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If investing is where you see yourself (i.e putting your money into a company for more than a year), then fundamental analysis is the first tool you need in your toolbox. This doesn't mean you can't learn it even if you're a trader. We believe fundamental analysis should be the foundation of making sound investment decisions.

Now that you can trade, place an order, or read a quote, and have decided to become an investor, the next question you want to ask yourself is "How can I pick the right stock for the long term?" While market returns aren't guaranteed, utilizing fundamental analysis as an investor will help you maximize your returns and minimize your losses.

This is going to be a long and interesting module, but we are certain that after completing it, you will be well-equipped to be an investor and make the right decisions for your investments. We will play interactive games throughout the module, and at the end, you will be placed in a real-world simulator where you will use fundamental analysis to make an investment decision using simulated money to test your results.

Introduction to Fundamental Analysis

Fundamental Analysis (FA) is a comprehensive method for evaluating a company’s intrinsic value. It involves studying a business’s financial statements, management team, competitive advantages, and market position to make informed long-term investment decisions. This approach helps investors sift through the daily volatility of stock prices and focus on the company’s actual performance and potential for growth.

In the American market, there are numerous examples of companies that have consistently delivered strong returns over the years. For instance, consider tech giants like Apple Inc. and Microsoft Corporation, or retail behemoths like Walmart Inc. and The Home Depot Inc. These companies have provided investors with impressive compounded annual growth rates (CAGR) for extended periods. For example, a CAGR of 20% would allow an investor to double their investment in approximately 3.5 years. The higher the CAGR, the quicker the wealth accumulation. Some companies, like Amazon.com Inc., have even achieved CAGRs nearing 30%, showcasing the rapid pace at which investments can grow when placed in fundamentally sound businesses.

To visualize the impact of long-term investment in such companies, one could look at the historical stock price charts of Apple, Microsoft, or Meta. These charts reflect the substantial wealth that can be generated over time, reinforcing the value of fundamental analysis in guiding investment decisions. Remember, these are just a few examples from the multitude of success stories available in the U.S. stock market.''

Here is the long term charts of Meta that can set you thinking about long term wealth creation.

While we're on that topic, let me show you the long-term results of another stock. This is AMC Entertainment Holdings Inc.

As you can see, holding a stock for a long time isn't enough to build generational wealth. The trick has always been to separate good companies which create wealth from the companies that destroy wealth. All good companies have a few common attributes that set them apart. Likewise, all wealth destructors have a few common traits which are clearly visible to an astute investor.

Fundamental Analysis is the technique that gives you the conviction to invest for a long term by helping you identify these attributes of wealth-creating companies. We will come back to our example of Meta and AMC later once we have a better understanding of fundamental analysis techniques and see how to differentiate bad from good investments.

The only way you can understand a company's fundamentals is through its Quarterly Reports, which we'll talk about in seconds. Does that mean you'll have to read each company's 10- to 150-page report every quarter to understand if they're a good company or not? No, we've built a tool for this module that will give you a concise summary of any company in less than 5 minutes. Now, let's dive into what a quarterly report is and how to read it.

Quarterly Report of a Company

The quarterly report (QR) is a key document released by companies in the United States, providing a snapshot of financial performance every three months. It’s a crucial tool for shareholders and potential investors to assess a company’s health and prospects. Typically, these reports are accessible on the company’s website or in physical form upon request.

The information in a quarterly report is considered official and is backed by auditors’ certifications, ensuring the accuracy of the financial data. It’s essential for investors to rely on these reports rather than third-party media sources, which might present the data differently due to various reporting standards. For example, a company might list depreciation as an expense, while a media site might categorize it separately, leading to confusion.

In short, for accurate and reliable financial information, investors should consult the quarterly reports directly from the company, ensuring they have the most relevant and correctly sequenced data for making informed decisions.

The quarterly report has many sections that contain useful information about the company. One has to be careful while going through the annual report as there is a fragile line between the company’s facts and the marketing content that the company wants you to read.

