How-to
How to do fundamental analysis on a stock
Fundamental analysis means judging a company by its business and financials rather than its stock chart, to estimate what the shares are actually worth. You read the three financial statements, track the key numbers over several years, and compute a few ratios: growth, margins, free cash flow, debt, and returns on capital. Then you compare those figures to the company's own history and to close peers, and tie them back to how the business works. The goal is not to collect metrics. It is to decide whether the company earns good returns, can keep earning them, and is priced sensibly for it.
By The Brief Equity Team · Published
What is the process?
- Read the three financial statements: income statement, balance sheet, and cash flow statement.
- Track the key numbers over five years, not one, to see the trend.
- Compute a few ratios: margins, returns on capital, and debt levels.
- Compare them to the company's own history and to close peers.
- Tie the numbers back to the business: why are they what they are, and will they hold?
Fundamental analysis is the opposite of chart-reading. You are estimating the value of the underlying business and comparing that to the price, on the theory that price eventually follows the fundamentals. The chart tells you the mood; the statements tell you the machine.
Five years of history matters more than any single year. One good quarter can be luck or accounting; a five-year trend in margins or returns is much harder to fake and much more telling.
Which numbers matter most?
| Metric | What it tells you | Where it comes from |
|---|---|---|
| Revenue growth | How fast the business is expanding | Income statement |
| Gross and operating margin | How much of each sale the company keeps | Income statement |
| Free cash flow | The cash left after running and reinvesting | Cash flow statement |
| Net debt | How leveraged the balance sheet is | Balance sheet |
| Return on invested capital | How well management reinvests the cash | The statements, combined |
No single number decides anything. A high margin with falling revenue, or fast growth funded entirely by debt, tells a different story than either figure alone. Read them as a set, and always over time.
Free cash flow deserves particular attention, because it is the cash a business actually produces after keeping itself running. For a fuller treatment, see what free cash flow is and why it matters.
How do the three statements connect?
The three statements tell one story from three angles. The income statement shows profit on paper. The balance sheet shows what the company owns and owes at a moment. The cash flow statement shows the actual cash that moved. Profit and cash can diverge for years, so read all three together, never one alone.
A common trap is reading only the income statement, because profit is the headline number. But profit is an accounting figure with judgment baked in, and a company can report earnings while burning cash. The cash flow statement is where that shows up.
Where does a model come in?
Fundamental analysis ends in a judgment about value, and a model is where you make it explicit. In Brief Equity you build a DCF or EV/EBITDA valuation on your own assumptions and watch it move as you change them. Capture the figures you used into a notebook so the analysis and its evidence stay together.
None of this requires a spreadsheet, but a model makes your conclusion testable. The value that falls out of a DCF is only as good as the assumptions you feed it, which is the point: you can see exactly how much your answer depends on a growth rate or a discount rate you can defend.
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Frequently asked questions
- What is the difference between fundamental and technical analysis?
- Fundamental analysis values the business from its financials and prospects. Technical analysis studies the price and volume patterns on the chart. One asks what a company is worth; the other asks what the price is doing. They answer different questions.
- Which financial statement is most important?
- The cash flow statement is the one most people underweight and the hardest to manipulate, so it is a good anchor. But the three connect, and reading any one alone will mislead you. Judge them together.
- How many years of financials should I look at?
- At least five, and more if the business is cyclical. A single year can be flattered by luck or accounting. A multi-year trend in growth, margins, and returns is far more reliable and far harder to fake.
- Do I need a valuation model to do fundamental analysis?
- No. Much of the work is reading and judgment. But a model forces your conclusion into the open by showing what value your assumptions imply, and how sensitive that value is to the numbers you chose.
Brief Equity is built by investors, for investors. For research, not investment advice; market data is delayed. Figures and rules reflect public information at the time of writing and can change. Verify anything time-sensitive at the linked primary source.