Your research may begin with an industry you believe you know something about, something related to your job or hobby. You can research a company’s financial statements and note things like return on investment (ROI), net cash flow, gross profit margins, dividend yield, and so on. Any discount broker will have that information available for you. That research gives you a basic understanding of the company’s ability to utilize assets and make money. It does not, however, necessarily translate into stock price appreciation due to myriad other exogenous factors, like the ones listed above.
It’s important to keep in mind that the fundamental analysis you do can exist in a vacuum, disconnected from the prevailing market sentiment. No matter how good the fundamentals of a company are, if the mood of the market is bearish, then the stock will not appreciate in price; and taking a short-term position in a stock the market does not love is a waste of time and capital. It becomes an opportunity cost versus investing in another company or sector the market does love and is rewarding with investment capital.
For example, I currently work in Vietnam attempting to find value in that market. It carries with it a different set of things to focus on fundamentally than if I were looking at the U.S. or European markets. In Vietnam, capital markets are very immature and information about companies is, at best, spotty. So the data that would be at my fingertips for a country like Germany has to be dug up by hand for Vietnam. Moreover, the flow of information from the companies to the analysts (where there is one interested) is slow. Where in the West the information channel is stuffed to the point of overload, in Vietnam the channel is still being dug. It presents a challenge, but that is ultimately what business is about, overcoming challenges to fill vacuums of demand.
After that the questions get more esoteric: Is the company an industry leader or follower? Is it an Apple or an LG? Companies that are innovators are valued differently than those that ride the coattails of innovation, so a strict comparison of price/earnings growth (PEG) is not necessarily valid. For example, there is what I like to call the “Picasso premium” attached with certain companies. It’s the psychological satisfaction of owning a share of a company you respect and admire, in the same way an art collector feels pride in owning work by a famous artist.
I find it interesting that fundamental analysis is changing right along with the market itself as analysts attempt to find more things to quantify to give them an edge over their competitors. I remain unconvinced that many of them can assist you in your trading, but without research there is no progress.
Related: Breaking with Tradition – Why I Don’t Use Technical Analysis: Part 1