If you want to invest like the greatest investor of all time, Warren Buffett, fundamental analysis will be an important tool for you to use.
So you've got some money saved and you want to invest it in the stock market. Good choice. Over time the stock market has returned an average of 11% on invested capital.
As an investor, you have many tools at hand to help you on your quest. One of the most useful of these tools is fundamental analysis – examining key ratios which show the worth of a stock and how a company is performing (this is a primary methods of Warren Buffet, the second richest man in America).
This method is very different from another method called technical analysis. Technical analysis analyzes the movement of stock prices and daily trading volume. Instead of looking at the companies on the exchange, you are watching how the people buying and selling stock are acting on a day by day basis. That's quite different from the use of fundamental analysis.
The goal of fundamental analysis is to determine how much money a company is making at present and what kind of earnings can be expected in the future. Although future earnings are always subject to interpretation, a good earning history creates confidence among investors. Through good earnings, stock prices increase and dividends may also be paid out.
Where does Fundamental Analysis begin?
Companies are required to report earnings on a regular basis and stock market analysts examine these figures to determine if a company is meeting its expected growth. If not, there is usually a downturn in the stock's price.
There are many tools available to help determine a company's earnings and its value on the stock market. Most of them rely on the financial statements provided by the company. Further fundamental analysis can be done to reveal details about the value of a company including its competitive advantages and the ratio of ownership between management and outside investors. All the figures can be confusing, but if you learn how to do it, it can be invaluable in how you invest your money.
Once you've found a business run well, making money, you then wait until it is undervalued. From time to time investors get rattled and the market goes down more than it should. Yes there are people who believe that the market is efficient and you can't find irrational values. That's not what Warren Buffet believes. He says, "I'd be a bum on the street with a tin cup if the markets were always efficient."
The key is to be ready to invest when the markets go down irrationally. That emotion will carry good stocks down with it. That is when you buy... good stocks. It sure beats trying to invest using some hot stock market pick suggested by a co-worker or relative. If you're going to buy stocks, buy smart.
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