What is fundamental analysis and what it is for

Fundamental analysis is an asset research method based on analyzing economic, financial and other fundamental factors that affect asset values. 

Using a stock as an example, it involves examining data about a company, such as its financial condition, operations, industry, and macroeconomic indicators. Through fundamental analysis, an investor can determine how "strong" and promising an asset is.

Fundamental analysis helps an investor identify stocks that may be oversold or overbought based on fundamental factors. If the stock is undervalued, it can be a good investment. In the case of overvalued stocks, it may be wise to get rid of them. In the end, the goal is to find instruments that have upside potential, as fundamental analysis can provide information that an asset is trading too high even though it has no corresponding value in itself, also fundamental analysis helps to determine the current phase of the market.

Fundamental analysis is built on the concept of intrinsic value, which includes three key principles:

• Often the current share price does not reflect the real value of the asset.
• The project's fundamentals probably best reflect its true value in sync with the chart analysis
• In the long run, the market always tends to bring the market value closer to the true value.

Adherents of fundamental analysis try to determine the real value of a stock based on financial indicators and other fundamental factors, and then compare it with the current market price, trying to assess the state of the asset: oversold or overbought. If the stock market price is significantly lower than the intrinsic value, the asset is considered undervalued and attractive for investment. At the same time, if the price is too high, the asset can be defined as overvalued. However, the process of equalization between market and intrinsic value often takes a long time, sometimes months or even years.

This is why adherents of fundamental analysis tend to be long-term oriented investors. 

Fundamental analysis of cryptocurrencies

Fundamental analysis involves examining all available information about a particular project.

First of all, fundamental analysis includes a thorough study of the project itself: its goals, founders, capitalization, hash rate, tokenomics, cost of commissions, number of active addresses, general market conditions, economic situation, and other parameters. By analyzing various indicators, it is possible to extract valuable information. The main purpose of such analysis in the cryptocurrency market, as well as in classical markets, is to determine whether the asset is overvalued or undervalued in the project. Having obtained all the necessary information, it is possible to judge the potential of a token or its overbought, i.e. overvalued.

This type of analysis also allows traders and investors to understand how economic events and indicators affect quotes. Today, the value of assets can depend not only on global economic events, but also on various factors, such as, for example, statements of famous personalities - as in the case of Ilon Musk and the Doge coin (we wrote more about it in the material about shieldcoins). This also includes information about partnerships. For example, in 2021, social networks "exploded" with reports that the American retail giant Walmart was going to introduce Litecoin as a payment starting October 1. Following the fake press release, the price of Litecoin rose 38% to $240. However, a CNBC rebuttal soon emerged, with a Walmart spokesperson confirming the fake press release, and the cryptocurrency's price dropped sharply in response. At the time of the last update, Litecoin was worth $176.8.

Although fundamental analysis provides a wide arsenal of information that determines the impact on the value of an asset, but without quality chart analysis, it will be difficult to make effective trading decisions.

Benefits of FA

Fundamental analysis has a number of advantages that make it an important tool for investors and traders:

1. Long-term perspective: fundamental analysis allows assets to be valued over the long term. This is particularly useful for investors who are interested in long-term investments. 
2. Determining "true" value: fundamental analysis seeks to determine the real, fundamental value of an asset based on its financial characteristics and prospects. This can help determine whether an asset is overvalued or undervalued in the market.
3. Understanding risks: Analyzing fundamentals helps investors and traders better understand the risks associated with assets. For example, analyzing financial statements can reveal problems in a company's financial sector.
4. Forecasting the future: fundamental analysis allows you to make predictions about a company's future earnings and results. This is useful for making decisions to buy, sell or hold assets.
5. Understanding the macroeconomic environment: Fundamental analysis involves evaluating macroeconomic indicators such as GDP, inflation and unemployment rates. This helps investors better understand the overall state of the economy, its outlook and its impact on the market.
6. Investing in fundamentally strong companies: analyzing fundamentals allows investors to select companies that have strong financial performance, sustainability and good prospects for the future.
7. Portfolio diversification: fundamental analysis can help investors diversify their portfolio by selecting assets from different industries according to their characteristics.
8. Conscious investing: fundamental analysis promotes more informed investment decisions based on facts and analysis rather than emotions and market trends.
9. Overbought Determination. Fundamental analysis also helps investors to determine the distribution phase of an asset - this helps to sell an overvalued asset in time.

