Investing in stocks can be both exciting and overwhelming, especially with over 1,700 listed and OTC stocks available in Taiwan alone. How do you identify the truly profitable ones? Whether you're into long-term dollar-cost averaging or short-term day trading, understanding the company behind the stock is essential. Before chasing high returns, it's crucial to understand how businesses generate profits. Only then can you sift through the noise and uncover high-performing stocks with real value.
There are three primary methods for stock analysis: fundamental analysis, technical analysis, and chip (sentiment) analysis. Among these, fundamental analysis forms the backbone of value investing—a strategy famously practiced by Warren Buffett. This guide will walk you through what fundamental analysis is and how to use it effectively to make smarter investment decisions.
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The Three Pillars of Stock Analysis
When selecting investment opportunities, investors typically rely on:
- Fundamental Analysis: Evaluates macroeconomic conditions, industry trends, and company-specific financial data.
- Technical Analysis: Studies price charts (like candlestick patterns), technical indicators, and volume-price relationships.
- Chip (Sentiment) Analysis: Focuses on institutional investor behavior, margin trading data, broker positioning, shareholder distribution, and insider transactions.
Each method has its strengths. While technical and chip analysis are often easier to grasp—relying on observable market behaviors such as moving averages or institutional buy/sell activity—fundamental analysis demands deeper financial literacy. It requires studying financial statements, industry dynamics, and economic trends over time. But this depth also makes it one of the most reliable ways to assess a company’s true worth.
Warren Buffett’s success stems from this very principle: invest in companies with strong fundamentals, not just momentum. While technical and chip analysis may help time entries and exits, only fundamental analysis reveals whether a stock is genuinely undervalued or overvalued.
Why Financial Statements Matter
To evaluate a company’s health, investors must examine its three core financial statements—often referred to as the "report card" of a business:
- Income Statement (損益表): Shows revenue, costs, and net profit over a period.
- Balance Sheet (資產負債表): Details assets, liabilities, and shareholders’ equity.
- Cash Flow Statement (現金流量表): Tracks cash inflows and outflows from operations, investments, and financing.
These reports provide insight into where money comes from, where it goes, and how efficiently a company generates profit.
Understanding the Income Statement
The income statement reveals profitability. At its core:
Revenue – Costs = Net Income
A higher net profit margin indicates better efficiency. Investors should look for companies that consistently grow revenue while controlling operating expenses, taxes, and non-operating costs.
Key metrics derived from the income statement include:
- EPS (Earnings Per Share): Net income divided by shares outstanding.
- Gross Profit Margin: (Revenue – Cost of Goods Sold) / Revenue.
👉 Learn how top investors analyze earnings data before making moves
Decoding the Balance Sheet
The balance sheet follows a simple equation:
Assets = Liabilities + Shareholders’ Equity
This shows how a company funds its operations—through debt (liabilities) or equity (investor capital). For shareholders, equity represents their stake in the company. Strong equity growth signals reinvestment of profits and long-term stability.
Important indicators include:
- Debt-to-Equity Ratio: Assesses financial leverage.
- Current Ratio: Measures short-term liquidity.
Tracking Cash Flow Health
Even profitable companies can fail if they run out of cash. The cash flow statement breaks down cash movement into three categories:
- Operating Activities: Cash generated from core business operations.
- Investing Activities: Spending on equipment, acquisitions, or asset sales.
- Financing Activities: Borrowing, issuing stock, or paying dividends.
Positive operating cash flow is a strong sign of sustainability. A company might report high net income but negative operating cash flow—an early warning of potential issues.
Connecting the Dots: How the Three Statements Work Together
True insight comes from analyzing all three statements together:
- Net income from the income statement flows into retained earnings on the balance sheet.
- Changes in cash from operations appear in the cash flow statement, ultimately affecting the ending cash balance listed on the balance sheet.
For example, consistent revenue growth (income statement), strong equity buildup (balance sheet), and healthy operating cash flow (cash flow statement) signal a fundamentally sound business.
Two Approaches to Fundamental Stock Selection
There are two main frameworks for applying fundamental analysis:
1. Bottom-Up Approach: Start with the Company
Individual Stock → Industry → Macroeconomy
Begin by selecting a company you understand well—perhaps one in an industry you work in or follow closely. Analyze its financials, competitive edge, and management quality. Then assess its industry landscape: Is demand growing? Are there technological shifts? Finally, consider whether broader economic conditions support growth.
This method emphasizes company-specific strengths over market trends.
2. Top-Down Approach: Start with the Big Picture
Macroeconomy → Industry → Individual Stock
Begin with global or national economic indicators like GDP growth, inflation (CPI), PMI, unemployment rates, and trade balances. Identify sectors likely to benefit—such as renewable energy during green policy pushes or tech during digital transformation waves. Then pick leading companies within those high-potential industries.
This strategy aligns investments with macro-level tailwinds.
👉 See how global economic shifts influence stock valuations today
Key Data Points in Fundamental Analysis
Beyond financial statements, consider these qualitative and quantitative factors:
- Macroeconomic Indicators: GDP, CPI, interest rates, currency trends.
- Industry Metrics: Supply chain health, market size, innovation cycles.
- Company-Level Data: Pricing power, sales volume, input costs, R&D investment.
Combining these insights allows for a holistic view of a company’s potential.
Frequently Asked Questions (FAQ)
Q1: What are the three financial statements?
The three financial statements are the income statement, balance sheet, and cash flow statement. Together, they provide a comprehensive picture of a company’s profitability, financial position, and cash management.
Q2: What are the three key aspects of fundamental analysis?
The core pillars are analyzing profitability (via income statement), financial structure (via balance sheet), and liquidity/operational efficiency (via cash flow statement).
Q3: What are the two main approaches to fundamental stock selection?
They are bottom-up (starting with individual stocks) and top-down (starting with macroeconomic trends). Both are valid; the choice depends on your investing style.
Q4: How does fundamental analysis differ from technical and chip analysis?
Fundamental analysis focuses on intrinsic value and long-term performance using financial data. Technical analysis studies price patterns for timing trades, while chip analysis examines investor behavior and positioning—both more suited for short-term strategies.
Q5: Is fundamental analysis suitable for beginners?
Yes—but it requires patience. Start by learning to read quarterly reports and tracking key ratios like P/E (Price-to-Earnings) and ROE (Return on Equity). Over time, you’ll develop confidence in identifying quality companies.
Q6: Can fundamental analysis predict short-term price movements?
Not reliably. It’s designed for long-term value assessment. Short-term prices are influenced by sentiment and speculation, but over time, stock prices tend to reflect underlying fundamentals.
By mastering fundamental analysis, you equip yourself with the tools to invest with clarity and confidence—not based on hype or trends, but on real business performance. While it takes effort upfront, the payoff is a more resilient, informed investment strategy that stands the test of time.