Are you looking for a method that allows you to invest in solid companies over the long term without taking unnecessary risks? Then you should take a close look at fundamental analysis.
In this article you will learn everything you need to know about this analysis method, from the basic concepts to the most important key figures you should know as an investor.
The most important in a nutshell
- Fundamental analysis focuses on the key financial figures of a stock corporation in order to determine its intrinsic value.
- An industry analysis as part of the fundamental analysis helps to understand the context in which the company operates.
- Fundamental analysis is particularly suitable for long-term investors who want to identify solid and sustainable stocks.
What is fundamental analysis?
Fundamental analysis is a method that allows you to determine the intrinsic value of a company in order to better assess its long-term growth potential.
Instead of focusing on price movements, as is the case with technical analysis, fundamental analysis examines the economic and financial data of a share.
The aim is to determine whether the current share price corresponds to the actual value or whether the share is overvalued or undervalued.
Fundamental analysts assume that the stock market prices of stock corporations will correspond to their intrinsic value in the long term. If the current share price is below this intrinsic value, there is a possibility that the share will rise in the future.
If the market price is higher than the intrinsic value, the price could fall in the future. This method is often used by value investors who specifically look for undervalued shares in order to buy them and benefit from their long-term increase in value.
Fundamental analysis looks at both quantitative and qualitative factors. Quantitative factors include key financial figures such as sales, profit and equity.
The qualitative factors include aspects such as the company's management, market position and competitive environment. Together, these factors provide a comprehensive picture of the organization and enable the investor to make well-founded decisions.
How does fundamental analysis work?
The first step in fundamental analysis is to analyze the company's balance sheet. The balance sheet is a financial statement that shows the assets, liabilities and equity of a company at a specific point in time.
By analyzing the balance sheet, you can obtain important information about the company's financial stability and asset structure. The key figures provide information on how well the company uses resources to generate profits.
There are a large number of key figures, but some are particularly important for the valuation of shares. Below is a list of the five most important key figures that you as an investor should definitely know:
1. price/earnings ratio (P/E ratio)
The Price-earnings ratio (P/E ratio) is one of the most frequently used key figures in fundamental analysis. It shows how much money investors are prepared to invest for every euro of a company's profit.
A low P/E ratio may indicate undervaluation, while a high P/E ratio may indicate overvaluation. The P/E ratio is particularly useful for comparing different stocks in the same industry, as industry-wide differences are common.
Companies from technology sectors, for example, usually have higher P/E ratios than financial companies, as they are expected to grow strongly.
Example:
A company has a share price of 100 euros and earnings per share of 10 euros. The P/E ratio is therefore 10 (100 euros / 10 euros). This means that investors are prepared to pay ten times the annual profit per share.
2. return on equity (ROE)
The Return on equity Return on equity (ROE) measures the profitability of a company in relation to its equity. It shows how well the management works with the shareholders' capital to generate profits.
A higher return on equity indicates a more efficient use of capital. However, investors should be aware that a very high return on equity can also result from a high level of debt, which increases the risk. It is advisable to look at this ratio in conjunction with the gearing ratio.
Example:
A company generates a profit of EUR 2 million with equity of EUR 10 million. The return on equity is therefore 20 % (2 million euros / 10 million euros × 100). The Group generates a return of 20 % on the equity capital employed.
3. dividend yield
The Dividend yield is an important indicator for investors looking for regular income from their investments. It shows how much a company pays out in dividends in relation to the current share price.
This ratio is particularly important for dividend investors who prefer stable and regular income. However, an extremely high dividend yield may indicate that the share price has fallen sharply, which could be a warning signal.
It is also advisable to pay attention to the payout ratio, as too high a payout could restrict future growth.
Example:
A company pays a dividend of EUR 4 per share and the current share price is EUR 80. The dividend yield is therefore 5 % (4 euros / 80 euros × 100). This means that investors receive 5 % of their invested capital as a dividend each year.
4. payout ratio
The Payout ratio indicates what proportion of a company's profit is distributed to shareholders in the form of dividends. This indicator is particularly important for dividend investors, as it shows how much of the company's profit is used for distribution and how much remains in the Group for reinvestment.
A high payout ratio may indicate that the company is distributing a large proportion of its profits to shareholders, but this may lead to less investment in future growth.
A payout ratio that is too low, on the other hand, may indicate that the company is holding back its profits for internal purposes, possibly to finance expansion or debt reduction.
A healthy company should have a balanced payout ratio. As a rule, the payout ratio is between 30 % and 60 %. A value above 70 % can be a warning signal that the company is not retaining enough capital for future investments or crises.
Example:
A company generates a profit of EUR 5 per share and distributes a dividend of EUR 2 per share. The payout ratio is therefore 40 % (2 euros / 5 euros × 100). This means that 40 % of the profit is paid out to the shareholders, while 60 % remains in the company.
A balanced payout ratio tells you how the company uses its profits and whether it pursues a sustainable dividend policy.
5. price/cash flow ratio (KCV)
The price/cash flow ratio (KCV) measures how well a company is able to convert profits into cash flow. Cash flow is particularly important in times of crisis, as it shows how liquid a company actually is.
The KCV is useful if the company has high depreciation or non-cash profits that could distort the P/E ratio. A low KCV indicates that the company can efficiently convert its profits into cash flow, which is a sign of financial stability.
Example:
A company has a share price of EUR 120 and a cash flow per share of EUR 20. The KCV is therefore 6 (120 euros / 20 euros). A KCV of 6 means that investors are prepared to pay six times the annual cash flow per share.
6. return on assets (ROA)
The Return on assets (ROA) measures how efficiently a company uses all of its capital (equity and debt) to generate profits. It indicates how well the company's management utilizes the available capital.
