3 min read Investment Learning

What is Fundamental Analysis vs Technical Analysis?

What is Fundamental Analysis vs Technical Analysis?
Photo by rc.xyz NFT gallery / Unsplash

Understanding what is fundamental analysis vs technical analysis is crucial for any serious investor. These are two distinct approaches to stock analysis, each offering a different lens through which to view potential investments. Charlie Munger and Warren Buffett famously champion fundamental analysis, while others use technical methods. Let us explore both, understanding their strengths and limitations.

Fundamental Analysis: The Business Owner's View

Fundamental analysis focuses on a company's underlying health and prospects. It seeks to determine a company's intrinsic value – what the business is truly worth, independent of its current market price. This approach is akin to buying a whole business, not just a stock.

How it Works:

  • Financial Statements: Analysts scrutinise income statements, balance sheets, and cash flow statements. These documents reveal revenue, profit margins, assets, liabilities, and cash generation. You can find these detailed financial reports for various companies on Screenwich.
  • Qualitative Factors: Beyond numbers, fundamental analysis considers management quality, competitive advantages (moats), industry trends, and brand strength. A strong management team and a durable competitive moat are hallmarks of a great business.
  • Economic Environment: Broader economic conditions, interest rates, and regulatory changes also impact a company's future earnings.
  • Valuation Models: Tools like a DCF calculator (Discounted Cash Flow) are used to project future cash flows and discount them back to the present. This requires estimating a WACC (Weighted Average Cost of Capital) and a terminal value for cash flows beyond the forecast period. Advanced practitioners might use a Monte Carlo simulation to model various outcomes and assess risk.

The goal is to buy shares when the market price is significantly below the estimated intrinsic value, offering a margin of safety. For upcoming financial disclosures, an earnings calendar on Screenwich can help you track key dates.

Common Mistakes in Fundamental Analysis:

  • Ignoring qualitative factors.
  • Over-reliance on past performance.
  • Using overly optimistic growth assumptions.
  • Failing to account for competitive threats.

Technical Analysis: Reading the Market's Psychology

Technical analysis, in contrast, focuses on price and volume data to predict future market movements. It operates on the premise that all relevant information is already reflected in the stock's price. Technicians believe that history tends to repeat itself in terms of price patterns and trends, driven by market psychology.

How it Works:

  • Chart Patterns: Analysts look for specific patterns on price charts, such as 'head and shoulders', 'double tops', or 'triangles', which are believed to signal future price direction.
  • Indicators: Various mathematical indicators, derived from price and volume data, are used. Examples include Moving Averages, Relative Strength Index (RSI), and MACD (Moving Average Convergence Divergence).
  • Volume: Trading volume is often used to confirm the strength of a price trend or pattern.
  • Support and Resistance: Identifying price levels where buying (support) or selling (resistance) pressure is expected to be strong.

This approach is typically short-term oriented, aiming to profit from price fluctuations rather than a company's long-term growth. While Screenwich primarily supports fundamental research, it also provides historical price data, which is a starting point for technical analysis.

Common Mistakes in Technical Analysis:

  • Over-reliance on a single indicator.
  • Ignoring the broader market context.
  • Failing to adapt to changing market conditions.
  • Confusing correlation with causation.

Bringing It Together: A Holistic View

While distinct, these two forms of stock analysis are not mutually exclusive. Many successful investors, including Bill Ackman, combine elements of both. Deep fundamental research helps identify great businesses at reasonable prices. Technical analysis can then assist with timing entry and exit points, understanding market sentiment around a fundamentally sound company.

For beginners, mastering fundamental analysis first provides a solid foundation. Understanding what you own and why you own it is paramount. Then, as your experience grows, you might incorporate technical insights to refine your investment decisions. The discipline lies in knowing which tool to use for which purpose, always seeking clarity and avoiding unnecessary complexity.

Screenwich