Term:FUNDAMENTALS

All those factors which will tend to influence the future profits of a company. The most important of these is its past profitability – which is best discovered by a careful examination of the past annual financial statements. Other factors include the industry which it is in, its competitors, the regulatory environment, technical developments, unionisation and so on, are also important. The more research into fundamentals you do, the better your understanding of the company will become. Ultimately, it is important to visit the company and perhaps talk to one of the directors. You will learn more from that visit than hours of analysis of the financial statements. Institutional fund managers typically produce a forecast of where they think the company’s earnings and dividends are going in the future (say, over the next five years). Then they discount that into a value for the share today using an internal rate of return (IRR). This is then compared to the shares price in the market to determine whether it is over- or under-priced. Obviously, each analyst’s forecast of future earnings is different – so the market price can be defined as “an average of all investors discounted cash flows of the future dividends of the company”.

 

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