Let us go through various sections of Meta Q1 2024 QR

The report typically includes several sections:

Financial Highlights: This section offers a snapshot of Meta’s financials, often presented in tables or graphs, comparing key metrics over multiple quarters.

CEO’s Statement: Here, Mark Zuckerberg shares his perspective on Meta’s business and broader industry trends. It’s crucial to gauge the realism and transparency of the management’s commentary.

Management Discussion & Analysis (MD&A): This section starts with an overview of economic conditions affecting the business. It then delves into industry trends, threats, opportunities, and Meta’s performance across various segments, providing specific numbers and future outlooks.

Corporate Information: This part includes essential details about Meta’s corporate governance and executive team.

Director’s Report: The board of directors offers their insights into the company’s operations and strategic direction.

Report on Corporate Governance: This report outlines Meta’s governance practices and compliance with regulatory standards.

Financial Section: Detailed financial statements give a thorough account of Meta’s financial health.

Notices: Any additional notices that may be relevant to shareholders are included here.

For instance, Meta’s latest report highlights significant growth in revenue and net income, with a substantial increase in daily active users. The company also discusses its investments in AI and the metaverse, reflecting its long-term strategic focus.

When reviewing such reports, compare the information with that of peers like Alphabet Inc. or Amazon.com Inc. to understand Meta’s competitive position. Pay attention to sections relevant to the tech industry, such as R&D and technology reports, which can indicate the company’s innovation trajectory and potential labor issues that might impact operations.

In summary, Meta’s quarterly report is a vital tool for understanding the company’s current state and future prospects. It’s essential to approach it with a critical eye, focusing on the hard data and management’s discussion to inform your investment decisions.

Financial Statements

Finally, the last section of the QR contains the financial statements of the company. As you would agree, the financial statements are perhaps one of the most important aspects of an Quarterly Report. It serves as the financial scorecards for a company, offering a detailed look at its fiscal condition at a specific point. The three primary financial statements are the income statement, balance sheet, and cash flow statement. Let’s simplify this with an example:

Consider you’re evaluating a leading social media company, Meta Platforms Inc. You delve into its:

Income Statement

The Profit and Loss (P&L) statement, also known as the Income Statement or Statement of Operations, is a financial document that outlines a company’s revenues, expenses, and profits over a specific period. It’s a crucial tool for assessing a company’s financial performance.

To illustrate, let’s examine Meta Platforms Inc.'s P&L statement from its latest quarterly report

The P&L statement typically includes:

• Revenue: This is the total income generated from Meta’s operations, such as advertising sales on its platforms.

• Expenses: These are the costs incurred in generating revenue, including operational costs, research and development, and marketing.

• Tax and Depreciation: The statement accounts for taxes owed and the reduction in value of assets over time.

• Earnings Per Share (EPS): This figure represents the portion of a company’s profit allocated to each outstanding share of common stock.

Meta’s P&L statement for the first quarter of 2024 shows a revenue of $36.46 billion, a 27% increase from the previous year. The operating income is reported at $13.82 billion, marking a 91% increase, and the net income stands at $12.37 billion, up by 117%. The diluted EPS is $4.71, a significant rise from $2.20 in the previous year.

The P&L statement starts with the top line, which refers to the company’s revenue. It then details the costs and expenses before arriving at the net income, or the bottom line, which indicates the company’s profitability after all expenses have been deducted.

In Meta’s case, the P&L statement reflects strong financial health, with substantial revenue growth and profitability. It’s important for investors to review the P&L statement to understand how a company’s business activities translate into earnings.

Balance Sheet

The balance sheet is a financial statement that provides a snapshot of a company’s assets, liabilities, and shareholders’ equity at a specific point in time. Unlike the Profit and Loss (P&L) statement, which focuses on a company’s profitability during a fiscal year, the balance sheet accumulates financial information from the company’s inception, reflecting its financial evolution.

For a practical understanding, let’s consider Meta Platforms Inc.'s balance sheet from its latest quarterly report.

The balance sheet details:

• Assets: These are resources owned or controlled by Meta, expected to provide future economic benefits. Assets include cash, investments, property, equipment, and intangible assets like patents and trademarks.

