It’s difficult to imagine that in the modern market an investor will invest in any financial instrument without checking it “from and to” in advance. Only a newcomer to the market can disregard the analysis of an asset, which is likely to lead to deplorable results later on. If you don’t want such a scenario for your capital, you will have to carefully check what you are going to invest in.
There are two main types of analysis: fundamental and technical. Basically, fundamental analysis tells you whether to buy or sell an asset, and technical analysis tells you when to buy or sell the asset. In this article, we will talk about fundamental analysis.
Fundamental analysis — is a method of evaluating assets by examining macroeconomic data, company reports, and comparisons with competitors to determine the real value of an asset and its future profitability. When studying financial and accounting reports, the investor understands for himself whether the value of an asset is real, overstated, or underestimated. If the price is overvalued, it’s worth refraining from investing in an asset, as it’s quite possible that it will become cheaper. If the price is underestimated, you can buy an asset in the hope that it will become more expensive. The value investment strategy, to which Warren Buffett is- the search for undervalued companies based on fundamental factors for the purpose of subsequent purchase. For example, in 2008 during the collapse of the U.S. banking system, which grew into a global financial crisis, Warren Buffet, unlike other investors, was looking for the most “resold” banks and bought cheaply their shares, which brought him billions of dollars today.
The value of any financial instrument is affected by many factors: the financial condition of the company, the economic and political situation in the country, the activities of competitors, inflation, the volume of industrial production, and others. Also, there are factors that cannot be predicted, such as natural disasters and the human factor.
The main problem with fundamental analysis is its correct interpretation. The data obtained by each investor can be understood differently and there is nothing special about it. For example, in April 2020 the US unemployment data for March was released, which stated that 14.7% of the population is unemployed, which is a lot. According to economists’ forecasts, in April 2020 the figure was to increase to 19.7%, i.e. the situation was to worsen due to the coronavirus pandemic. However, the reports showed that the unemployment rate not only didn’t increase but also fell to 13.3%, which is, in fact, also a lot. The dollar did not fall in price despite the terrible statistics but instead strengthened its position, as the expected data turned out to be much better than the actual ones. The fact that employment in the USA is not well known to everyone and is already included in the price of the American currency, so it doesn’t play any role.
The objectives pursued by private and large (institutional) investors are different:
- Private investors in fundamental analysis prefer assets that should grow in value and yield dividends.
- Large or institutional investors prefer assets that will make a profit in the future. This choice is conditioned by the ability to merge or to take over the issuer’s company if the choice is made in favor of shares. In the case of other assets, large companies are interested in long-term investments, as opposed to private investors.
The methods used by both groups of investors are different, even within these groups. Fundamental analysis is carried out differently, based on the information required and the amount of funds invested. At the same time, there are classical methods, which are used most often:
1. Deduction and induction. The deductive method extends the characteristics of the entire industry to the right company, for example, Tesla invented a battery that would be enough to travel 1.6 million kilometers, which means that the shares of traditional car companies will be cheaper because of the outdated type of engines. Inductively, some of the company’s characteristics are transferred to the industry, for example, Apple’s capitalization is $1.42 trillion, making it an industry leader, leaving Amazon behind with $1.2 trillion and Microsoft with $1.4 trillion.
2. A method of comparison. This method is used to compare companies by financial multipliers, i.e. it implies investment in shares.
3. 3. Grouping and generalization. Here, the investor generalizes or divides the indicators of the asset by one or more attributes, and then analyzes them.
4. Seasonality. This method of analysis is used for stocks and commodity markets. The prices of these assets can rise and fall due to cyclical social, derivative, and weather processes. Before the new year, share prices of manufacturing companies are rising due to rising costs in the consumer sector.
5. Correlation. Measurement of the relationship between two assets. The correlation coefficient is interpreted as follows: 1 — asset prices move equally, 0 — no correlation, -1 — asset prices move in opposite directions.
In addition to the applied methods, there are three main levels of fundamental analysis:
1. Sectoral analysis.
2. Economic analysis.
3. Analysis of companies.
Industry analysis identifies the most promising assets for investment. Information is collected based on sectoral indices, GDP, and GNP of individual countries. Based on the results of this analysis, the investor selects the asset he is most interested in. The assets are divided into several groups:
1. Growing assets. These assets overtake the others in terms of trading volume or sales volume and profit. These assets are called growth assets, and the issuing companies are called growth companies.
