How fundamental analysis can help you in wealth management

If you’re a professional who specializes in wealth management, having a sound understanding of fundamental analysis is a must. Whether your firm manages high-net-worth individuals, pensions, or institutional portfolios, the ability to interpret financial fundamentals allows for reduced exposure to unnecessary risk. 

In this article, Wealth Professional Canada will help you learn all about fundamental analysis. We will explore the basics as well as the steps and key points. We'll also talk about common pitfalls and other valuable insights. 

What is fundamental analysis? 

Fundamental analysis is the process of assessing the intrinsic value of a security. It looks at the underlying financial and economic drivers that impact that value. While technical analysis focuses on price movements, fundamental analysis is all about: 

• consideration of what a business does 
• how that business makes money 
• how external conditions affect it 

In most cases, fundamental analysis involves studying a particular company’s financial statements and industry position. It can also deal with its macroeconomic environment and even governance. Ultimately, the goal is to determine whether a stock or asset is fairly valued, overvalued, or undervalued. 

For wealth professionals, this type of analysis is especially important in a market where many sectors are dominated by a few large players, such as energy and financial services. 

Want to know more about fundamental analysis? Watch this video: 

Fundamental analysis is one method of measuring a stock's intrinsic value based on several factors. But if you need a more basic approach, here’s a beginner’s guide to investing in the stock market. 

What are the five steps of fundamental analysis? 

To carry out a fundamental analysis of a certain firm, you can follow these five steps: 

1. study the company 
2. evaluate financial statements 
3. examine the company’s debt 
4. check the competitors 
5. consider future growth potential 

Let's discuss each step below: 

1. Study the company 

Before anything else, take time to learn what the company does. Explore its products, services, and target markets. You can also check its website and research about its leadership team to assess the company’s objectives and core strategy. 

If possible, download and read its most recent annual report. This document can offer insight into the company’s recent performance and management commentary. Try to find and assess all available details so that you can have a full understanding of the firm. 

2. Evaluate financial statements 

Dig into the company’s financial documents to assess its performance. Focus on these four: 

• balance sheet: this lists a company’s assets, liabilities, and shareholders’ equity 
• income statement: this shows revenue, expenses, and profits over a period 
• cash flow statement: this tracks the movement of cash in and out of the business 
• statement of changes in equity: this details changes in all components of shareholders’ equity over a reporting period such as retained earnings, share capital, and other reserves 

Using these, try to look for trends in profit margins and net income over the past few years. A healthy company usually shows steady or growing revenue plus improvements in profitability. You should also watch for consistent operating performance and a solid cash position. This is especially true if your clients are leaning toward long-term investing. 

3. Examine the company’s debt 

A company’s debt level can directly affect its ability to grow and reward shareholders. Use the D/E ratio to see how much debt it carries compared to shareholder equity. In general, a D/E ratio below one suggests a manageable debt load. 

You can also look at interest payments, liquidity, and any red flags like declining margins or mounting liabilities. 

4. Check the competitors 

Comparing a company to its main competitors can help you judge whether it stands out in its industry. You can look at factors such as: 

• market share 
• innovation 
• pricing power 
• brand reputation 

Understanding how a company stacks up can help you decide if it has a durable advantage or unique value proposition that sets it apart. 

5. Consider future growth potential 

Strong investments often come from companies with promising long-term prospects. Look beyond current numbers and consider where the business is headed. Are its products likely to stay relevant in the next few decades? Is there room to expand into new markets or revenue streams? 

Evaluating future potential can help you recommend good stock picks with staying power and growth opportunities. 

What are the key points of fundamental analysis? 

Fundamental analysis can be broken down into several key points. Each component helps provide a different layer of understanding about the security being analyzed. Here’s a quick glance at some of them: 

1. financial statement analysis 
2. ratios and metrics 
3. industry and competitive analysis 
4. macroeconomic and geopolitical factors 

Below is a more in-depth look at these key points: 

1. Financial statement analysis 

As mentioned above, the foundation of any fundamental analysis is the study of a company’s financial statements. These documents provide a view of a company’s profit potential, financial health, as well as its ability to generate future cash flow. 

2. Ratios and metrics 

Financial ratios and metrics can provide quick snapshots of a company’s performance. Here are some that you can use when conducting fundamental analysis: 

• Earnings per share (EPS): This shows how much profit a company earns for each share. You can calculate it by dividing net profit by the number of outstanding shares. 

