Capital Markets: Forecasting Future Trends

The financial statements described above serve as a basis for analysis, the results of which serve forecasts of expected price trends on capital markets. Theory and practice know of two kinds of analyses, i.e. fundamental and technical analysis, respectively.

Fundamental analysis is a method of estimating a company's "fundamental" value and business by measuring its "inner, fair" value. The goal of the analysis is to determine the inner (objective, fair) value of a given security, which an investor can compare to the current market price. If the market price is below the estimated one, the investor should buy the shares, since the share is undervalued, and vice versa. Fundamental analysis is more useful for long-term investors, who buy undervalued shares and wait for them to reach the realistic market value, than for short-term ones, who are more speculative in nature.

Fundamental analysis analyzes the following factors:

• Macroeconomic factors (international environment, national economy, population, profitability...)
• Industrial conditions (technology, trade policy, barriers, monopolies...)
• The company's business (financial statements)
• Qualitative and quantitative factors

By contrast, technical analysis is a form of market analysis that covers securities supply and demand based on examination of price and volume of trade. It is based on the analysis of graphs and trends resulting from empirical research in this area.

Technical analysis refers to studying the behavior of the market itself, rather than the goods traded on the market. This method is also characterized by the fact that it puts less stress on the academic foundation than on practical application.

Technical analysis indicators include EPS (earnings per share), which equals:

EPS provides information on how profitable a company is. Earnings per share are mostly calculated on the last four quarters. Investors and analysts tend to forecast profits in the following four quarters and, on this basis, to calculate EPS and P/E as a multiplier that shows how willing the investor is to pay on the profit unit. The formula for this indicator is:

A high P/E means a high projected future profit. It only makes sense to compare the P/Es of companies within the same industry, or to the market as a whole, or to the historical value of the company's P/E. A company whose P/E is higher than the industry average or the market means that the market expectations for the few following months or even years are high.

Another important indicator is PB (Price-to-Book), which shows a ratio between market price and bookkeeping value. This indicator measures the debt to equity ratio and shows how indebted it is.

A low P/B ratio can mean that a share is undervalued or that there is something wrong with the company business (the company is not worth a lot on the market). A high ratio means the company finances its development by borrowed resources, which may result in unstable share prices and high risk.

Other important indicators include ratios between assets and liabilities, net profit and assets (ROA), net profit and equity (ROE), and other financial indicators.

Another important measure is Capital Flow Analysis, which says that by studying the flow of funds accounts in historical and sociological context, it is possible to explain the forces of supply and demand that move financial markets.

Such analysis increases investor awareness of otherwise unexplained market risk.