Fundamental analysis

 Fundamental analysis

Fundamental analysis is a method of determining a stock's real or "fair market" value. Fundamental analysts search for stocks that are currently trading at prices that are higher or lower than their real value.There are two primary methods used to research and analyze securities and make investment decisions.


Introduction to fundamental analysis:


Fundamental analysis has been one of the most rewarding analyses in the history of stock markets. In fundamental analysis, you evaluate a security by using economic, financial, qualitative and quantitative factors to determine its intrinsic value. It is believed that macroeconomic and microeconomic factors can affect a security’s value. These factors can be economic conditions, industry conditions, financial conditions and management’s proficiency. The main motive while doing a fundamental analysis should be to evaluate a security’s intrinsic value and compare it with the current stock price of the security, thus determining if the security is undervalued or overvalued. Fundamental analysis is a way to avoid short-term information about a company/stock. Every day there is some news on stocks. While these information may form the basis of trades, not everyone in the stock market is a trader. Many people believe in long-term investing. They want to buy and hold stocks.Fundamental analysis helps you identify attributes of companies. The process of fundamental analysis will require you to understand a bit of mathematics, business and accounting basics. Along with this, you will need to have some common sense of how the company operates, the industry/sector and other things that can be imbibed from various documents.


Procedure of Fundamental analysis:


The analysis of a business's health starts with a financial statement analysis that includes finacial ratio. It looks at dividends paid, operating cash flow, new equity issues and capital financing. The earnings estimates and growth rate projections published widely by Thomson Reuters and others can be considered either "fundamental" (they are facts) or "technical" (they are investor sentiment) based on perception of their validity.

Determined growth rates (of income and cash) and risk levels (to determine the discount rate) are used in various valuation models. The foremost is the discounts cash flow model, which calculates the present value of the future:

  • dividends received by the investor, along with the eventual sale price; (Gorden  model)
  • earnings of the company;
  • or cash flow of the company.

The simple model commonly used is the  P/E ratio (price-to-earnings ratio). Implicit in this model of a perpetual annuity (time value of many) is that the inverse, or the E/P rate, is the discount rate appropriate to the risk of the business. Usage of the P/E ratio has the disadvantage that it ignores future earnings growth.



Importance of fundamental analysis:


Fundamental analysis is a method used by investors to identify the intrinsic value of a stock.The current price of a stock may not reflect the actual value of the stock. The stock may be overvalued or undervalued in the market. Fundamental analysts study the underlying health of the company in order to find the intrinsic value.This is done by using various qualitative and quantitative factors such as the company’s revenues, profit margins, return on equity, future growth potential and other metrics. The main purpose of this method is to identify companies that that are fundamentally strong in order to invest in them for the long term.Many famous investors such as Warren Buffett and Peter Lynch use fundamental analysis to identify and select potential winners in the stock market.The bedrock of investment, fundamental analysis helps you in better making an investing decision. Fundamental analysis of stocks helps you determine their fair value. Also, with stock fundamental analysis, you can evaluate the health and performance of any organisation through crucial numbers and major economic indicators.


How do you start a fundamental analysis?

How to do Fundamental Analysis of Stocks

1)Understand the company. It is very important that you understand the company in which you intend to invest. ...

2)Study the financial reports of the company. ...

3)Check the debt. ...

4)Find the company's competitors. ...

5)Analyse the future prospects. ...

6) all the aspects time to tiow to do Fundamental Analysis of Stock. ...


Advantage & Disadvantages of Fundamental analysis:
Fundamental analysis is the term used in the context of stock markets; the basis of fundamental analysis is that stocks have intrinsic value due to various factors like the company’s financial performance, industry demand, government policies, global demand, and so on and if one is able to calculate the intrinsic value of a stock than depending on the market price of stock one can buy an undervalued stock that is when the market price is lower than intrinsic value or sell overvalued stock that is when the market price is greater than intrinsic value. In order to understand more about this concept, one should look at some of the advantages and disadvantages of fundamental analysis.