However, it should be remembered that fundamental analysis is not without disadvantages, and it is not always able to predict short-term price changes in the market, which may be caused by the behavior of market participants, news and other factors. 

FA disadvantages

Despite its many advantages, fundamental analysis has disadvantages to consider:

1. Complexity: Fundamental analysis requires analyzing a large amount of data, including financial reports, industry trends and macroeconomic indicators. It can require considerable effort and time.
2. Relevance: financial reports and other fundamental data may be published with a delay - this means that investors may learn about events that occurred months ago, which can affect the quality of analysis.
3. Subjectivity: the assessment of fundamental factors, such as an estimate of the "true" value of an asset, can be subjective and dependent on the methodology used by the analyst. Different analysts may reach different conclusions.
4. Ignoring short-term factors: fundamental analysis often focuses on long-term factors and may not take into account short-term changes in prices caused by investor and trader behavior, news or other short-term factors. Predicting future events and results based on fundamental analysis is not always accurate. External events and unexpected factors can significantly affect the market and make forecasts less accurate.
5. Manipulativeness. Many inexperienced traders and investors may absorb low quality information that will create an erroneous view of an asset, which can lead to financial losses in the future.

Despite these shortcomings, fundamental analysis remains an important tool for investors, especially those who are focused on long-term investing and seek to understand the fundamentals of financial markets.

Fundamental analysis on classical markets: what to pay attention to

Fundamental analysis in classic financial markets such as stocks, bonds, currencies and commodities includes a number of key aspects to pay attention to:

• Company financial statements (stock market): Examine financial statements such as a company's balance sheet, income statement, and cash flow statement to understand its financial condition, earnings growth, and solvency. Generally, companies provide financial reports once a quarter. For example, in October 2023, Tesla released its financial report for the third quarter of 2023. On it, by the way, we can see that the number of digital assets held by the company has not changed for 2023.

• Stock valuation: determining the "true" value of a stock based on fundamentals such as price to earnings per share (P/E) ratio, dividends, capital structure, cash flow, capitalization, peer comparisons, and more. These and other metrics help determine whether a stock is overvalued or undervalued in the market.

P/E ratio

The P/E ratio (Price-to-Earnings) is one of the key indicators of fundamental analysis in finance. It is used to measure the ratio of the current share price to earnings per share (EPS).

The P/E formula is simple: P/E = Share Price / Earnings per Share

A low P/E ratio, say 3 or 5, will indicate low confidence in the company's stability, while a high P/E of 20+ demonstrates great optimism about the company's future.

A high figure indicates that investors are willing to pay more for each dollar of profit in anticipation of further growth in the value of the company's shares. This can often indicate that a stock is overvalued. On the other hand, a low P/E can indicate a potentially undervalued stock, but it can also be the result of problems within the company. As an example, Apple's P/E is currently at 32.8.

This indicator is considered to be quite high, but it should be understood that in order for it to "win back" its time is needed, and there are cases when its realization in principle does not occur.

What's a normal P/E?

The average P/E across industries typically ranges from 12-15. A P/E above 20 may indicate that a company is overvalued, while values below 6 may indicate that it is undervalued.

During the dot-com crash, when there was a surge of interest in Internet company stocks, the P/E values of some of them reached 700 and even higher, while the market average on U.S. stock exchanges was 70. This fantastic overvaluation was one of the reasons for the new financial bubble.

Dividends

Dividends are the share of profits that a company pays to its shareholders. It is cash or additional shares that are distributed to the owners of the company's stock. Dividends are usually paid periodically, such as quarterly or annually. Depending on the company in which an investor invests, the amount of dividends also varies. Typically, dividends range widely from 0% to 20% depending on the company.