• Price-to-earnings (P/E) ratio: This compares the stock price to the company’s earnings. It can help you judge whether a stock is overvalued or undervalued. 

• Price-to-book (P/B) ratio: This compares the stock price to its book value per share. You can assess whether a stock is trading above or below the value of the company’s actual assets through its P/B ratio. 

• Debt-to-equity (D/E) ratio: This measures how much debt a company has compared to shareholder equity. To get a company’s D/E ratio, divide its total liabilities by the total equity balance. 

• Return on equity (ROE): This tells you how well a company uses shareholder money to make profit. Dividing net income by shareholder equity can give you a firm’s ROE. 

These metrics are not interpreted in isolation. Always remember that context matters, especially in environments where sectors like mining or banking can distort benchmarks. 

3. Industry and competitive analysis 

No company operates in a vacuum. Understanding the industry structure is the key to interpreting financial results. Fundamental analysis should consider: 

• the number of competitors and barriers to entry 
• market share and pricing power 
• regulatory risks or dependencies 

Let’s use a contrasting example. Banks operate in an oligopolistic system. This means strong margins and consistent profitability. In contrast, the cannabis sector remains volatile and oversupplied. 

4. Macroeconomic and geopolitical factors 

Canada’s economic condition and currency values have a huge impact on company fundamentals. When performing fundamental analysis, wealth professionals should factor in: 

• GDP growth and inflation forecasts 
• Bank of Canada interest rate policy 
• exchange rate volatility, especially CAD/USD 
• global commodity prices and trade relationships 

For firms with US exposure or multinationals listed on the Toronto Stock Exchange (TSX), currency fluctuations and global monetary policy can affect earnings and asset values. 

The two main approaches in fundamental analysis 

In practice, wealth professionals can use two broad approaches in fundamental analysis: top-down and bottom-up. Each offers distinct advantages depending on your clients’ strategy or portfolio objectives: 

Top-down approach 

This starts by analyzing macroeconomic trends and then narrows down to sectors and companies. It is useful for thematic investing or positioning a portfolio for economic cycles. Wealth professionals might begin by examining global and national indicators before identifying industries likely to outperform. 

Example: If the Bank of Canada signals rate cuts, financial advisors might favor rate-sensitive sectors like utilities or real estate investment trusts. 

Bottom-up approach 

This starts at the company level and works upward. The emphasis is on company-specific strengths, such as a new product line or efficient capital allocation. This approach is valuable for identifying undervalued firms regardless of broader economic trends. 

Example: An analyst might find a small-cap tech firm trading below book value with free cash flow and minimal debt. 

Watch this clip to know more about these two approaches in fundamental analysis: 

While fundamental analysis entails a traditional approach to finding a potential investment, there’s a modern strategy called social trading. It’s done by newbie traders and investors who use a common social trading platform with those who have more experience.  

Common pitfalls in applying fundamental analysis 

While fundamental analysis is a powerful tool, it is not without limitations. Wealth professionals should be aware of several common issues that can distort results or lead to poor decisions: 

• Overreliance on past data: Financial statements reflect past performance. Using them without adjusting for forward-looking risks, such as changes in industry demand or technology disruption, can be misleading. 

• Ignoring qualitative factors: Some variables, like brand strength or leadership quality, are difficult to quantify but still important. A company might have solid numbers but a flawed strategic vision or weak governance. 

• Confirmation bias: You might fall into the trap of finding data that supports a pre-existing view about a particular company. This can lead to ignoring warning signs or overestimating upside potential. 

• Sector misapplication: Ratios like P/E can vary widely by sector. To avoid this, always compare metrics to sector-specific benchmarks. 

Mastering fundamental analysis 

Fundamental analysis is all about using the key elements of a company to assess the value of its stock. When conducted accurately, your clients will be able to see a clearer picture of a company’s financial health and industry position. You can also show them how a certain business might perform in the broader market environment. This kind of insight can set high-growth portfolios apart from average ones. 

If you want to help investors build their portfolios, using fundamental analysis is beneficial. For instance, if they’re interested in bank stocks, you’ll be able to assist them in picking the best ones. You can also point out the most volatile choices and guide them in understanding their risk appetite. With fundamental analysis, you can turn data into action for your clients’ benefit. 

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