Quick Answer
Technical analysis reads price and volume charts to time trades and assumes all information is already in the price. Fundamental analysis studies financials to find intrinsic value and answer what to buy. The Dividend Discount Model (DDM) and Discounted Cash Flow (DCF) assign a dollar value; both are fundamental tools.
The whole unit on one sheet: technical versus fundamental analysis, the ratios, and the two intrinsic-value models the exam loves to compare.
Which One-Liners Win Points?
- Technical analysis = charts, price, volume, patterns; answers when to trade, never intrinsic value.
- "All information is already in the price" is a technical assumption, not a fundamental one.
- Fundamental analysis = financial statements, ratios, and economics; answers what to buy by finding intrinsic value.
- Top-down starts with the economy, then sector, then industry, then company; bottom-up starts with the individual company. Both are fundamental.
What Does Technical Analysis Answer?
- Studies past market data (primarily price and volume) to forecast future price movements.
- Does NOT analyze financial statements, earnings, management, or competitive position.
- Volume confirms price: a breakout above resistance or breakdown below support on high volume is a stronger signal than one on low volume.
- Support = price floor where buying pressure historically halts a decline; resistance = price ceiling where selling pressure historically halts a rise.
- Moving averages (for example, 50-day, 200-day) smooth price trends; relative strength compares a stock to a benchmark index.
- Technical analysts do NOT try to find undervalued stocks; they bet supply-and-demand patterns repeat.
What Does Fundamental Analysis Answer?
- Evaluates a company's intrinsic value to judge if a stock is overvalued, undervalued, or fairly valued versus market price.
- Key ratios (learn the formula and what it measures):
| Ratio | Formula | What It Measures |
|---|---|---|
| Price-to-Earnings (P/E) | Market Price / Earnings Per Share | Price paid per dollar of earnings |
| Price-to-Book (P/B) | Market Price / Book Value Per Share | Trades above or below accounting value |
| Debt-to-Equity | Total Debt / Total Equity | Financial leverage and risk |
| Current Ratio | Current Assets / Current Liabilities | Short-term ability to pay obligations |
| Return on Equity (ROE) | Net Income / Shareholders' Equity | Efficiency using shareholder capital |
- A low P/E versus peers may suggest undervaluation; a high debt-to-equity signals greater financial risk.
- P/E alone tells you nothing; compare it to industry peers or the stock's own history.
How Does the Dividend Discount Model Price a Stock?
- The tested version is the Gordon Growth Model (constant growth DDM):
Where:
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r = required rate of return
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g = constant dividend growth rate (assumed indefinite)
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Example: current dividend $2.00, growth 5%, required return 10%. D1 = $2.00 × 1.05 = $2.10; Stock Value = $2.10 / (0.10 - 0.05) = $2.10 / 0.05 = $42.00.
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The formula breaks when g is greater than or equal to r: the denominator hits zero or goes negative, giving a meaningless result.
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Best for mature, stable dividend payers (utilities, consumer staples, financials, blue chips); not useful for non-dividend growth stocks or startups.
When Do You Use Discounted Cash Flow?
- Values a security as the present value of ALL expected future cash flows; more flexible than DDM (free cash flow, operating cash flow, earnings, or any measurable stream).
- Three steps: estimate future cash flows (often a 5-to-10-year forecast), select a discount rate (often the weighted average cost of capital, or WACC), calculate present value and sum.
- Calculated value greater than market price = undervalued (buy); less than = overvalued (sell or avoid); equal = fairly valued (hold).
- Higher risk demands a higher discount rate, which lowers present value; a safer company earns a lower rate and higher valuation.
- Garbage in, garbage out: small changes in the discount rate or growth assumptions swing the value sharply.
Which Numbers Matter Most?
| Item | Value |
|---|---|
| DDM example next-year dividend (D1) | $2.00 × 1.05 = $2.10 |
| DDM example stock value | $2.10 / 0.05 = $42.00 |
| DDM validity condition | required return r must exceed growth rate g |
| Common moving-average periods | 50-day and 200-day |
| DCF forecast period | typically 5 to 10 years |
Which Gotchas Trip Students Up?
- D1 is next year's dividend. Given the current dividend, multiply by (1 + g) before plugging in; using the current dividend is the classic trap.
- Identify the method from the analyst's activity. Charts, volume, support/resistance = technical; financial statements, ratios, intrinsic value = fundamental.
- DDM is not useful for a company that pays no dividends (for example, a tech startup); DCF fits better there.
- Volume matters: a price move without strong volume is a weaker, less reliable signal.
One-Breath Recap
Technical analysis reads charts, price, and volume to answer when to trade, assuming all information is already in the price, while fundamental analysis studies financial statements and ratios to answer what to buy by finding intrinsic value; within fundamental analysis, both top-down (economy first) and bottom-up (company first) hunt for that intrinsic value. The Dividend Discount Model prices a stock as the present value of future dividends, next year's dividend divided by required return minus growth, and it breaks when growth meets or exceeds the required return. Discounted Cash Flow generalizes this to the present value of any future cash flows, so it can value non-dividend growth companies, bonds, and real estate. A calculated value above market price signals undervalued, below signals overvalued, and higher risk means a higher discount rate and a lower valuation.
Need more than the recap? Read the full Equity Valuation Methods unit.