Approach, software and tools
Lincoln believes that when creating your investment portfolio, fundamental analysis must first be applied in order to ensure you are focusing on selecting superior shares.
Fundamental analysis: what is it?
Fundamental analysis applied to the sharemarket is a method of assessing whether a company is a good investment using information from various sources such as financial statements, company announcements, disclosures and economic and industry reports.
It is an academic approach and considers the overall economy, the industry in which the business operates and the Financial Health of the company. Fundamental analysis looks at both 'quantitative' data (eg. revenue growth, margins and financial ratios) and 'qualitative' data (eg. management strength, market position, patents and proprietary technology).
Under this method, the company's valuation is based on past performance, industry trends, growth potential management and competition. Unlike the Efficient Market Theory (EMT), which says that all information is already reflected in current prices and therefore cannot be predicted, fundamental analysis believes that an intrinsic value may be derived and that investors can profit by buying 'undervalued' shares and, where short selling is allowed, selling 'overvalued' shares.
'Undervalued' shares are those that have a higher intrinsic valuation compared to the current market price. Conversely, 'overvalued' shares are those with intrinsic valuations less than the current market price. The assumption here is that in the long run, shares will move towards the intrinsic valuation or the 'correct price'.
Tim Lincoln, MD
"Without knowing the true financial health of a company, investors are purely speculating."
'Top-down' and 'bottom-up'
There are two approaches to conducting fundamental analysis: top-down and bottom-up. Both have their strengths and weaknesses and both have the same goal of choosing the best companies for investment. The important thing is to use the approach that you are comfortable with and which suits your investment style.
The bottom-up approach starts from the individual company before proceeding to the general economic and market conditions. Advocates of this approach such as Warren Buffett, Peter Lynch and Benjamin Graham primarily look for companies that are financially healthy, have a strong track record of earnings growth and good prospects. The general idea behind this is that there are the companies that can deliver profits in any market environment and thrive even under difficult conditions. Industry and macroeconomic factors are then considered, but are only secondary under this approach.
On the other hand, the top-down approach, as the name suggests, begins from the macro level (general or broad) and ends at the micro level (specific). Under this approach, one first looks at the global market conditions, then drills down to the state of a country's economy, then a specific sector and finally an individual company.
Lincoln applies a bottom-up approach to its fundamental analysis as we believe picking the best companies on the Australian Securities Exchange (ASX) gives you the best chance of outperformance over the long term.
Fundamental vs. technical analysis
In sharemarket analysis this is probably one of the most debated issues. Having already discussed fundamental analysis, let us now look at technical analysis.
Technical analysis is a method of assessing whether a company is a good investment using charting to plot historical trading data, such as security price and volume. It believes that the current market price already reflects all the information available in the market. The main assumptions of technical analysis are: (1) the market discounts everything; (2) price moves in trends; (3) investor psychology manifests in the chart, and (4) history repeats itself.
Technical analysts then believe that the future price of a security can be deduced by looking at the charts and the trends and formations that appear. Unlike fundamental analysis, where the basis of under and overvaluation is relative to the calculated 'intrinsic value', the basis in technical analysis is relative to its historical trading averages and trends.
With both fundamental and technical analysis approaches enjoying support from a wide variety of investors, a settlement on the debate between the two will likely never be reached. What we need then is simply to understand both methods to determine which is suitable for us. Many choose one or the other. A growing number of investors believe both approaches can be used together to maximise returns. Fundamental analysis is best used for share selection, while technical analysis can sometimes help time an entry into, and exit out of, the market.
Elio D'Amato, CEO
"Lincoln applies a bottom-up approach to its fundamental analysis as we believe picking the best companies on the ASX gives you the best change of outperformance over the long term."
Fundamental analysis is the best way of selecting shares
Lincoln believes that when creating your investment portfolio, fundamental analysis must first be applied in order to ensure you are focusing on selecting superior shares. It is important to remember at this point that a share represents part ownership of a company. A company that operates on a daily basis, generating revenues through the sale of goods and services, pays expenses and wages from that revenue, operates within an economy and ultimately is there to generate a return for shareholders who have invested in the business.
Given that fundamental analysis performs a detailed study on a company, including its financial health and growth prospects, and does not rely solely on price and volume movements, fundamental analysis ensures that we are investing in a pool of quality companies. These are shares that offer us peace of mind because we would not mind holding them should sudden unexpected shocks, like the recent global financial crisis, occur again.
Lincoln's fundamental analysis approach and the tools used
Lincoln is a staunch supporter of fundamental analysis and we believe that it should be the primary method adopted by serious investors. Stock Doctor, Lincoln's stock research and analysis solution, provides an extensive range of data for all companies listed on the ASX. We offer a unique methodology focused on Financial Health that is applied across all sectors and companies, thereby simplifying the filtering and selection process. Without knowing the true financial health of a company, investors are purely speculating.
Stock Doctor provides exhaustive fundamental data drawn from financial statements, annual reports, disclosures and company announcements. Clients may opt to conduct their own analysis and select shares using the information available on Lincoln's database or by simply looking at our Stock Doctor Star Stocks which represent a pool of quality companies that have met a core group of Lincoln's Nine Golden Rules criteria for successful investing.
The Nine Golden Rules use fundamental analysis to look at a company's financial health based on selected profit and loss, balance sheet and cash flow ratios, plus earnings growth, management, operations, share price value, liquidity and size. Furthermore, Stock Doctor provides subscribers with current and historical dividend data, company and industry price to earnings ratios and company news.