• Liabilities: These are Meta’s obligations, including loans and accounts payable, which the company must settle in the future.

• Shareholders’ Equity: Also known as net worth, this represents the owners’ claim after liabilities are settled.

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The fundamental balance sheet equation is:

Assets = Liabilities + Shareholders’ Equity

This equation ensures the balance sheet is always balanced, signifying that all assets are financed either through debt (liabilities) or equity.

Shareholders’ Equity is sometimes confusing because it appears on the liabilities side of the balance sheet. However, from the company’s perspective, this equity represents an obligation to its shareholders and is therefore listed as a liability.

Meta’s balance sheet would show its Share Capital, which is the amount invested by shareholders when they purchase the company’s stock. Additionally, Reserves and Surplus reflect funds set aside for specific purposes and undistributed profits.

For example, Meta’s balance sheet might show:

• Share Capital: The total value of shares issued, reflecting the equity stake of shareholders.

• Reserves: Funds earmarked for future projects or contingencies.

• Retained Earnings: Profits retained in the company for reinvestment or future distribution.

The interaction between the P&L statement and the balance sheet is evident, as the net income from the P&L contributes to the retained earnings on the balance sheet. This relationship highlights the interconnectedness of financial statements.

In summary, Meta’s balance sheet would provide a comprehensive view of its financial standing, including the resources it has to generate future growth and the obligations it must meet. Investors use this information to assess the company’s financial health and make informed investment decisions.

Cash Flow Statement:

The Cash Flow Statement is a crucial financial document that reveals the actual cash generated by a company, which is not always apparent from the Profit and Loss (P&L) statement. While the P&L statement includes revenues, some of these may be from credit sales not immediately converted into cash, potentially leading to a cash crunch if obligations exceed available funds.

For example, let’s consider Meta Platforms Inc. and its operations.

Meta might report substantial revenues from advertising on its platforms, but if a significant portion of these sales is on credit, the cash required for immediate reinvestment or debt repayment might not be fully available. The Cash Flow Statement provides clarity on such scenarios by detailing the cash inflows and outflows from three types of activities:

• Operating Activities (OA): These include day-to-day business operations like ad sales, content creation, and employee salaries.

• Investing Activities (IA): This category covers investments in long-term assets, such as acquisitions of other companies or investments in new technology.

• Financing Activities (FA): These are related to raising capital and returning value to shareholders, such as issuing new stock, paying dividends, or repurchasing shares.

Each activity impacts the company’s cash balance. For instance, investing in new technology (IA) would decrease the cash balance but is recorded as an asset on the balance sheet. Conversely, issuing new stock (FA) increases the cash balance and is noted as equity on the balance sheet.

Understanding the Cash Flow Statement is essential as it provides a transparent view of a company’s liquidity, offering insights into its ability to fund operations, grow its business, and meet financial obligations. For Meta, analyzing the Cash Flow Statement alongside the P&L and balance sheet offers a comprehensive picture of its financial health and operational efficiency

We have so far looked into how to read the financial statements and what to expect from each of them. We have not yet ventured into how to analyze these numbers. One of the ways to analyze the financial numbers is by calculating a few important financial ratios.

Ratios and Metrics

Ratios and metrics are like the magnifying glass Sherlock Holmes uses to examine clues. They help investors analyze a company's financial health in more detail. Let's look at some common ratios and metrics with a real-life example:

Price-to-Earnings (P/E) Ratio: The P/E ratio tells you how much investors are willing to pay for each dollar of a company's earnings. For example, if Meta Gaming has a P/E ratio of 20, it means investors are willing to pay $20 for every $1 of Meta Gaming's earnings. A higher P/E ratio may indicate that investors have high expectations for the company's future growth.

Debt-to-Equity Ratio: The debt-to-equity ratio measures how much debt a company is using to finance its operations compared to its shareholders' equity. Let's say Meta Gaming has a debt-to-equity ratio of 0.5. This means that for every dollar of equity, Meta Gaming has 50 cents of debt. A lower debt-to-equity ratio indicates that a company is less reliant on debt financing.