2. Stable assets. They are the least exposed to negative factors (crisis, wars, inflation, etc.).
3. Cyclical assets. Very sensitive to the economic situation in a particular country (crisis, recession, recovery).
4. Dwindling assets. As a rule, this type of assets includes shares of companies that cannot maintain healthy competition due to outdated production technologies; currencies with hyperinflation; cryptocurrencies that turned out to be benign projects.
5. Speculative assets. There is not enough information about such assets to think of a further action plan. A striking example is the market of cryptocurrencies, which is famous for its volatility and lack of fundamental factors for analysis.
The analysis of national economies takes into account political and economic factors that may affect the price of an asset. By studying these factors it’s possible to estimate the situation for investment, whether it’s favorable or not. Macroeconomic data play a huge role in investments, allowing to bring losses even for a diversified portfolio. Indicators that are taken into account when analyzing the state of the economy:
1. The political system and the ruling party.
2. Level of economic activity.
3. Interest rate from the Central Bank of the country.
4. Volume of GDP and GNP.
5. Oil prices.
This level of analysis is suitable only for the stock market. The investor needs to analyze as many aspects of the company as possible, namely:
- Court proceedings, the subject matter of the court, and its outcome.
- Company materials that are published in the public domain.
- Whether there are plans to launch new products.
- How often did the company change its managers.
- How many shares of the company are owned by the board of directors.
- Dividend history, whether increasing or decreasing.
- Which companies are being absorbed, with which mergers have occurred.
- Quarterly and annual reports on company activities.
- Information that companies report on themselves in public speeches.
Applying fundamental analysis to cryptocurrencies is a rather modest matter. On the one hand, each crypto-currency has fundamental data, due to which it’s possible to perform analysis. On the other hand, there is a lot of volatility on the crypto market, which is not very much caused by fundamental factors, which pushes away many professional traders around the world. In addition, there are and have been many crypto projects, the developers of which turned out to be scammers. These people could tell us anything: about further development plans, about a professional team of developers, about protection of an incredible level, and many other things — just to attract people and to invest in their projects. The problem is that these factors are fundamental in fundamental analysis. Although the number of such projects has decreased since the crypto boom of 2017, they still exist.
If you have decided to do a fundamental analysis of a cryptocurrency, you should rely on the following indicators:
1. Demand and position of the currency in the crypto market.
- It is necessary to understand the function of the coin, whether it carries something new or can be an improved analogue of an existing coin. If the analogue, whether the innovation makes sense and whether it will be in demand.
- Which blockchain functions. If it’s a blockchain of the Ethereum, there is nothing to worry about, as there are plenty of specialists in this field. If it’s a blockchain of your own design, you should familiarize yourself with its features, whether it will be interesting and safe for users.
- The position of a coin on the crypto market can be tracked using the Coinmarketcap service, as long as it’s there. If a coin was found in a pump or dump, it will move to the end of the list or beyond.
- Limited issue or not. If the emission is not limited, the coin may not be suitable for long-term investment as it may be subject to inflation.
- The method of extracting the coin. A PoS or PoW algorithm is used. If PoW, which devices can be used to mine the coin. If PoS, then how can you become a network validator? How well the network is safe from attack 51%.
2. Coin position outside the crypto market.
- Is the coin recognized by any country?
- Are there permits for the establishment and operation of the coin from state regulators.
- Are there bans on activities from government regulators or individual countries.
- News about the coin in the media. What is the general news background?
3. Information about the development team.
- By whom the coin was created: one person, a team of developers, a company, a group of companies. Under which jurisdiction is the project. After clarifying the jurisdiction, specify how exactly the crypto and currency activities take place on its territory.
- Is there any information about the past activities of the persons who created the coin.
- Was there any known individuals from the crypto community involved in the process of coin creation.
4. Feedback from coin holders and users.
- What is the general background of reviews, positive or negative?
- Has there been observed any unreasonable activity from the coin developers?
- How the project support works.
- There may be feedback from other crypto companies.
These are the main factors that should be used in the fundamental analysis of a coin. But even with the general collection of all factors together, the fundamental analysis in cryptocurrencies is still quite a mean solution.
If you are going to use the fundamental analysis in cryptocurrencies — approach to this question with all responsibility and consider that even in traditional markets results of the fundamental analysis interpret far not always correctly. Accordingly, one should study different data about the project or the impact of the global economic situation on crypto in a reinforced mode. The very modest history of crypto in the global economy has not yet formed any clear fundamental phenomena that have a clear impact on the value of digital assets.
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