1. Why fundamental analysis works
Stock prices oscillate around intrinsic value — the present value of all future cash a business will produce for its owners. In any given week the gap can be huge; over decades it closes. Fundamental analysis is the toolkit for estimating that intrinsic value and only buying when the market is offering it at a discount.
"Price is what you pay. Value is what you get." — Warren Buffett
2. The magic of compounding
Albert Einstein supposedly called compounding "the eighth wonder of the world." Whether or not he did, the math is unforgiving in its favor: a dollar invested at 10% doubles every 7.2 years (Rule of 72 — divide 72 by your rate of return).
Compounding Visualizer
Three return scenarios: 5% (bonds), 8% (60/40 portfolio) and 11% (long-run S&P 500 with dividends reinvested).
The lesson
The first decade looks boring — interest on a small base. The last decade looks magical because the base is huge. Most investors quit during the boring decade. Time in the market beats timing the market.
3. Income statement
Top to bottom of an income statement:
| Line | Meaning | What to watch |
|---|---|---|
| Revenue (Sales) | Total $ of goods/services sold | Year-over-year growth, segment mix |
| Cost of Goods Sold | Direct cost of producing the revenue | Trend in % of revenue |
| Gross Profit | Revenue − COGS | Gross margin — pricing power |
| Operating Expenses | SG&A + R&D | Operating leverage as revenue grows |
| Operating Income (EBIT) | Profit from core business | Operating margin |
| Interest, Tax | Below-the-line | Tax rate normalization |
| Net Income | Bottom-line profit | Watch for one-time items |
| EPS (Diluted) | Net income / diluted shares | Buybacks shrink the denominator |
4. Balance sheet
Assets = Liabilities + Equity. Always. The balance sheet is a snapshot at a point in time.
- Current assets: cash, receivables, inventory — convertible to cash within a year.
- PP&E: property, plant, equipment.
- Goodwill / intangibles: from acquisitions; large goodwill is a yellow flag for serial acquirers.
- Current liabilities: payables, short-term debt.
- Long-term debt: compare to EBITDA — net debt / EBITDA < 3 is healthy for most sectors.
- Equity: book value. Often understates intangible-heavy businesses.
5. Cash flow statement
The cash flow statement is the lie detector. Profits can be massaged; cash cannot.
- Cash from operations (CFO) — cash actually generated by the business. Should track net income over time. If CFO << net income for years, dig in.
- Capex — investments in long-lived assets.
- Free cash flow = CFO − Capex. The dollars truly available to owners.
- Cash from financing — debt issuance/repayment, buybacks, dividends.
6. Ratios that matter
| Category | Ratio | Formula | Healthy band |
|---|---|---|---|
| Profitability | Gross margin | Gross / Rev | 40%+ for software, 25%+ for manufacturing |
| Profitability | Operating margin | EBIT / Rev | 15%+ great |
| Profitability | FCF margin | FCF / Rev | 15%+ great |
| Returns | ROE | NI / Equity | 15%+ for 5y avg |
| Returns | ROIC | NOPAT / (Debt+Equity) | 15%+ = moat candidate |
| Leverage | Debt/Equity | Total debt / Equity | <1 conservative |
| Leverage | Interest coverage | EBIT / Interest | 5x+ safe |
| Liquidity | Current ratio | Curr Assets / Curr Liab | >1.5 |
| Valuation | P/E | Price / EPS | Compare to growth + sector |
| Valuation | EV/EBITDA | Enterprise Value / EBITDA | Capital-structure neutral |
| Valuation | PEG | P/E / EPS growth % | <1 cheap, ~1 fair |
| Valuation | P/FCF | Mkt Cap / FCF | The honest one |
7. Quality first
A great business compounds capital at high rates without needing more capital. Screen for 5-year average ROIC ≥ 15% with stable or rising trend. ROE can be inflated by leverage — ROIC strips that out.
8. Growth
Sustained 10%+ revenue growth, accompanied by stable margins, is rare and valuable. Distinguish:
- Organic vs acquired growth (read the MD&A)
- Volume vs price growth (pricing power)
- End-market growth vs market-share gains
9. Valuation multiples
S&P 500's median P/E since 1900 has been ~15. Above 22 = expensive era, below 12 = cheap era. But within sectors: software historically 30–50x, banks 8–14x, utilities 14–20x. Always compare to a stock's own 10-year history and to its peers.
10. DCF in 5 lines
- Project FCF for 5–10 years.
- Pick a terminal growth rate (2–3% — long-run GDP).
- Pick a discount rate r (8–10% for U.S. equities).
- Terminal value = FCFn+1 / (r − g).
- Sum the discounted cash flows + discounted terminal. Divide by share count = intrinsic value per share.
Apply a 30% margin of safety to your fair value before buying — DCF is sensitive to inputs.
11. Economic moats
Morningstar's five moat sources, in order of durability:
- Intangible assets — brands (LVMH, Nike), patents (pharma), licenses (utilities).
- Switching costs — Microsoft 365 inside an enterprise, Adobe Creative Cloud for designers.
- Network effects — Visa, Mastercard, Meta, LinkedIn.
- Cost advantage — Costco, Walmart, TSMC manufacturing scale.
- Efficient scale — niche markets where one or two players are enough (railroads, pipelines).
12. Red flags
- Revenue grows but receivables grow faster (channel stuffing).
- Net income up but operating cash flow down or negative.
- Repeated "one-time" charges every year.
- Goodwill > 50% of assets and rising — serial acquirer.
- CEO/CFO turnover during a stretched valuation.
- Heavy stock-based comp masked by "adjusted" non-GAAP metrics.
- Auditor change without clear reason.
13. The 60-minute analyst routine
- 0–10 min: What does the company sell, to whom, and how does it make money? (Item 1 of 10-K)
- 10–25 min: Pull 10-year revenue, FCF, ROIC, share count. Is this a compounder?
- 25–35 min: Read MD&A. What does management say about the next year?
- 35–45 min: Risk Factors. Anything terminal?
- 45–55 min: Build a back-of-envelope DCF or apply a peer multiple. Compare to current price.
- 55–60 min: Write the one-paragraph thesis: I own this because ___, the price reflects ___, and I will sell if ___.