterns.
Prerequisite: History repeats itself, market psychology influences price.
Objective: Identify trends, predict price movements, find bargain buying and selling moments.
Strengths: Helps to find short-term trading opportunities, gives a visual overview of the market.
Weaknesses: Does not take into account company fundamentals, may be subjective.

So which method is better? In fact, one method is not better than the other. Each has its strengths and weaknesses and the best results can be achieved by combining both approaches. Technical analysis helps to identify favourable buying and selling moments, while fundamental analysis helps to select investments with long-term potential.

Fundamental analysis:

Focus: The company's financial performance, economic situation, future prospects.
Prerequisite: The value of a company is reflected in its financial performance.
Objective: Assess the true value of the company, find undervalued shares.
Strengths: Helps find long-term investment opportunities, gives a more in-depth overview of the company.
Weaknesses: Does not take into account the psychology of the market, can be time-consuming.

Summary from

Fundamental analysis is a long-term process that requires patience and thoroughness. It gives the investor a knowledge of why he is investing, rather than simply speculating on price movements. While technical analysis gives you the best entry or exit point, fundamental analysis tells you whether an investment is worth considering at all.

The two methods of analysis are not contradictory but complementary. An experienced investor will use both to get the full picture. After fundamental analysis confirms that a company is valuable, technical analysis can help to find the best time to buy. This combined approach is the basis for successful investing.