Fundamental analysis is something many traders tend to relegate to the back burner. This makes sense for those using a short-term timeframe; chart patterns and moving average violations are much more telling than the underlying business dynamics, which take time to impact a stock's price.
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Longer-term traders, however, can wield some basic fundamental analysis as a powerful tool for trade selection. The key to understanding this approach is taking the mystery out of the numbers. For those used to deciphering chart patterns, a list of dry figures or a balance sheet doesn't lend much immediate information.
The bread and butter of the fundamental approach is to find stocks with attractive valuations. In a nutshell, a good valuation means that a company's projected business outlook hasn't yet been priced in by the market. The basic idea is that over time, money will naturally gravitate towards stocks that offer the best bargains. It's a common-sense idea that can be easily overshadowed by other factors that attract traders' attention: broader market dynamics, geo-political events, and so on.
The Price/Earnings ratio is one of the basic ways that valuation can be gauged. Generally speaking, a lower P/E suggests a more attractive valuation. Oftentimes you'll see a company's P/E compared against the benchmark S&P 500 average, which tends to hover in the 20-25 range.
A more useful approach is to compare a stock's P/E to its primary competitors and the average for the overall industry. Utility stocks, for instance, often trade at relatively low valuations, while tech stocks clock in at higher levels. To use a real-life example, shares of Ameren (AEE), a diversified utility, have a P/E of 22. That's roughly in-line with the broader market. But when compared to the overall utility sector, it doesn't look quite so attractive; the average for the industry is 19.
Periodic business updates can provide another window into a company's fundamental performance. For retailers, this includes the monthly same-store sales data. Analysts will venture guesses as to the results, just like they do with earnings.
When holding a retail stock, it's always a good idea to be aware of any upcoming same-store sales announcements. These can often have a strong impact on the equity's
price, depending on how the actual results compare with the consensus estimate. Companies also frequently offer regular mid-quarter updates. All traders, regardless of
their chosen timeframe should be aware of these events because of their potential impact on a stock's price.
