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Recently I was reading about different fundamental analysis approaches, and specifically about Value Investing, as proposed by Ben Graham and David Dodd. This approach describes a strategy which based on finding "under-priced" securities using some for of fundamental analysis. This allows filtering out "good" companies which are more likely to gain profit on a long term.

I know that fundamental analysis could be based on global parameters such as the following, focusing on a whole industry sector or area:

  • GDP growth rates
  • Inflation
  • Interest rates
  • Exchange rates
  • Productivity
  • Energy prices, etc...

As well as focusing on a specific company and analyzing:

  • The Income Statement
  • The Balance Sheet
  • The Cash Flow Statement

So I wonder where can I find a step-by step procedure, which describes the process of security evaluation(or as referred in Ben Graham theory - intrinsic value) using the above data? Specifically, I would like to see some practical guidance as how to use this data.

  • If a set-in-stone procedure like this were to exist, I presume each and every trading firm would use it, thus removing any potential for arbitrage. – John Bensin Apr 23 '13 at 11:09
  • @JohnBensin Thank you for your comment. Are you saying that all those people who use fundamentals to analyze their securities, are doing it differently? I mean everyone just makes different decisions based on the same balance sheets and cash flow statements? Isn't the whole idea of fundamental analysis (compared to technical) is the ability to evaluate a real price depending on real numbers (or at least choose healthy financially company)? And if everybody are interpreting the same data differently then how is it different from technical analysis which considered by many to be just gambling ? – Eugene S Apr 23 '13 at 12:22
  • See Dilip Sarwate's answer; he's making pretty much the exact point I was. – John Bensin Apr 23 '13 at 20:50
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Your items

  • The Income Statement
  • The Balance Sheet
  • The Cash Flow Statement

are presumably available to any analyst, but some of the items in

  • GDP growth rates
  • Inflation
  • Interest rates
  • Exchange rates
  • Productivity
  • Energy prices, etc...

might not be assessed in the same way by different analysts. For example, should general measures of inflation be used (and if so, which ones? e.g. changes in CPI or chained CPI?) or should one take into account how inflation affects or will affect consumers of the specific products manufactured by the company being considered? In short, as John Bensin's comment points out, there is no set-in-stone procedure with fixed inputs that every analyst uses, and so different analysts might reach different conclusions as to how much a particular company stock is under-valued, and make recommendations of different strengths as to whether the stock should be purchased.

  • +1 You summarized my thoughts in a better fashion than I would have. I would also add that sector-specific factors are important as well, because (strangely) not every analyst takes them into account. For example, I've seen analyst reports on the biotech industry that draw comparisons to Silicon Valley tech companies but completely ignore info about clinical trials, etc. It's as if they saw the term "technology" and applied a blanket strategy. – John Bensin Apr 23 '13 at 20:49
  • Thanks a lot for your answer! I didn't realize that this is how it works. For some reason I thought it to be a more "built-in" procedure. Anyway, if I disregard the second set of items in my questions (Inflation, productivity, etc..) and just want to focus on the first set (Income Statement, balance sheet, cash flow), can I ask how these factors are used to determine a company health? I guess these ones are pretty much consistent even when considered by different analysts? (Or maybe it is a topic for another question..) – Eugene S Apr 24 '13 at 9:05
  • @EugeneS Even the first set of factors aren't necessarily consistent between analysts, because a) analysts may have a different understanding of the specific industry, and b) analysts have different preferences, so (for example) some may be willing to tolerate higher levels of debt on a balance sheet than others. – John Bensin Apr 24 '13 at 11:13
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    @EugeneS See also en.wikipedia.org/wiki/Value_investing. Notably "Book value is most useful in industries where most assets are tangible. Intangible assets such as patents, software, brands, or goodwill are difficult to quantify". A lot of what's on the balance sheet could be subject to varying valuation techniques. – Chris W. Rea Apr 24 '13 at 12:43

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