13. Fundamental And Technical Analysis

SECTION 5

INVESTMENT ANALYSIS

13 Fundamental and Technical Analysis

14 Company Analysis

Fundamental and Technical Analysis

In this chapter, you will learn how analysts use statistical, market, and industry information to value securities and make recommendations on their purchase or sale. You will be introduced to two primary methods of analysis: fundamental analysis and technical analysis.

LEARNING OBJECTIVES

CONTENT AREAS

1. Compare and contrast fundamental and technical analysis.
2. Describe how the three macroeconomic factors affect investor expectations and the price of securities.
3. Explain how industries are classified and how industry classifications impact a company’s stock valuation.
4. Describe the tools used in technical analysis.

Key Concepts and Terms

Key terms are defined in the Glossary and appear in bold text throughout the chapter. Here are some essential terms you should be familiar with:

• Blue-Chip: High-quality, widely accepted stocks of well-established, financially stable, and highly reputable companies.
• Chart Analysis: The process of examining security price and volume data to identify patterns that can predict future price movements.
• Continuation Pattern: A technical chart pattern signifying that the current price trend will continue after a brief consolidation period.
• Cycle Analysis: A technique used in technical analysis to identify recurring cycles in the prices and economic indicators to forecast future trends.
• Efficient Market Hypothesis (EMH): The theory that all available information is fully and immediately reflected in securities prices making it impossible to consistently achieve higher-than-average returns.
• Sentiment Indicators: Tools that gauge investor sentiment to predict market movements, such as surveys or flow of funds data.
• Technical Analysis: The method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume, without considering a security’s intrinsic value.
• Fundamental Analysis: The method of evaluating the intrinsic value of a security by examining related economic, financial, and other qualitative and quantitative factors.

Methods of Equity Analysis

Fundamental Analysis

Fundamental analysis involves evaluating the intrinsic value of a security. Analysts will consider financial statements, external factors including macroeconomic indicators, industry conditions, and company-specific news to estimate the true worth of a security.

1. Financial Statement Analysis: Studying balance sheets, income statements, and cash flow reports.
2. Industry Analysis: Examining industry conditions, competitors, market position and cyclical factors.
3. Economic Analysis: Reviewing broader economic indicators such as GDP, inflation rates, and employment levels.
4. Qualitative Analysis: Assessing management quality, companies’ business models and strategy, brand value and market share.

Technical Analysis

Technical analysis focuses primarily on price and volume activity to predict future price variations rather than the intrinsic value.

1. Chart Analysis: Detecting patterns and interpreting charts of past prices and volumes.

       graph LR
   	A[Price Movement] --> B[Support and Resistance]
   	C[Trendlines] --> A
   	B --> D[Head and Shoulders]
   	B --> E[Continuation Pattern]
   	F[Moving Averages] --> C
   

2. Sentiment Indicators: Gauging market sentiment through various methods like trader surveys or option trading volume.

Key Takeaways

• Fundamental Analysis and Technical Analysis are key methods for security analysis, each with unique applications and tools.
• Macroeconomic factors can substantially affect investor sentiment and security prices.
• Industry classifications and fundamental factors are crucial in evaluating a company’s stock.
• Technical tools and patterns, such as moving averages and trendlines, help predict market behavior.

Frequently Asked Questions (FAQs)

What are the primary differences between fundamental and technical analysis? Fundamental analysis evaluates the intrinsic value of securities using financial and economic data, while technical analysis uses past market data like price and volume to predict future price movements.

How do macroeconomic factors affect stock valuation? Macroeconomic factors like GDP growth, interest and inflation rates significantly influence investor sentiment, which in turn impacts the price of securities.

What are support and resistance levels in technical analysis? Support levels are price points below which a stock price typically does not fall, while resistance levels are points above which it rarely rises.

What role does qualitative analysis play in fundamental analysis? Qualitative analysis involves assessing non-quantifiable factors such as management quality, brand value, and company strategy to gauge a company’s long-term potential.

By understanding and applying these methods and principles, analysts can make more informed decisions and provide nuanced investment recommendations. This section will equip you with the foundational knowledge required for sophisticated investment analysis.

In this section

• 13.1 Introduction
  This introduction provides a comprehensive overview of the essential tools and techniques for evaluating investment opportunities, incorporating both fundamental and technical analysis within the financial markets.
• 13.2 Methods Of Equity Analysis
  A comprehensive guide covering the methods of equity analysis, focusing on fundamental and technical analysis, and providing detailed insights, formulas, charts, and key takeaways to help you prepare for the Canadian Securities Course certification exam.
  • 13.2.1 Overview Of Fundamental Analysis
    Learn about fundamental analysis in the context of the Canadian Securities Course (CSC), including its importance in evaluating capital market conditions, economic conditions, industry conditions, and individual companies to measure intrinsic value.
  • 13.2.2 Overview Of Technical Analysis
    Discover the fundamentals and key concepts of technical analysis in securities trading. Learn how past price movements and market sentiment help predict future price directions.
  • 13.2.3 Market Theories
    Explore the three major stock market theories - efficient market hypothesis, random walk theory, and rational expectations hypothesis, along with their variations and implications for investment strategies.
• 13.3 Fundamental Macroeconomic Analysis
  Understand how three macroeconomic factors—fiscal policy, monetary policy, and inflation—influence investor expectations and the price of securities. Learn the impact of unpredictable events such as international crises, regulatory changes, and technological innovations.
  • 13.3.1 Fiscal Policy Impact
    A comprehensive analysis of how fiscal policy impacts economic performance, government spending, taxation, and investment.
  • 13.3.2 Monetary Policy Impact
    Learn about the impact of monetary policy on the economy, securities market, and the effects of inflation on corporate profits and price-earnings multiples.
• 13.4 Fundamental Industry Analysis
  Detailed guide on fundamental industry analysis explaining industry classification, impact on stock valuation, and factors affecting company profitability.
  • 13.4.1 Classifying Industries By Product Or Service
    Detailed guide on classifying industries by product or service, using the Global Industry Classification Standard (GICS) as defined by Standard & Poor’s (S&P) and Morgan Stanley Capital International (MSCI).
  • 13.4.2 Classifying Industries By Life Cycle
    A thorough examination of Industries Life Cycle stages: Emerging Growth, Growth, Maturity, and Decline. Understand how each stage affects industry performance, companies involved, and investment valuation.
  • 13.4.3 Classifying Industries By Competitive Forces
    In-depth insight into how competitive forces classify industries according to Michael Porter's framework, critical for understanding industry attractiveness and investment potential.
  • 13.4.4 Classifying Industries By Reaction To Economic Cycle
    Discover the classification of industries by their reaction to economic cycles: cyclical, defensive, and speculative. Learn how these classifications affect investment strategy and stock valuation.
• 13.5 Technical Analysis
  Explore the essentials of technical analysis within the Canadian Securities Course (CSC). Understand the tools and assumptions that technical analysts utilize to determine future price trends based on historical market data.
  • 13.5.1 Comparing Technical Analysis To Fundamental Analysis
    Understanding the key differences and applications of technical analysis and fundamental analysis in investment strategies.
  • 13.5.2 Commonly Used Tools In Technical Analysis
    Explore the commonly used tools in technical analysis, including chart analysis, quantitative analysis, sentiment indicators, and cycle analysis. Learn how these methods can help identify trends and make informed investment decisions.
• 13.6 Summary
  This summary covers the key aspects of fundamental and technical analysis, highlighting their differences, underlying hypotheses, macroeconomic factors, industry classifications, and the role of competitive forces.