Return on Equity (ROE): ROE measures how effectively a company is using its shareholders' equity to generate profit. If Meta Gaming has an ROE of 15%, it means the company is generating a 15% return on every dollar of shareholders' equity. A higher ROE is generally favorable, as it indicates that a company is generating more profit with less equity.

Wow, we've unpacked a lot, and by now you are wondering if you have to go through the same process every time you need to evaluate a company's fundamentals. The answer is NO. As we mentioned earlier, we've built a tool that takes in this complex quarterly report and turns it into something you can understand in 5 minutes. In the next chapter, we will show you how you can use this tool to evaluate a company, and lastly, you will get to buy and sell a stock in a virtual environment using your investment decisions.

Evaluating Company Health

Evaluating a company's health involves putting all the pieces of the puzzle together to paint a complete picture. Let's continue with our example of Meta and AMC.

To analyze the stocks of Meta Platforms Inc. (Meta) and AMC Entertainment Holdings Inc. (AMC) using the ConsX analytics tool, we will focus on these five key points: Company Overview, Financial Health, Future Growth, Valuation, and Peer Analysis. Here’s how each point will be addressed:

Company Overview

The overview page provides a high-level summary of each company's core business. When choosing a company, focus on one that has a great business model and is well-positioned in its industry.

Meta: For Meta, we'll examine its position as a leading social media and technology company, focusing on its core platforms like Facebook, Instagram, and WhatsApp, as well as its strategic pivot towards building the metaverse.

AMC: For AMC, we'll look into its status as a major player in the movie exhibition industry, exploring its theater operations and how it has adapted to changing consumer behaviors and the impact of the pandemic.

Financial Health

We've simplify this on the dashboard. A Financial Health score of 1 or 2 means the company is doing well financially, while a score of 1 means the company isn't doing well. We aim to select companies with scores of 1 or 2.

We’ll assess Meta’s financial statements, including its income statement, balance sheet, and cash flow, to understand its revenue streams, profitability, and liquidity.

For AMC, we’ll review its financial results to gauge its revenue trends, operating expenses, and net income, which will help us determine its financial stability and operational efficiency.

Future Growth

The future growth section is already simplified as well. You want to look at recent dates and select companies with the highest POSITIVE forecast. 

Meta's future growth will be analyzed by looking at its investments in AI, virtual reality, and other innovative technologies that could drive its next phase of expansion.

AMC's growth prospects will be evaluated based on its strategic initiatives, such as enhancing the theater experience and expanding its content offerings.

Valuation

Our goal is to identify undervalued companies and capitalize on their potential future growth. We'll leverage ConsX's tools to calculate

Meta's valuation metrics, such as price-to-earnings (P/E) ratio and market capitalization. By comparing these metrics to industry standards, we can determine whether Meta's stock is fairly valued. 

Similarly, we'll scrutinize AMC's valuation by examining its market cap, enterprise value, and other relevant financial ratios to assess if the stock is undervalued or overvalued.

Peer Analysis

This tool empowers you to compare companies with their peers before deciding whether to buy a particular company or its competitor. By analyzing how a company stacks up against its rivals, you can gain valuable insights into its competitive advantages and challenges.

Peer analysis for Meta will involve comparing its financial performance and market position with other tech giants like Google, Amazon, and Apple. This comparison will help us identify Meta's competitive advantages, such as its dominant social media platforms and user base, as well as potential challenges, such as regulatory scrutiny and competition from emerging technologies.

AMC's position will be evaluated by comparing it with its peers in the entertainment sector, such as other theater chains and entertainment companies. This analysis will help us understand AMC's market share within the movie exhibition industry and the competitive landscape it faces, including factors like changing consumer preferences and the rise of streaming services.

Now, let's use the tool below

By leveraging the ConsX analytics tool, we can conduct a comprehensive analysis of Meta and AMC across these five key areas, providing us with a well-rounded view of each company’s strengths, weaknesses, opportunities, and threats. This will enable us to make informed investment decisions based on data-driven insights.

From your analysis, which one is a good buy, AMC or META, and why?

Happy investing!