Fundamental analysis basics

Not the chart — the business itself

Technical analysis looks at price: candles, levels, volume. Fundamental analysis looks at the business behind the price: how much the company sells, how much of that stays as profit, whether that profit turns into cash and whether it grows over the years.

Why does it matter? A stock is a share of a company. Over the long run a shareholder's return depends on the cash the business earns. In the short run price moves with mood, news and flows, but over five or ten years price usually follows profit and cash flow. For a long-term investor fundamental analysis is the core work; for a trader it is a protective layer of "I know what I am buying".

In this lesson we work with one fictional company — Nur Tech. It sells software and devices and has very little debt. The next lessons reuse the same company's numbers, so keep them in mind.

Three statements and how they connect

Every public company publishes three main financial statements:

1. The income statement — how much was sold over a period (a quarter or a year), what was spent and how much profit was left. It is the business's "video".
2. The balance sheet — the position on a single day: what the company owns (assets), what it owes (liabilities) and what is left for shareholders (equity). It is a "photo".
3. The cash flow statement — how much cash actually came in and went out. Profit can be an accounting number; cash does not lie.

They are linked like a chain. Net income from the income statement becomes the first line of the cash flow statement. Non-cash charges (depreciation) are added back and changes in working capital (money customers still owe, inventory in the warehouse) are adjusted — the result is operating cash flow. The part of net income left after dividends and buybacks is added to equity on the balance sheet. Cash at the end of the period is the "cash" line on the balance sheet.

That is why judging by one statement alone is dangerous. Profit rising while cash shrinks shows up on the balance sheet and the cash flow statement. We cover those two in depth in the Financial health lesson. This lesson is about the income statement.

The income statement line by line

Nur Tech's latest year (in $m):

• Revenue: $100m — everything sold to customers. It is the top line of the statement, hence "top line".
• Cost of revenue: $40m — the direct cost of making the product or delivering the service: materials, servers, shipping.
• Gross profit: $100m − $40m = $60m. Gross margin = 60 ÷ 100 = 60%.
• Research and development (R&D): $15m — for new products.
• Selling, general and administrative (SG&A): $20m — salaries, marketing, offices, lawyers.
• Operating income: $60m − $15m − $20m = $25m. Operating margin = 25%. This is the cleanest number for what the core business earns.
• Interest and other income/expense: Nur Tech's debt is small ($10m) and its interest expense is $0.5m. It also earns $0.5m of interest on its cash — the two offset, so pre-tax profit is $25m.
• Tax: 20% → $5m.
• Net income: $25m − $5m = $20m. Net margin = 20%. This is the "bottom line" — the final figure left for shareholders.

On the chart the bar shrinks at every step: $100 → $60 → $25 → $20. Each cut is one type of cost. The key question for an investor: at which step does most of the money "disappear", and is that normal for the industry?

This chart shows the same numbers another way: where $100 of sales goes. At Nur Tech the biggest slice is cost of revenue ($40m), then SG&A ($20m) and R&D ($15m). Net income ($20m) is one fifth.