Advantage of fundamental analysis:

1)Identification of Good Stocks

The biggest advantage of fundamental analysis is that it helps you in learning about the various complexities of the stock market and thus helps an investor to identify goods stock having good business model and future while avoiding bad stocks. In simple words just like a good soldier knows about the landmines and avoids putting his foot on the landmine in the same way a good investor through fundamental analysis can avoid the landmines of stock markets which are nothing but fundamentally poor stocks.In simple words when you have an umbrella with you then you will not worry about heavy rains as an umbrella will save you from heavy rains in the same way fundamental analysis is that umbrella which saves you from bad weather which keeps happening during the panic in stock markets.

2)Objective:

The quantitative part of fundamental analysis helps eliminate biases in making decisions on investments.

3)Long term:

Fundamental analysis is good for long-term investments based on long-term trends, very long-term. The ability to identify and predict long-term economic, demographic, technological or consumer trends can benefit patient investors who pick the right industry groups or companies.

Disadvantages of fundamental analysis:

1)No Guarantee of Profit


The biggest disadvantage of fundamental analysis is that there is no sure shot guarantee that if an investor has identified an undervalued stock that he or she will make a profit because there are many examples where an undervalued stock keeps performing poorly for a very long period of time and besides not all information is available in the public domain which results in the fundamental analysis being incomplete and thus inaccurate.

2)Time Consuming


Fundamental analysis is not a walk in the park as it involves considerable effort and time on the part of the person doing the analysis and hence it is a tradeoff between time spent on doing fundamental analysis and profit due to fundamental analysis which for many is not feasible option and hence people tend to avoid getting too much into the fundamental analysis.

3)Long Time Frame

In the case of fundamental analysis if one is able to identify an undervalued stock and purchase that stock in the hope that it will rise then it is not a surety that stock will catch up with intrinsic value quickly. In the case of stock markets, there are numerous examples where stocks traded below their intrinsic value for several years and hence if you are putting money into the stock for a very long term that is 10 to 20 years than fundamental analysis can be of good help otherwise chances of you getting frustrated with non-movement of stock price are high.

Types of Fundamental analysis:

1)Qualitative Fundamental analysis

2)Quantitative Fundamental analysis

There are two types of fundamental analysis – Qualitative and Quantitative. Qualitative is inclined towards goodwill, market conditions, brand value, and company performance. In contrast, the quantitative analysis is statistically driven. Fundamental analysis is often compared with technical analysis.

1)Qualitative analysis

Qualitative analysis involves the study of a company’s goodwill  consumer behavior, demand, and company recognition in broader markets. It aims to unearth answers to questions like how it is perceived, how management decisions or announcements create a buzz in the market, and how it is different from its substitutes. In addition, its brand value and other common factors depict its socio and economic position in the market.

2)Quantitative analysis

Quantitative analysis is inclined towards statistics, reports, and data. It is solely based on its financial statements, quarterly performance, balance sheets, debt, cash flow, etc. It involves a analyzing numbers, ratios, and values to understand the price of the shares and the company’s overall financial health.

Following step of Fundamental analysis:

  • How to do fundamental analysis.
  • Step 1: Economic and Market Analysis.
  • Step 2: Analysis of Financial Statements.
  • Step 3: Forecasting relevant payoffs.
  • Step 4: Formulating a security value.
  • Step 5: Making a recommendation.

Part of Fundamental analysis:


Fundamental analysis consists of three main parts:

         1)Economic analysis

  1. 2)Industry analysis
  2. 3)Company analysis

Fundamental analysis is an extremely comprehensive approach that requires a deep knowledge of accounting, finance, and economics. For instance, fundamental analysis requires the ability to read financial statements, an understanding of macroeconomic factors, and knowledge of valuation techniques. It primarily relies on public data, such as a company’s historical earnings and profit margins, to project future growth.             

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