A high return on assets shows that the company is using its resources efficiently to generate profits. The ratio is particularly useful for evaluating companies in capital-intensive industries, such as the automotive industry.
Example:
A company has a total capital of 100 million euros and a profit of 10 million euros. The total return on capital is therefore 10 % (10 million euros / 100 million euros × 100). The company generates a return of 10 % on the total capital employed.
7. price-to-book ratio (P/B ratio)
The Price-to-book ratio (P/B ratio) compares the share price of a company with its book value. The book value is the assets of a company minus its liabilities.
The P/B ratio helps investors to assess whether a share is overvalued or undervalued in relation to its actual asset value.
A P/B ratio of less than 1 may indicate an undervaluation, while a P/B ratio above 1 could indicate an overvaluation. The P/B ratio is particularly useful in capital-intensive industries, as it reflects the intrinsic value of the organization.
Example:
A company has a book value of EUR 50 per share and a share price of EUR 75. The P/B ratio is therefore 1.5 (75 euros / 50 euros). A P/B ratio of 1.5 means that the share is trading at 1.5 times its book value.
8. gearing ratio
The Debt-equity ratio shows the ratio of debt to equity of a company and provides information on its financial stability.
A high gearing ratio means that the company is heavily reliant on borrowed capital, which can represent a risk in difficult economic times.
A low gearing ratio shows that the company is mainly financed from its own funds, which gives it more flexibility in times of crisis. This ratio is particularly important in order to better assess the risk of a company.
Example:
A company has borrowed capital of 200 million euros and equity of 100 million euros. The gearing ratio is therefore 2:1, which means that the company uses twice as much debt capital as equity.
Differences between fundamental analysis and chart analysis
There are two main approaches to analyzing the value of shares: fundamental analysis and chart analysis (technical analysis). Both methods pursue different objectives and use different tools.
Fundamental analysis focuses on the key financial figures of a company in order to determine the intrinsic value of the share. It assesses the long-term profitability and stability of a company on the basis of its balance sheet data, such as profit, turnover and equity. The aim is to determine whether a share has long-term potential.
In contrast, chart analysis mainly looks at price movements and patterns in share prices to predict short-term market movements. Chart analysts use technical indicators such as moving averages and resistance lines to make trading decisions.
A key difference between the two approaches therefore lies in the time horizon: fundamental analysis is aimed at long-term investments, while chart analysis is more suitable for short-term trades. However, both methods can be used in combination to develop a comprehensive investment strategy.
The importance of sector analysis
Sector analysis is a key part of fundamental analysis as it looks at companies not in isolation but in the context of their market environment. A company may have solid key figures, but if it operates in a stagnating or declining industry, its potential may be limited.
It is therefore crucial to understand the specific dynamics of the industry in which the company operates. Each industry has its own rules, risks and opportunities that can strongly influence the success or failure of a company.
A thorough industry analysis helps to position the company in comparison to its competitors. You can find out whether the company is operating in a growing, future-oriented industry or in a sector that is threatened by disruption, for example through new technologies or changing consumer preferences.
Especially in areas such as technology, healthcare or renewable energies, companies often offer better growth opportunities, as these sectors are supported by continuous innovation and social trends.
Important questions that should be answered in the sector analysis include the dependency on economic fluctuations. In cyclical industries, such as the automotive industry or construction, there can be major fluctuations in demand, while other industries, such as the food and utilities sector, remain more stable as their products and services are always in demand.
Another decisive aspect is the existence of market entry barriers. Industries with high barriers to market entry, such as the aviation industry, are less susceptible to new competitors. The reason for this is the high initial investment and strict regulations. This protects existing companies from increasing competition and enables them to maintain their market position.
The intensity of competition within the industry is also important. In highly competitive markets, such as retail or telecommunications, a company's growth potential may be limited, even if it has strong internal metrics.
Markets with less competition, such as niche markets, often offer companies more pricing power and therefore potentially higher profit margins.
Good to know:
Overall, the industry analysis provides valuable insights into a company's long-term prospects for success. It helps investors to assess whether the company is operating in a growing market and how external factors such as competition, regulations and technological developments could affect the business model.
The regulatory landscape of an industry should also be taken into account. Highly regulated industries, such as the energy sector or banking, may be stable, but regulatory changes can have a significant impact on the business model. On the other hand, less regulated industries can offer more flexibility and growth opportunities.
Criticism and limits of fundamental analysis
Although fundamental analysis is a valuable tool for investors, there are also some criticisms and limitations that you should be aware of.
One of the most common criticisms is that fundamental analysis is based too heavily on past data. These figures reflect the company's past and there is no guarantee that the company will be just as successful in the future.
Another point of criticism is that fundamental analysis often finds it difficult to quantify qualitative factors, such as the management of the company. While quantitative key figures such as turnover and profit are easy to calculate, it is much more difficult to assess the competence of the management or the innovative strength of a company.
Furthermore, not every aspect of a company can be captured in figures. Companies that operate in rapidly changing sectors can find it difficult to accurately predict their future development. Disruptions caused by new technologies or geopolitical events can also represent risks that are difficult to calculate.
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Conclusion: Why fundamental analysis is indispensable
Fundamental analysis offers you as an investor the opportunity to determine the true value of a company and make informed decisions about buying or selling shares. By analyzing a company's balance sheet data and key figures, you gain valuable insights into its financial health and future development opportunities.
Although fundamental analysis has some limitations, it remains an indispensable tool for long-term investors who want to back solid companies. With the right strategy and a sound understanding of key figures, you can identify undervalued stocks and benefit from their long-term growth potential.
Use fundamental analysis to optimize your investment strategy and make informed decisions. Remember: patience and thorough analysis are your best allies when it comes to investing successfully in the stock market.