However, not all companies pay them out. For example, Tesla is currently a non-dividend stock. This means that shareholders do not receive a payout. Let's take a closer look at dividends using Coca Cola as an example.

The graph shows that The Coca-Cola Company has increased its dividend every year for the past 10 years. In 2022, the company's dividend was $1.76 per share. This means that investors owning 100 shares of the company received a dividend of $176.

The Coca-Cola Company is a consistent dividend payer, and its dividend yield in 2022 was about 2.8%. This means that investors who own shares of the company at that time could expect to receive about 2.8% of their investment in dividends each year.

Currently, Coca Cola's dividend yield has risen to 3.31% per year.

Capital structure 

A company's capital structure reflects the sources from which it finances its operations and how these sources are allocated. It includes two main categories of financing: equity and debt.

Equity (Equity) represents funds owned by the shareholders of a company. It includes common and preferred shares, as well as accumulated and retained earnings. Shareholders are co-owners of the company and share its profits and assets.

Borrowed capital (Debt) represents funds borrowed by a company from various lenders. This can include corporate bonds, bank loans, borrowings and other forms of debt. The company agrees to repay these funds with interest at a future date.

For example, as of December 31, 2022, Meta's shareholders' equity was US$108.2 billion. Of this amount, US$100.2 billion was in common stock and US$8 billion in preferred stock. And Meta's total debt amounted to US$32.5 billion. Of this amount, US$25.2 billion was short-term debt and US$7.3 billion was long-term debt.

What does this information tell us? Meta's capital structure is moderate. The company has some debt, but its equity significantly exceeds it. This means that the company has good financial strength and can easily repay its debt. However, Meta tends to increase its debt in recent years. This may be due to the company's growth and its investment in new products and services.

Cash flows

The cash flow of a company (cash flow) represents the dynamics of cash inflows and outflows over a certain period of time (often a quarter). This indicator is an important element of analysis, as it reflects the financial condition and stability of the company. 

A company's cash flows are generally divided into three main categories:

1. Operating Cash Flow: These are the cash flows associated with a company's core business activities. They include receipts from the sale of goods or services, as well as payments for operating expenses such as salaries, rent and raw materials.
2. Investing Cash Flow: reflects a company's investment in capital assets, such as the purchase of equipment, real estate or securities, and the receipt of money from their sale.
3. Financing Cash Flow: this includes flows related to the raising or repayment of debt, payment of dividends, and the purchase and sale of treasury stock.

Let's take Tesla as an example: 

As of 09/30/2023, the company generated $3.308 billion from operating activities at last report, investment activities generated $4.762 billion in losses for the company, and the company generated $2.263 million from financing activities. If we summarize these numbers, we see that overall the company earned $711 million in net income when all expenses are taken into account.

What to look for when analyzing fundamentals:

• Macroeconomic Indicators (in currencies and commodities): the study of macroeconomic data such as GDP, inflation, unemployment, interest rates, exchange rates and others to assess the impact of economic indicators on the prices of currencies, assets and commodities.
• Industry analysis: understanding the characteristics and trends in a particular industry, including competition, market growth, innovation and regulation, to assess the prospects for companies in that industry.
• Political and geopolitical events: assessing the market impact of political decisions and geopolitical events. These factors can strongly influence asset prices, especially in commodities and currencies.
• Events and news: you should pay attention to news and events that may affect fundamentals, such as corporate announcements, regulatory changes, central bank decisions and other important events.
• Reporting and event calendars: It is also important to keep track of updates on financial results and economic indicators. For this purpose, investors use reporting calendars that clearly mark the dates on which company reports are published and statistics are released.

• Correlation: There are sectors of the economy where companies' performance is highly dependent on fluctuations in the price of their products, such as in the metals or oil and gas industries. However, even when oil prices rise, stocks of companies in this sector may react differently due to the level of correlation between them. This factor plays a significant role. It is important for an investor to consider that some stocks may exhibit more pronounced upward or downward behavior for the same changes in the market.
• Competitor analysis: studying a company's or asset's competitors to understand their strengths, weaknesses, and their impact on the market. In addition, if when analyzing similar companies you find that their share prices are very divergent, this may signal that one of the companies is overbought and the other is oversold. 

