The most important principle of fundamental analysis is finding profitable companies in which it would be profitable to invest after comparing the management, sales and revenues.There are basically two kinds of drivers in fundamental analysis. They are:
1. Internal Drivers: The factors which are related directly to the business in question are known as internal drivers. They include assets, liabilities, income, revenue, management, products and the like. The internal drivers help in obtaining a general understanding of the position of the company in comparison to others. The internal driver analysis can be further classified into:
• Management: Companies having a weak management cannot last for a long time. News, Internet, Analyst reports etc. can help one in making an informed judgment about the management of a company.
• Profit: Profit is one of the most important factors for fundamental analysis. This is because companies earning most profit have larger potential for price growth as well as dividends.
• Production: Production is an extremely important factor when we talk about companied producing wood, gas, oil, metal or power. This is because their value depends complete on the production output and the value of the product.
• Share Volume: One needs to check whether the company is question has enough share volume to sell the shares of its stockholders at a later stage.
2. External Drivers: The factors that are outside the influence of a company but can affect its profit margin are known as external drivers. These include inflation, economy, politics, interest rates, bond markets and the like.
• Inflation: Inflation exerts a direct influence on stock market. Though observing inflation rate can prove to be subjective for the trade, knowledge of history can explain the effect of inflation on stock markets in the past. The inflation is ever increasing as individuals and businesses are borrowing rapidly from the market. In this situation, the Federal Reserve intervenes in order to find a solution to the problem. When these control activates, the direction of inflation trend changes. Having control is most important for success on the bull market. Besides this, inflation also has a direct impact on the rate of interest.
• Interest Rates: Interest is of two types namely, short term and long term interest. When the economic growth is strong, the short term rates rise. On the other hand, long term rates ascend depending on the inflation and difference in the currencies of foreign countries.
The federal rate and discount rate are controlled by the Federal Reserve. They are used to manage the trend of inflation as well as the trend of rate of interest. Thus, there rates have an immense impact on all kinds of investors. Also, the ‘real’ interest rate, which is the average of federal funds rate after subtracting the inflation rate from it, are used to determine the future of interest rates as well as the overall market.
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