Taking a fundamental approach to investment is not easy. It requires quite a lot of investigative work, number crunching, and the application of careful judgment. For many young analysts the process can feel overwhelming and it's hard to know where to start. After 10 years of doing fundamental analysis, I thought it would be useful to share some practical advice on the subject.
Before you start ask yourself the simple question “What does this company do?” You'd be surprised how many analysts find it hard to answer that simple question. It's not enough to know what industry they operate in. You need to know exactly what role they fulfill. Who are they selling to and how do they generate their income? In most cases the company will have more than one product or service, so draw up a pie chart showing the split of revenues and profit for each line of business. You can get this information from the latest annual report on the website of the company.
Having established what the company does, you want to dig bit deeper. A good place to start is usually the “Management Discussion” from the latest annual report. Also on the investor relation page of the website you'll be able to find webcasts of the latest results and the most recent investor day. These are all worth listening too for background information. Nowadays there is also a lot of valuable free research available online, it's worth getting a number of different views on a stock.
As you conduct your research in step 2, you should be getting a good sense for the key drivers of the business. You can usually reduce any business to between 2-5 such key drivers. For example, a retail business will likely be driven by factors such as space growth, same-store-sales growth, and gross margin. An integrated oil company may be driven by the oil price, production growth and cost of exploration. Your sense for the key drivers will evolve as you carry out more analysis but it's worth doing this exercise now as it will help you to focus on what's important in the next steps.
