Traders don't look at balance sheets and income statements, right? Not so fast. Fundamental analysis might be able to tell you something your charts can't.
When it comes to analyzing stocks, there are two primary schools of thought: fundamental analysis and technical analysis. Fundamental analysis involves poring over income statements and balance sheets, whereas technical analysis involves poring over charts to identify patterns or trends. Technical analysts often resist the notion that fundamental analysis matters. “It’s already built into the charts,” they cry. And fundamental analysts often write off technical analysis as voodoo. But the two may complement each other. Yup, even die-hard technical traders may find useful fundamental nuggets that can help with their trading analysis.
In a nutshell, fundamental analysis of stocks involves evaluating and researching companies to determine if a company is healthy. There’s no one right way to go about analyzing companies. Look at two well-known investors, Warren Buffett and Peter Lynch. They each have a different approach. Buffett looks for great companies that trade at a fair price (value investing). And Lynch believes in researching the companies whose products you already enjoy. It comes down to your personal objectives or what you want to achieve.
How do you become your own analyst? Company Profile, a fundamental analysis tool on the thinkorswim® platform from TD Ameritrade, opens the door to the world of fundamental investment analysis to help you focus on the fundamental data that matters to you. That could mean price-to-earnings ratios, company earnings, or key economic indicators such as housing, jobs, and interest rates.
Investors who base their decisions on fundamental analysis tend to approach the markets in two ways: top down and bottom up. The approach you use often depends on your goals. So put on your analyst hat and start by asking yourself, “What am I looking for?”. If you prefer a top-down approach, you might start with global economics, make your way to sector analysis, then to industry analysis, and finally to a couple of stock picks. A bottom-up approach starts with the stock picks and then a broader analysis of each stock.
Stock analysts are notorious for building out complex equity models that let them adjust a company’s valuation based on pulling certain “levers.” For instance, suppose sales of widget X are up 10%, advertising pricing is decreasing by 1%, and operating margins are increasing by 2%. The Company Profile tool lets you automatically adjust these levers to make your own projections. You may want to know if there’s anything about the company (or companies) you’re about to trade that could potentially give you an edge.
Let’s look at how you might benefit from using the tool.
For example, imagine it’s the start of the new year. You promise to hit the gym, and with that, you figure millions of wishful thinkers will not only be going for six-pack abs; they’ll also be shopping for new workout clothes. So, you look for a company that specializes in “performance apparel.” You’ve narrowed your selection to two companies. Both have diversified businesses, so out of the gate, you’re looking for one where there is a higher concentration of revenue in performance apparel. In addition, you’re looking for the brand that’s squeezing out higher margins in its apparel business. Finally, you’re looking for the company that’s trading at a discount to its valuation. In about 45 seconds, you should be able to zero in on what you think looks like the better opportunity. How?
Fire up thinkorswim, select the Trade tab, and enter a stock symbol. Then select Company Profile at the top right to bring up the tool (see figure 1).
FIGURE 1: THE COMPANY PROFILE TOOL. Studying the business divisions of a company could tell a story you may not have heard. Just enter a symbol and select a business division in the left bar. Select a forecast measure in the right column and view the data, or slide the levers to see what your forecasts may reveal. Chart source: the thinkorswim platform from TD Ameritrade. Data source: Trefis. For illustrative purposes only. The company profile is not available for every symbol. Past performance does not guarantee future results.
Pulling the levers:
Finding divergence: When there’s a difference between your projections (which you adjusted with the levers), analyst estimates (available in the thinkorswim platform by selecting Analyze > Fundamentals > Overview), and the current market price, you've found what’s called divergence. And divergence is where you can often discover some helpful directional-trading potential—both to the upside and downside.
There are still plenty of ways fundamentals—along with the Company Profile tool—can help.
Remember in high school when Cliffs Notes were your BFF? With so much great technology in the trading world these days, the thought of fundamental analysis no longer has to provoke anxiety attacks and extreme dread. Think of the Company Profile tool as the Cliffs Notes of the trading world that can give you some quick hints. You can potentially save yourself countless hours wading through beefy analyst reports and speedily get the insights you need to trade companies whose products and services make you want to profile with joy.
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Jayanthi Gopalakrishnan is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
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