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Fundamental Analysis Basics by Jordan at Investing Blog

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A company has to produce something to make money. Maybe it has a few websites like Yahoo, or maybe it makes stickers and Post-it notes like 3M, or it could be a bank, which makes money in the future available to people today via loans.

So where is this going?

Well, just like you may look at a business from the outside and only see the wonderful product it makes or the services it performs, when you look at a business from the inside out, you see a totally different picture. At its most basic element, businesses are just little money factories. They put out a certain amount of money to buy labor, capital equipment, and materials and put out a finished product that is the culmination of all three of those things.

When you buy 3Ms Post-it notes, you aren’t just paying for paper. You’re paying for the paper, the dies, the sticky stuff, a portion of the salary of every employee, part of their health care, some of the debt, the cost of marketing that product to you, shampooing the carpets at the corporate headquarters, and on and on and on.

Looking from the inside out, this is what we see. We see a little money factory that buys thousands of different products and services and pushes out just a few. One great example is Google, which has thousands of employees, demands all kinds of physical goods, and their only product is a bunch of 0 and 1s. The only difference between Google.com and say, Google Docs or Google Chrome browser is the different order that the 0s and 1s appear. Crazy, huh?

So Let’s Look Out From the Inside

This is why we have to look from the inside out if we’re going to be investors. We can’t just say, “Oh, I love this company’s product so I’m sure I’ll love their stock, too!” Well, you probably could, but you wouldn’t be making money for very long unless you happen to represent the collective thought of everyone else in the world. But all that aside, to find good investments at the fundamental level we have to find businesses that are perfect little cash machines.

We have a billion different numbers we can use to quantify a business’s standing from the inside out. Here are a few from my “fundamental trading” week, and I’ll be sure to keep adding these as we go along.

Net Profit Margins
Return on Equity
Growth at a Reasonable Price

Admittedly these numbers aren’t as exciting as enjoying McDonald’s new cold drinks and analyzing consumer reaction. But these numbers are easier to quantify, and are the numbers that actually count. As much as you may enjoy McDonald’s smoothies, they may not be profitable, or they may be the most profitable product they sell. (They’re actually very profitable.)

What matters with fundamental analysis is the bottomline. You have to think like a CFO and look at a company and how its current financial system will perform 2, 5, 10 years down the road. How will the company’s long term debt financing today affect future profits? How will a different company with short term debt deal with higher interest rates going forward? How will McDonald’s smoothies sell in the winter? Etc.

About Jordan

Jordan is the web master of www.investingblog.org, a site dedicated to skillful investing, news and recent trends. You can read the original article here.

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