What you will learn
Fundamental analysis chases one simple question: "What is this stock really worth?" and it answers that question apart from the daily noise of the trading board. In this lesson you will learn what a stock's intrinsic value is and why it differs from the market price, why the two families of company (earnings-based and asset-based) are valued with two different logics, and where on Codal to find the raw data this analysis relies on. This lesson gives you a tool for judgment, not a buy or sell recommendation.
Definitions
Fundamental analysis: an attempt to estimate the real value of an asset from its "fundamentals", that is, the company's profitability, assets, liabilities and cash flow, rather than from a price chart. Its core question is what the company is worth, independent of what it happens to trade at today.
Intrinsic value: an estimate of a stock's "real" worth based on fundamentals. Unlike the market price, which is a definite, moment-to-moment number, intrinsic value is an estimate and depends on the analyst's input assumptions.
Market price: the price a buyer and seller have agreed on right now, shown on the trading board. The whole idea of fundamental analysis is to compare this price with intrinsic value.
Earnings-based company: a company whose value comes mainly from the stream of profit it generates from its operations, such as a steelmaker, an automaker or a pharmaceutical firm.
Asset-based company: a company whose value comes mainly from the worth of what it "owns" rather than from operating profit, such as an investment company or holding that holds shares of other firms, property and assets.
Net Asset Value (NAV): the current market value of all the company's assets minus all its liabilities. Divide it by the number of shares and you get NAV per share.
Book value: the recorded value of assets minus liabilities on the balance sheet, that is, shareholders' equity. The ratio of market price to book value per share is called the price-to-book ratio (P/B).
Financial statements: the three core reports of every company: the income statement (how much it sold and how much profit it made), the balance sheet (what it owns and what it owes), and the cash-flow statement (how real money came in and went out). Fundamental analysis grows out of these.
The mechanism: the path fundamental analysis takes
Fundamental analysis has four simple steps:
Step one, read the reports. You read the financial statements, the monthly activity report and management's interpretive report to learn what the company does and how it makes money.
Step two, judge quality. The profit figure alone is not enough; whether the profit came from core operations or from a one-off event (such as selling a property or revaluing an asset) makes a big difference. Durable profit is worth more than fleeting profit.
Step three, estimate intrinsic value. Depending on the type of company, the tool changes: for an earnings-based company you typically use profit and ratios such as price-to-earnings; for an asset-based company you use net asset value.
Step four, compare with the price. You place your estimated intrinsic value next to the market price. If the price is below your estimate, the stock is said to be "undervalued"; if above, "overvalued". Note that this is a judgment, not a definite fact.
Two families of company: earnings-based and asset-based
The most important decision at the start of fundamental analysis is which type of company you are dealing with, because the valuation tool differs.
In an earnings-based company, the main question is: "How much durable profit does this company make each year, and how many times that profit is the market willing to pay?" Here earnings per share and the price-to-earnings ratio are the main tools. A manufacturer whose machinery is merely a means of making product is measured by its profit, not by the value of its warehouse and land.
In an asset-based company, the question changes: "How much is the sum of what this company owns worth today?" An investment company that holds a portfolio of shares in several other firms generates little operating profit; its value is roughly equal to the current value of that portfolio minus its liabilities. That is why such companies are measured with NAV and price-to-book, not just price-to-earnings. Measuring an investment company with price-to-earnings alone is like weighing water with a ruler: the tool does not fit the problem.
A worked example
Both examples below are entirely hypothetical and for teaching.
Earnings-based example. Suppose Company "A" is a manufacturer that makes 500 tomans of durable profit per share each year. If investors in this company's industry are typically willing to pay about 8 times annual profit (a price-to-earnings ratio of about 8), the approximate intrinsic value per share becomes 8 x 500 = 4,000 tomans. Now if the market price is 3,200 tomans, the stock is below your estimate; and if it is 5,500 tomans, above it. But note: the 4,000-toman figure is an estimate, not a certainty. It only takes changing the "8 times" assumption to "6 times" for intrinsic value to fall to 3,000 tomans.
Asset-based example. Suppose investment company "B" owns only shares in a few listed firms and one building. If the current value of all these assets is 12 trillion tomans and the company's liabilities are 2 trillion tomans, net assets equal 10 trillion tomans. If the company has 10 billion shares, NAV per share becomes 1,000 tomans. Now if that same share trades at 700 tomans in the market, we say it trades at "a 30 percent discount to NAV". This discount is common among investment companies on the Tehran Stock Exchange and has its own specific reasons (such as potential tax on selling the assets, or the illiquidity of part of the portfolio).
In Iran's market: where to get the reports
On the Tehran Stock Exchange, the raw data of fundamental analysis is free and available in one place: the Codal system at codal.ir, the "Comprehensive Database of All Listed Companies" (in Persian, the comprehensive issuer-disclosure system), operated under the Securities and Exchange Organization. Every listed company is required to publish its reports there, including:
- financial statements (quarterly, semi-annual, nine-month and audited annual);
- the monthly activity report (each month's sales and production, published earlier than the financial statement);
- management's interpretive report (the company's own explanation of performance and outlook);
- notices of general-assembly meetings and their decisions (including the cash dividend approved).
Codal is free for everyone to use, and this equal access to information is the backbone of fundamental analysis in Iran's market. One more important note: since late 2017 (Dey 1396), the mandatory publication of "profit forecasts" was removed and companies now provide management's interpretive report instead; as a result, most of the work of estimating future profit today falls to the analyst. (We covered this change in more detail in the previous lesson.)
Common mistakes
"Intrinsic value is a definite number." No. Intrinsic value is the output of several assumptions (profit growth rate, discount rate, profit durability); change the assumptions and the number changes too. Two honest analysts can estimate two different intrinsic values for the same stock.
"Fundamental analysis means predicting tomorrow's price." No. Fundamental analysis says whether a stock is expensive or cheap today relative to its fundamentals; but the market can keep an "undervalued" stock undervalued for a long time. This is a tool for the long horizon, not for guessing daily swings.
"One ratio is the whole story." No. A low price-to-earnings ratio can be a sign of cheapness or a warning of a profit drop on the way; the number alone does not say which. Always read ratios alongside the quality of profit and a comparison with peers.
"Measure every company with one tool." No. Measuring an investment company with price-to-earnings alone, or a high-profit manufacturer with NAV alone, are both misleading. First identify the type of company, then choose the tool.
Summary
Fundamental analysis means estimating a company's intrinsic value from its fundamentals and comparing it with the market price. The key to starting is identifying the type of company: an earnings-based company is measured with profit and price-to-earnings, and an asset-based company with net asset value; and the raw data is free on Codal. The most important point is that intrinsic value is an estimate, not a promise. To see exactly how earnings per share and the price-to-earnings ratio, the pillars of analyzing earnings-based companies, are read, see our previous lesson, Earnings Per Share (EPS) and Price-to-Earnings (P/E). For a better grasp of NAV, the lesson What Is an Investment Fund helps. The full set of lessons is available at Sahmino Academy.
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