Hi there! 👋 Biritu here with your Friday for Knowledge session!
As another week comes to a close, it’s time to fuel our minds with insights that matter. In this edition of Friday for Knowledge, we dive into thought-provoking Fundamental vs. Technical Analysis.
Investing, especially in a developing economy like Ethiopia, can feel like navigating uncharted territory. But don’t worry, there are tools to help you find your way. Two main approaches, fundamental and technical analysis, are like having two different maps of the same terrain.
Fundamental Analysis: Digging Deep for Value
Fundamental analysis is all about understanding the intrinsic value of an asset – what it’s really worth. It’s like trying to figure out if a company is a good deal, regardless of what the current market price says.
- Financial Statements (The Company’s Story): These are like the company’s report card. The income statement shows revenue, expenses, and profits over a period. The balance sheet shows what the company owns (assets) and owes (liabilities) at a specific point in time. The cash flow statement tracks how cash is moving in and out of the company. We analyze these to calculate ratios and metrics that tell us about profitability, liquidity, and solvency. Profitability tells us how much profit a company makes relative to its revenue. Liquidity tells us if a company can meet its short-term obligations. Solvency tells us if it can meet its long-term obligations.
- Economic Indicators (The Big Picture): Think big picture. How’s the Ethiopian economy doing? Is it growing? Is inflation eating away at our savings? Is the Birr stable? These things affect everyone, including the companies we might invest in. For instance, high inflation can make it harder for companies to make a profit because their costs are rising.
- Industry Analysis (The Competitive Landscape): Who are the company’s competitors? Are there new players shaking things up, like the recent entry of Safaricom in the Ethiopian telecom market? What are the government’s plans for the sector? Is the market growing? Understanding the competitive landscape is crucial for assessing a company’s future prospects. Porter’s Five Forces is a common framework used here.
- Qualitative Factors ( The Intangibles ): This is where things get interesting. Is the company’s management team competent? Do people trust their brand? How good is their network, especially in rural areas (in the case of Ethio Telecom)? Are they innovative? Things like this are harder to measure, but they matter a lot.
Basically, you’re trying to figure out if a company is a good investment before everyone else realizes it. If you think it’s undervalued, you might buy its stock (if it were publicly traded), hoping the market will eventually catch on to its true potential.
Technical Analysis: Reading the Market’s Mood
Technical analysis is different. It doesn’t focus on the intrinsic value of a company. Instead, it looks at market data – past prices and trading volume – to try and predict future price movements. The core assumption is that all known information is already reflected in the price, and that price patterns tend to repeat themselves.
- Charts and Patterns (Visual Clues): Imagine drawing lines and shapes on a chart of a stock price. Technicians look for patterns – like “head and shoulders,” “double bottoms,” or “triangles” – that might suggest where the price is headed next. These patterns are believed to reflect market psychology and investor sentiment.
- Indicators (Mathematical Insights): These are mathematical calculations based on price and volume. They can help identify trends and potential turning points. For example, moving averages smooth out price fluctuations and can help identify the underlying trend. The Relative Strength Index (RSI) measures the speed and change of price movements and can help identify if a stock is overbought or oversold. MACD (Moving Average Convergence Divergence) is another popular indicator that uses moving averages to identify potential buy and sell signals.
- Trendlines (Support and Resistance:) Drawing lines on the chart can help you see where the price has struggled to go above (resistance) or below (support). These can be good places to buy (at support) or sell (at resistance).
