Quick Answer
Fundamental analysis reads financial statements and ratios to find a security's intrinsic value (undervalued is a buy, overvalued is a sell). Technical analysis studies price and volume with trendlines, support and resistance, chart patterns, and moving averages. Know the ratio formulas, the sentiment indicators, and the insider-trading boundaries.
The whole unit on one sheet: reading statements, running ratios, insider rules, and chart sentiment.
How Do You Read the Financial Statements?
- Fundamental analysis measures intrinsic value: above market price means undervalued (a buy); below means overvalued (a sell). Uses both quantitative and qualitative data.
- Top-down goes economy to industry to company; bottom-up goes company to industry to economy.
- Balance sheet = snapshot at a point in time: Assets = Liabilities + Shareholders' Equity. Income statement and cash flow statement cover a period of time. Cash flow statement categories: operating, investing, financing.
- Total capitalization = long-term debt + preferred stock + common equity.
- Depreciation and depletion are non-cash charges; land is never depreciated.
- Rising prices: FIFO (First In, First Out) gives higher earnings and higher inventory value; LIFO (Last In, First Out) gives lower earnings but lower taxes. LIFO is barred under International Financial Reporting Standards (IFRS).
Which One-Liners Win Points?
- EBITDA = net income plus interest, taxes, depreciation, and amortization (all four, not just the non-cash pair) but is not actual cash flow.
- Fully diluted EPS is the most conservative figure: always equal to or lower than basic EPS. Dilutive securities are convertible bonds, convertible preferred, options, and warrants.
- Current ratio includes all current assets; quick ratio (acid test) excludes inventory (the least liquid current asset).
- Book value per share excludes intangibles and preferred stock; bond interest coverage uses EBIT, not net income.
- P/E (price-to-earnings) uses market price, not book value; dividend payout ratio + retention ratio = 100%.
- Bidder in a tender offer CAN buy the target's shares; everyone else holding the material nonpublic information cannot trade.
- Technical analysis ignores financial statements: it studies price and volume only.
Which Numbers Matter Most?
| Ratio | Formula |
|---|---|
| Working capital | Current assets - Current liabilities |
| Current ratio | Current assets / Current liabilities |
| Quick ratio (acid test) | (Current assets - Inventory) / Current liabilities |
| Debt-to-equity | Total debt / Total shareholders' equity |
| Bond ratio | Total bonds outstanding / Total capitalization |
| Inventory turnover | COGS / Average inventory |
| Net profit margin (net profit ratio) | Net income / Revenue |
| Return on equity (ROE) / return on common equity | Net income / Shareholders' equity |
| Asset coverage | (Total assets - Intangible assets) / Total debt outstanding |
| NAV per bond | (Total assets - Intangible assets - Current liabilities) / Number of bonds outstanding |
| Bond interest coverage | EBIT / Annual interest expense |
| Basic EPS | (Net income − preferred dividends) / weighted avg common shares |
| P/E ratio | Market price per share / EPS |
| Dividend payout ratio | Annual dividends per share / EPS |
| Straight-line depreciation | (Cost - Salvage value) / Useful life |
How Do Sentiment Indicators and Chart Patterns Work?
- Contrarian indicators: put/call ratio, short interest, VIX, mutual fund cash. High put/call or high VIX (extreme fear) reads bullish; low VIX (complacency) reads bearish.
- Confirming indicators: trading volume, market breadth (advance/decline), and market momentum validate the current trend.
- DJIA (Dow Jones) is price-weighted; the S&P 500, Nasdaq Composite, and Russell 2000 are market-cap-weighted (Russell 2000 = small-cap benchmark).
- Bond Buyer indexes (see the classification below): the 40 Bond Index (Municipal Bond Index) standardizes to a 6% coupon and publishes daily; the 11 Bond, 20 Bond, and Revdex-25 publish weekly. Rising index yields mean falling prices.
- Support = floor; resistance = ceiling. Role reversal runs both ways: broken support becomes resistance, broken resistance becomes support. Uptrend line drawn along the lows; downtrend line along the highs.
- Head and shoulders at a top = bearish; inverted head and shoulders at a bottom = bullish. Neither is confirmed until price breaks the neckline on increased volume. Consolidation, flags, and pennants signal the trend continues.
- Golden cross (short-term moving average crosses above long-term) = bullish; death cross (below) = bearish. Typically the 50-day and 200-day moving averages.
What Is the Memory Aid for the Bond Buyer Indexes?
- 11 and 20 = General Obligation only
- 40 = GO + Revenue
- Revdex = Revenue only
Which Gotchas Trip Students Up?
- An unqualified opinion is the best outcome: it sounds negative but means "no qualifications needed."
- Total capitalization includes preferred stock; forgetting it is the classic mistake.
- A rising debt-to-equity ratio warns bondholders, not just equity holders (higher bankruptcy risk).
- High put/call ratio is bullish, not bearish; the crowd is usually wrong at extremes.
- DJIA is price-weighted: a higher-priced stock has more influence regardless of company size.
- Short tendering is prohibited: tender only shares held net long.
- Overbought does not mean sell immediately; prices can stay overbought for a long time, and a breakout without volume is suspect.
- Stabilization by the managing underwriter is legal during distribution, but the stabilizing bid must be at or below the public offering price.
One-Breath Recap
Fundamental analysis reads the statements and ratios to judge intrinsic value, so undervalued is a buy and overvalued is a sell, while technical analysis reads price and volume through trendlines, support and resistance, patterns, and moving averages. Lock in the ratio formulas, remember the contrarian sentiment indicators and the Bond Buyer indexes, and respect the tender-offer insider rules. Nail those and this unit answers itself.
Need more than the recap? Read the full Fundamental and Technical Analysis unit.