Methods of fundamental analysis

Fundamental analysis includes several methods that are used by investors and analysts:

Comparison:

• Constant and varied comparison of companies, market sizes and shares, various ratios (profitability, leverage, multiples, etc.).

Induction:

• Induction involves deriving a general rule from particular cases. For example, if companies in a certain industry show similar profitability indicators, we can infer typical characteristics for that industry.

Deduction:

• Deduction is the application of a general rule to a particular case. For example, if a decrease in the price of a certain commodity affects the profitability of companies involved in its extraction, observation of price changes allows us to infer a possible impact on profitability. 

Fundamental analysis of cryptocurrencies: what to pay attention to

Fundamental analysis of cryptocurrencies is different from analyzing traditional assets, and includes a number of unique aspects to consider when researching and evaluating a crypto project:

1. Blockchain technology: One of the key factors in analyzing cryptocurrencies is to examine the blockchain technology on which they are based (Ethereum, BCS, etc.). This includes assessing the level of innovation, security and scalability of the blockchain platform.
2. Purpose and Use: understanding what purpose a particular project is created for and what benefits it provides over other similar projects.
3. Team and Developers: An examination of the team and developers behind cryptocurrency. Experience, professional skills and a history of success in blockchain project development can be important factors.
4. Community and participants: the activity and size of the community around a cryptocurrency project, as well as the level of support from participants, can influence its popularity and value
5. Security: an assessment of the level of network security and the measures taken to protect against hacker attacks and breaches.
6. Inflation and issuance: an examination of cryptocurrency issuance policy and what inflation control mechanisms are present.
7. Institutional support: exploring interest from financial institutions, investment funds and large corporations in this cryptocurrency.
8. Uses and partnerships: exploring which companies and projects are partnering with this cryptocurrency and how it integrates into real business processes. 
9. Historical data: analyze historical data on price, trading volumes and other parameters to identify trends and patterns.
10. Tokenomics: an assessment of the project's tokenomics, including reward structure, ownership stakes, and token utilization in the ecosystem.
11. Problem solving: exploring what real-world problems cryptocurrency solves and how it can improve existing processes.
12. Competition: assessing the competition and competitive advantage of cryptocurrency compared to other projects.
13. News and Events: monitor news and events on this project as they can have a significant impact on prices and prospects. 
14. Funds: It is important to look at the funds that have invested in the project. How much money was invested, by which funds - all this is very important to understand the value of the project. 
15. Regulation of the market and the specific industries to which the project belongs: regulation has a significant impact on crypto projects, as it determines the conditions and rules of their operation. A clear and favorable regulatory environment can create favorable conditions for a project to grow and attract investment. Conversely, unfavorable regulatory measures can create risks for the project.
16. Industry analysis: understanding the current state and prospects of the industry in which a crypto project operates helps to assess its potential. The competitive environment, technological trends and consumer demand all influence the success of a project. The more knowledgeable an investor is about the industry context, the better he or she can assess the prospects of a crypto project. If a project is launched in the P2E industry, for example, and this industry is not popular at the moment, this indicator can affect the fundamental value of the project. 

The most important thing when analyzing a cryptoproject

In order to make an informed investment decision regarding a cryptocurrency project, it is important to conduct thorough research. First of all, you should pay attention to the information provided on the official website, in the Whitepaper of the project. You can also find some of the necessary information on rating platforms: Coingecko, Coinmarketcap, etc.

You should also follow the news and updates of the project: as a rule, such information is published on the official Twitter accounts of the project.

The next step is to examine the value of the token, its liquidity, development team, technology, and economic model. Token value estimation is based on the potential value of the project and the demand for the token. Liquidity is determined by trading volumes on exchanges. The qualifications and experience of the development team are also key factors in the success of the project. The creators, their experience in the field and previous successes should be studied. 

