Stock Selection Strategies: Fundamental Analysis

Fundamental analysis focuses on studying a company's financial statements in order to predict its future performance. This method looks at the revenue, expenses, assets, liabilities and all other financial aspects of a company to try to determine if its stock is underpriced, fairly priced or overpriced. Qualitative factors such as quality of management, competitive advantages within an industry and the state of the global economy are also important when performing fundamental analysis.

Fundamental analysis relies on two basic assumptions:

1. Companies provide accurate and complete financial statements.
2. In the long run, the price of a security will revert to its fair price.

With fundamental analysis, therefore, you can use a company’s financial information to estimate future share price targets.

You can think about what a stock is worth in a number of ways. For example:

• Consider the estimated future earning potential of the company
• Evaluate how much the company would cost if another company were to try to buy it.
• Compare key quantitative measures amongst similar companies (referred to as industry peers) to get a sense of the company’s worth.  

Good fundamental analysis requires a solid understanding of accounting and the time and ability to analyze financial statements. Many professional equity analysts train for years to develop fundamental analysis skills.

If you want to choose stocks using a fundamental approach but don't have the time or skills to do the research yourself, there are many resources available in the Research Centre:

• Canadian Research Highlights, a monthly publication that discusses Morningstar^‡ analysts' best ideas and surfaces recent developments from their Canadian coverage universe. Also included are an earnings calendar and a Canadian stock coverage snapshot.
• Global Investment Outlook, a quarterly publication provided by analysts at RBC Global Asset Management that presents global forecasts for numerous markets and provides asset allocation recommendations.
• RBC Dominion Securities Morning Commentary, a daily publication that includes commentary on specific companies, analysts’ price targets and more.
• On the Move, a list of the week's analyst upgrades and downgrades

The Stock Screener lets you select companies based on fundamental measures such as price/earnings ratio and net profit margin.

If you have a stock in mind and want to learn more about its company fundamentals, a number of tools are at your disposal from the Detailed Quote of a stock:

• On the Overview tab, you will find an analyst consensus recommendation.
• The Research tab provides research from Morningstar (for companies covered) as well as forecasts for future earnings.
• The Fundamentals tab provides the key measures and ratios that fundamental analysts use – for both the stock and the industry.
• The Financials tab lets you access the income statement, balance sheet and cash flow statements of a company. You will find up to four years of data, which you can even download into a spreadsheet.