Fundamental Analysis

What is fundamental analysis?

The Conditions Behind Market Movement

Fundamental analysis is a method of evaluating financial markets by studying the underlying factors that can influence the value of an asset or instrument.

For stocks, this can involve analysing a company's revenue, profitability, debt, cash flow, financial statements and future business outlook. For currencies, commodities and indices, it can extend to economic growth, inflation, interest rates, employment data, central bank decisions and geopolitical developments.

The objective is not simply to observe how a market price has moved, but to understand the economic and financial conditions behind that movement.

Fundamental analysis can be used alongside technical analysis. Technical analysis focuses primarily on price behaviour and charts, while fundamental analysis focuses on the information that can influence market expectations.

The basics of financial statements

Three Perspectives on a Company's Financial Condition

Financial statements provide information about a company's financial position and performance. They are particularly important when conducting fundamental analysis of stocks and companies.

Together, these statements provide different perspectives on a company's financial condition, including its cash position, debt levels, assets and overall financial structure.

Key financial ratios

Valuation, Profitability, Debt and Efficiency

Financial ratios allow information from financial statements and market prices to be compared more easily. Ratios are generally more meaningful when compared with a company's history, industry peers and expected growth.

Dividend yield and payout ratio

Understanding Dividend Measures

Dividends are distributions that some companies make to shareholders from available earnings or reserves. Two commonly followed measures are dividend yield and payout ratio.

A higher dividend yield should not automatically be viewed as more favourable. Share price, earnings, company policy and financial conditions can all influence dividend-related ratios, and dividend payments are not guaranteed.

Earnings reports

Actual Results Compared with Market Expectations

Public companies generally release earnings reports periodically to provide updated information about their financial performance. Investors may examine revenue, earnings per share, profit margins, expenses, cash flow and management guidance.

Market reaction is often influenced by more than whether a company reported a profit. A key consideration is how the reported figures compare with market expectations.

A company could report higher earnings than in the previous year but still experience a negative market reaction if results were below expectations. Conversely, stronger-than-expected results or an improved business outlook can change how market participants value the company.

Earnings announcements can lead to significant short-term volatility in individual stocks and, in some cases, broader stock indices.

Other events that affect stocks

Company and Industry Developments

Company share prices can respond to developments beyond scheduled earnings reports.

Broader developments can also affect stocks. Interest-rate changes, inflation, economic growth and changing consumer demand can influence entire industries rather than one company.

Market reaction ultimately depends on how new information changes expectations about a company's future financial performance and risk.

Economic indicators and market data

Following the Condition and Direction of an Economy

Economic indicators can influence expectations for currencies, stock indices, commodities and other financial markets.

Markets often react not simply to whether a figure is positive or negative, but to the difference between the actual result and what markets expected.

Interest rates and central banks

Monetary Policy Across Global Markets

Central banks use monetary policy to influence economic conditions and price stability. Interest-rate decisions are among the most closely followed fundamental developments in global financial markets.

Changes in interest rates can affect borrowing costs, economic activity, currencies, company valuations and investor behaviour.

For currencies, traders often consider the relationship between monetary policies in two economies. EUR/USD, for example, can be influenced by expectations surrounding both the European Central Bank and the US Federal Reserve.

Gold and stock markets can also respond to interest-rate expectations because those changes can affect financing conditions, bond yields and the relative attractiveness of different assets.

Supply and demand

Fundamental Drivers in Commodity Markets

Supply and demand are particularly important when conducting fundamental analysis of commodities such as crude oil, gold and silver.

For crude oil, analysts may follow global production, consumption, inventories, OPEC+ decisions and geopolitical developments affecting major producing regions.

For precious metals, factors can include investment demand, industrial demand, mining production, central bank activity and broader economic conditions.

Actual market prices are influenced by many factors simultaneously, so supply and demand should be considered within the wider market environment.

Geopolitical events and sentiment

Changing Expectations Around Growth, Trade and Risk

Geopolitical developments can affect financial markets by changing expectations around economic growth, trade, energy supply, government policy and financial risk.

International conflicts, elections, trade disputes, sanctions and major policy changes can contribute to increased market volatility.

Different markets may react differently to the same development. It is important to understand the relationship between an event and the specific market being analysed rather than assuming every geopolitical development will produce the same response.