Evaluating a project idea includes several criteria:

• The innovation criterion allows to identify the uniqueness and potential of the idea, but it is also necessary to take into account the goals of the project: a sustainable long-term business should be preferable to a quick way to make money;
• project security in cryptocurrency markets is a key aspect, given the risk of fraud and hacker attacks;
• competitiveness in the current environment and the benefits of the project are also important for success. Solving real user problems gives the project significance. Network efficiency becomes an important factor for development and success in the market.

To analyze the token, it is recommended that:

• examine token distribution, distribution periods, and the total number of tokens in circulation;
• studying the method of token mining: which mechanism is used - PoW or PoS. This is important because PoS is considered a more environmentally friendly way of mining coins and some projects that used to work on PoW are switching to PoS. For example, Ethereum used to use PoW (coins could be mined by mining) and in 2022 Ethereum, the second largest cryptocurrency, switched to the Proof of Stake (PoS) model to reduce the amount of energy consumed.
• analyze the deflationary mechanism proposed by the developers, by means of which the number of tokens in circulation will be reduced and thus the value of tokens will be increased;
• investigate the existence of incentives to keep tokens in the market, such as staking and other mechanisms;
• Evaluate how the demand for the token grows as the protocol usage increases and the project evolves;
• To investigate whether the token model provides an opportunity for income generation while holding it in the long term for investors.

These steps will help you get a clearer picture of the project and its investment prospects.

Fundamental analysis of the Arbitrum project

Let's analyze the Arbitrum project with the help of fundamental analysis. Let's start by examining the project's website.

On it we learn that Arbitrum is a second-level blockchain built on the Ethereum infrastructure. On the project's website, we immediately see the inscription: "Welcome to the future of Ethereum".

Using Optimistic Rollup technology, Arbitrum makes it easy to deploy Ethereum smart contracts and decentralized applications with improved throughput and more affordable transaction fees.

In the first half of 2022, Arbitrum took the leading position among L2 solutions for Ethereum in terms of number of transactions, application diversity and total blocked funds (TVL). Currently, more than $1.842 billion dollars are frozen in Arbitrum smart contracts.

Who founded the project?

The Arbitrum project was conceived and implemented by Offchain Labs, an American company founded in 2018 by three experts in crypto and blockchain technologies: Ed Felten, Steven Goldfeder and Harry Kalodner. Ed Felten, a former professor of computer science at Princeton University, has been involved in blockchain research since 2014. His professional career includes a stint at the White House, where he served as Deputy CTO under President Barack Obama. He then returned to Princeton University, where he started building Arbitrum with his then graduate students, Steven Goldfeder and Harry Kalodner.

What is the essence of the project? 

Arbitrum is Optimistic Rollup embedded in the Ethereum ecosystem. The Rollup mechanism is a key technology for Ethereum's secondary protocols, providing a high level of transaction privacy and scalability to the Ethereum core network. Its essence is to combine multiple transactions into a common block, which is then validated on the core network.

The Arbitrum Virtual Machine (AVM), which is fully compatible with the Ethereum Virtual Machine (EVM), is responsible for transferring transactions between the L1 and L2 layers. Within the L2 network, smart contracts and transaction processing are performed by the ArbOS operating system, which sends transactions through the AVM to the Rollup protocol's "outgoing transactions" folder for inclusion in the blockchain.

The algorithm of transaction processing in Arbitrum is as follows:

• The user initiates a transaction on the Arbitrum network, which goes to the Inbox.
• The Sequencer node creates a strict sequence of transactions, forming a "package" out of them.
• The compressed packet is sent to the Ethereum core network.
• Arranged transactions are sent to Arbitrum validators.
• Once the block is formed, the data is also transmitted to the Ethereum network, completing the transaction.

As a result, Optimistic Rollup has significantly sped up transaction processing and lowered the cost of fees, making them on average 90-95% more affordable than Ethereum, with the potential for further reductions.

ARB Tokenomics

To introduce its tokens to the market, the company created Arbitrum Foundation, as well as a decentralized autonomous organization (DAO) to manage the entire ecosystem. ARB token holders have the ability to vote on DAO proposals, and according to the developers' idea, this process will be automated, which means that token holders' votes can directly influence changes to Arbitrum's software code.

