Six Key Tools to Unlock Fundamental Value

Fundamental analysis may not be able to hand us immediate information on the psychology of the herd, but what it can unveil is long-term value.  With it, we’re trying to identify six key pieces of information that will help tell us if a company is overvalued, or undervalued with good chances for upside.

Those six include:

  • Competitive advantage
  • Earnings growth
  • Sales revenue growth
  • Market share
  • Product pipeline
  • Quality of the company's management

With fundamental analysis, the goal is to buy companies at a deep discount to their intrinsic value.  Billionaire Warren Buffett subscribes to fundamental analysis, for example.  And, as we all know, he’s swimming in money because of it. 

Using fundamental arguments, Buffett bought more than billion dollars worth of Coke (KO) in 1988.  Buffett saw consistent performance and good long-term prospects based on the nuts and bolts of Coke.  He also saw bargain in the stock price after years of disaster.  The stock, said Buffett, wasn’t reflective of the growth set to occur in the company’s international business.  So he bought in 1988, and watched his $1 billion investment in Coke explode to $12 billion by the close of 1999. 

Warren Buffett does it by keeping it simple. He wants to know:

  • Has the company's performance been consistently good?
  • Does the company carry too much debt compared to its peers?
  • Are profit margins high compared to its peers? Are they increasing?
  • Is the company cheap on a valuation level?

Fundamental analysis is key to understanding the underlying nuts and bolts of a company’s engine.  Without it, you’re often just blindly buying a stock, hoping for the best. A fundamental analyst is also trying to answer these simple questions:

  • Is the stock overvalued / undervalued based on its price to earning ratio? 
  • Is it trading at or below future growth, per its price to earnings growth ratio (PEG)? 
  • Is the company making a profit? 
  • How does the stock trade in comparison to overall sales? 
  • Where does the company stand with regards to competition?

For example, in August 2017, shares of True Car (TRUE) were sent screaming lower. 

Adjusted EPS was one penny on revenues of $81.8 million. Both topped estimates. However, it was forward guidance that knocked the stock down unfairly.

While the company expected for third quarter revenue of $85 million to $87 million – a solid year over year gain – it was still below expectations for $87.68 million, upsetting the Street and sparking the sell off.  However, if we were to dig a bit deeper, we can see that there truly was nothing to get upset about at all. 

The company is still gaining market share, and best of all adjusted EBITDA jumped from 3.7% last year to 9% this past quarter.  That’s something a smart fundamental analyst would dig for and account for before selling a growing company.

It’s just something to keep in mind.