“Most of the world’s most successful investors use fundamental analysis to find investment opportunities.” — INVESTOPEDIA.COM
FA is the evaluation of the information under the hood of an industry, company or sector to determine its economic health and financial performance. In the case of cryptocurrency, FA also helps to determine legitimacy of a coin or token.
Usually, the main goal is to scrutinize for information that would lead to a forecast or future of a company. To decide whether or not the stock, coin or token is a good investment.
In stocks, this type of examination may take years before investors come to a conclusion, and a couple of weeks or even a couple of months, when it comes to cryptocurrencies due to the fact that they are not corporates but instead storage of value on a network.
FA is mostly used to filter which or what company to invest in. As in opposed to TA (Technical Analysis) that evaluates companies to decide when to buy or sell.
You might want to check out our post about “Technical Analysis Basics”.
This is one method investors use to evaluate a company to invest in, followed by bottom-up approach;
With top-down approach investors check:
- The economic health of a company first.
- The industry second.
- The earnings last.
To only then, decide whether or not to buy.
This is the same approach but as the name suggests in the opposite order.
- The earnings first.
- The industry second.
- And then, the economic health of a company.
This is not necessarily a rule and it may change from investor to investor, they come up with their own ways of examining the economics of an asset.
Financial analysis may include income statements, balance sheets and cash flow statements.
- Balance sheets usually shows how a company makes money and stays balanced between assets, liabilities and owner’s equity.
- Liabilities are bills or accounts to be paid.
- Assets are the properties, cash and equipment.
- Owner’s equity is the assets minus the liabilities.
- Income statements shows the revenues and expenses of the company, subtract one from the other and you the net income, in other words the earnings.
- Cash Flow Statements shows operations, investments and debts. Basically, showing how the company spends its cash, how it operates the business, and how it invests.
Also, how much it has borrowed from banks and bondholders.
Companies have tons of financial documents to be studied, so it’s important to know which one’s will give you a better analysis. Here are some other lists to look for in addition to the documents listed above:
- Quarterly Financial Reports (10-Q)
- Annual Financial Reports (10-Q)
- Earnings Press Release
Ratio Analysis are used in fundamental analysis to examine the financial performance such as profitability, efficiency and liquidity.
PE RATIO is one of the most used tools in FA.
Price-to-Earnings ratio is the current market price of a stock divided by it’s earnings.
Value per unit or price per share(PPS)
Earning per unit or earning per share (EPS)
The average PE Ratio of a company is between 15 to 25. And in theory it basically tells how much an investor is willing to pay per dollar of earnings. In other words, a PE ratio of 20 means an investor is willing to pay 20$ for every 1$ earnings produced within a year.
Higher PE Ratios basically means investors will expect elevated or higher earnings, which does not mean it is better than a lower PE Ratio, because that particular stock could simply be overvalued.
Ps: Overvalued stocks means high prices are unjustified and for that reason are expected to suddenly drop.
PE ratios are considered a much better number to evaluate a company than the actual market cap number but are not enough to decide whether or not to invest in a stock.
Market Cap is the amount of shares x the price of each share. For example, 100 shares x 100$ = 1000$ Market Cap.
Fundamental Analysis for Cryptocurrencies, however, can be a bit different, due to the fact they are volatile at the moment, they are just getting started so studies would be performed a little bit different. Here are some things to analyze:
· Coin’s White Paper: Coin’s Mechanism, infrastructure, the team behind, what is the purpose of the coin? Does the coin solve a real problem? Is it crowded with marketing language? etc.
· Coin’s Blog: Content, Frequency, Reviews…etc.
· Coin’s governance: decentralized or centralized? Is it a utility or security?
· What is the consensus mechanism?
· Development Road Map?
· How is the project being funded? How much money has it made? Successful ICO’s?
The importance of Fundamental Analysis in cryptocurrency is the same as with stocks, which is to keep you safe from bad investments and frauds. You should not invest until you have studied the underlying values, morals, legitimacy and financial conditions of a coin or token.
Also, it might be beneficial to invest in both FA to know in which to invest, and TA to know when to sell or buy.
In this post, we have only scratched the surface of the complex understanding of Fundamental Analysis, to give you a base to begin understanding the basics, to help you to engage in your own studies at your own diligence.