Fundamental Analysis: Types, Popular Indicators, and Examples

In the financial market, we distinguish between two main types of analysis: technical and fundamental. While the former focuses solely on identifying historical price patterns on charts to predict future price fluctuations, the latter examines all crucial financial data to determine the “foundation” of an instrument’s valuation.

This applies most often to company stocks. In this article, we’ll delve into the fundamental analysis used to assess publicly traded companies’ economic, financial, and business conditions. Remember, it is one of the most essential tools in the hands of investors, both institutional and retail.

Basics of Fundamental Analysis

Fundamental analysis is an approach to evaluating assets, particularly securities, that gained popularity at the turn of the 19th and 20th centuries. It involves exploring the “fundamentals” of their value. This method goes beyond the superficial price movements visible on charts, aiming to uncover the true value of an investment based on a wide range of factors.

Benjamin Graham is considered the father of fundamental analysis. Born in Great Britain but associated with the United States for most of his life, he was an analyst, investor, and professor. Benjamin Graham is considered the father of modern fundamental analysis of companies. Source: Wikimedia Commons

If you want to delve into the details of his approach, we highly recommend reading “The Intelligent Investor,” which is considered the encyclopedia of fundamental investing and value investing. A contemporary proponent of this method is, among others, Warren Buffett.

When looking for the fundamentals of value, we can start from the general to the specific or vice versa. Two popular methods of fundamental analysis are:

1. Top-down: This approach begins with a broad economic overview and gradually narrows its focus to specific industries and, ultimately, individual companies.
2. Bottom-up: In this case, we start by analyzing individual companies, regardless of their sector or prevailing economic conditions. Moreover, fundamental analysis can be divided into qualitative and quantitative components:

• Qualitative analysis: Involves assessing intangible factors such as brand strength, corporate culture, and leadership quality.
• Quantitative analysis: Here, the emphasis is on hard numbers and financial indicators that can be measured and compared.

However, regardless of whether you conduct your research “from the top” or “from the bottom,” “qualitatively” or “quantitatively,” three key elements are always considered:

1. Economic landscape: Examining indicators such as economic growth rates, inflationary pressures, and monetary policy decisions. This macroeconomic perspective provides a foundation for understanding the environment in which companies operate.
2. Industry dynamics: Here, the focus is on specific sectors. Analysts examine industry trends, competitive forces, and growth trajectories. This step helps determine a company’s market position.
3. Company-specific analysis: The most intensive phase involves thoroughly examining individual companies. This includes analyzing financial statements, assessing management effectiveness, and competitive advantages.

Popular Fundamental Analysis Indicators

Although fundamental analysis can be a complex process, understanding its basics should be relatively easy. It’s best to choose one specific company and examine the key data sources from an analyst’s perspective:

• Financial statements – cash flows, balance sheet, income statement
• Periodic and current reports
• Prospectuses
• Analyst forecasts (including recommendations) and management projections

Screenshot of a sample financial report of a company listed on the WSE. Source: XTB

You’ll determine the company’s market value based on the data in these documents. To do this, it’s worth using some of the most basic indicators:

• EPS (Earnings Per Share): One of the most basic metrics, showing how much net profit is attributable to one company share. It’s calculated by dividing profit by the number of issued shares. EPS is an important measure of a company’s profitability from the shareholders’ perspective. A growing EPS is usually viewed positively as it suggests increasing the profitability of the company per share.
• P/E (Price/Earnings): Shows how many times a company’s stock price exceeds its earnings per share. In other words, it indicates how long it would take for the company’s earnings to equal its current market valuation, assuming current earnings levels are maintained. Lower P/E values suggest that stocks may be undervalued, while higher values may indicate overvaluation.
• P/B (Price/Book Value): This ratio compares a stock’s market price to its book value, which is the difference between a company’s assets and liabilities. A P/B ratio below one may suggest the stock is undervalued, as its market price is lower than the company’s book value. However, the interpretation of this indicator should take into account industry specifics.
• EBIT: Also known as operating profit, it’s the company’s income before deducting interest and taxes. This indicator focuses on the company’s operational efficiency, disregarding the impact of financing structure and taxation. EBIT allows for assessing how well a company is performing in its core business, regardless of financial costs and tax burdens.
• EBITDA: Earnings before interest, taxes, depreciation, and amortization. This indicator goes a step further than EBIT by adding amortization costs. EBITDA is often used to assess a company’s ability to generate cash from operating activities, disregarding the impact of investment and financial decisions. It’s particularly useful when comparing companies with different capital and tax structures.
• EV (Enterprise Value): A measure of a company’s total value that takes into account not only its equity but also its debt. It serves as a theoretical takeover price for the entire company. EV is commonly used to create ratios together with EBIT and EBITDA. EV/EBIT shows how many times the enterprise value exceeds its operating profit (low value = potentially more attractive valuation). EV/EBITDA additionally includes depreciation.

We also can’t forget about profitability ratios, which show how a given company manages its capital and what growth potential it has. Examples of the three most popular ones are:

• ROE (Return on Equity): A ratio measuring the efficiency of using a company’s equity capital. It shows how much net profit the company generates from each dollar invested by shareholders. A higher ROE suggests that the company effectively transforms shareholders’ investments into profits. It’s a key indicator for investors as it directly relates to the return on their investment. However, a high ROE can also result from high debt, so it’s worth analyzing it in the context of other indicators.
• ROA (Return on Assets): Shows how effectively a company uses its assets to generate profits. This ratio is calculated by dividing net profit by the company’s total assets. ROA allows determining how much net profit is attributable to each dollar invested in the company’s assets. A lower ROA may suggest inefficient asset management or operation in a capital-intensive industry. Conversely, a higher ROA indicates effective use of company resources to create profits.
• ROIC (Return on Invested Capital): A ratio assessing how effectively a company uses its capital to generate profits. It’s calculated by dividing operating profit after tax by invested capital (sum of equity and interest-bearing debt). ROIC is particularly important when assessing a company’s long-term value, as it shows how effectively management allocates capital to profit-generating projects. A higher ROIC suggests that the company creates greater value for shareholders from each invested dollar. By analyzing all these indicators collectively, investors can gain a fuller picture of a company’s ability to generate profits from available resources and investments.

Example of Fundamental Analysis

After gaining basic knowledge about the most popular fundamental analysis indicators, it’s time to put it into practice. Below are the values of the mentioned indicators for the stock of a financial sector company listed on the WSE, XTB. For comparison, values from Q2 2024 and the same period in 2023 are presented:

Indicator	Q2 2023	Q2 2024
EPS	$1.51	$1.77
ROE	52.30%	51.91%
ROA	15.17%	16.03%
P/E	5.91	7.48
P/B	2.92	3.69
EV/EBIT	3.98	5.02
EV/EBITDA	3.87	4.89
Source: XTB financial data

What could we say about such a company?

• EPS increased from $1.51 to $1.77, indicating an improvement in the company’s profitability per share.
• ROE slightly decreased from 52.30% to 51.91%, but remains at a very high level, indicating efficient use of equity capital.
• ROA increased from 15.17% to 16.03%, suggesting improved efficiency in the company’s asset utilization.
• Valuation ratios, namely P/E, P/B, EV/EBIT, and EV/EBITDA, significantly increased year-over-year. Such an increase may mean that investors have higher expectations for the company’s future results or that the stock price is entering an overvaluation zone.

The chart shows how XTB’s stock price changed from quarter to quarter. Source: Tradingview.com

The analysis presents solid fundamentals with high profitability. The increase in EPS while maintaining high ROE and ROA ratios indicates good financial condition and effective management. On the other hand, the significant increase in valuation ratios may raise some concerns about potential stock overvaluation.

You can compare fundamental indicators between different periods, companies, and even entire sectors, allowing you to determine the intrinsic value of a business against its competition.