ARB is the native token of the ecosystem. The total number of coins is 10 billion at the moment. The project provides for an inflationary model. There is also an additional issue, but it is limited to 2% per year. What it means. Within one year, only 200 million ARBs can be added to the maximum total of 10 billion coins.

ARB tokens will be distributed as follows:

42.7% of tokens will go to DAO participants. 26.94% of coins are intended for the project's team and consultants. Investors will receive 17.53% of the total issue. 11.62% of the issue will be fully distributed to Arbitrum network testing participants. 1.13% of the total coins will remain with the developers of the main network. 

The Arbitrium team plans to issue more than $1.2 billion worth of ARB tokens in March 2024. The unlocking process is a phased issuance of cryptocurrency. The freezing of coins is done to prevent their mass sale by early investors or project team members. That is, in March 2024, early investors and team members will receive a portion of their coins and only then will they be able to sell them.

The initial unlocking on March 16 will be followed by regular releases of a predetermined number of tokens every 4 weeks for the next 4 years.

Investments in Arbitrum

In 2019, Offchain Labs raised $3.7 million in a seed investment round. In the spring of 2021, before launching the alpha version of the Arbitrum network, the company successfully completed a Series A investment round that raised $20 million. The main Arbitrum One network was officially launched on August 31, 2021, and during the same period, Offchain Labs announced it had raised $120 million in a Series B round led by Lightspeed Venture Partners. The funds ended up with 17.53% of tokens. The entire issue of 10 billion means the funds received 1.753 billion tokens for $143.7 million. That works out to a price of $0.08 per token.

Other major investors included Polychain Capital, Ribbit Capital, Redpoint Ventures, Pantera Capital, Mark Cuban and Alameda Research. After the completion of this round, the company's valuation was $1.2 billion.

Arbitrum Ecosystem

The Arbitrum ecosystem is an amalgamation of all projects and protocols functioning within this network. On the project website you can see the list of areas in which the project is working.

At the moment there are many well-known and "strong" projects in their niches working with Arbitrum:

• The largest DeFi protocols are Uniswap, SushiSwap, Curve, and 1inch;
• Reserve and algorithmic stablecoins USDT, USDC, DAI, FRAX, TUSD, etc;
• Yield aggregators yEarn Finance, Pickle Finance, Badger, Beefy Finance;
• NFT marketplaces: AlienSwap, Lootex, Stratos, ToFunFT, etc;
• Payment systems: 0xSplits, BoomFi, Cask Protocol, etc.
• GameFi: Bridgeworld, CastleDAO, Halls of Olympia, etc.

Conclusion 

Arbitrum is a key blockchain project offering a second layer solution for Ethereum using Optimistic Rollup technology. Ethereum needed a quality second layer - which is why Arbitrum is so valuable. The community has met Arbitrum very positively, which emphasizes its importance. Vitalik Buterin (founder of Ethereum) has also repeatedly emphasized that both zk Rollup and Optimistic Rollup are the future of Ethereum as they contribute to its scalability and optimization.

However, an examination of tokenomics revealed that too much of the issuance is owned by the funds and team. Arbitrum currently has extensive liquidity, with active participation from strong projects (1inch, Curve, Uniswap, Lido Finance, etc.). This shows the broad and diverse influence of the ecosystem.

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Fundamental analysis should be the first step of an investor when studying a project - this is the basis on which the investment decision should be built. It helps investors understand what factors influence the potential returns and risks of an investment, providing a basis for making decisions about whether to buy, sell, or hold an asset. When analyzing a project, it is important to carefully study the financial situation, reports, news background, the current phase of the market, the need for the product and much, much more. This type of analysis is especially useful for medium- and long-term investments, rather than for opening speculative positions. It is important to understand that fundamental analysis is a piece of the puzzle, which must also include competent chart analysis. Will be reckless in making trading and investment decisions based only on fundamentals, despite their importance.