What is Fundamental Analysis? Role of Fundamental Analysis While Investing in Stocks?

Fundamental analysis is a holistic approach to study business. Whenever an investor invests in business either for the long term (5-10) or for the short term it extremely becomes important to comprehend the business you are going to invest in. So that you can acknowledge what it will bring on the table after years of holding money on it.

The fundamental analysis is considered the foundation step of all investment. Good familiarity with fundamental analysis supports you to formulate a good investment portfolio. Such a portfolio will appreciate over time and build a strong company, thereby creating wealth for its investors.

So let’s dive deep and understand fundamental analysis and what fundamental analysts do?

What is Fundamental Analysis?

Fundamental analysis is the process of determining the intrinsic value of the share. This value is determined based on the fundamental study of macro and microelement in the environment [i.e. circumstances of the world economy, national economy, industrial situations for a particular niche, company’s management, etc.] these elements further can be studied in qualitative and quantitative terms.

Purpose of fundamental analysis? 

The end goal is to estimate the intrinsic value of a particular company share.

Situation 1- When the intrinsic value of a share is more than the Market Value of share.

When the intrinsic value of a share is more than the Market Price. The stock is deemed to be undervalued. The market soon will adjust to attaint to attain the intrinsic value. Thus, a buy recommendation is given to the investor.

Situation 2- When the intrinsic value of a share is less than the Market Value of share.

When the intrinsic value of a share is less than the Market Price. The stock is deemed to be overvalued. The market soon will adjust to attaint to attain the intrinsic value. Thus, a sell recommendation is given to the investor.

Hence, the calculation of intrinsic value is the real game while investing because the intrinsic value cannot be the same for every analyst. Each person estimates it based on some quantitative and qualitative factors that differ from everyone based on their judgements and logical reasoning.

How to do Fundamental Analysis?

If you are involved in the market you also know, good knowledge, brings a good result. Fundamental Analysis of a company can be done by dividing it into two analyses.

1. Qualitative Analysis.

Factors included in the study of Qualitative Analysis are such that they cannot be measured or expressed in terms of number. But they have a heavy influence on the performance of a stock.

For Example:

The recent investment made by Facebook, Silver Lake, Vista, General Atlantic, and KKR in the Reliance Jio cause a dramatic shift in the share prices. One can gain from these positive injections either by making short term investments or even can create wealth in the longer run. But before making any investment what is essential is to study the company goals and plans to predict the growth aspects.

 

Hence, all the above study majorly depends on many factors that cannot be measured. Also, each of these factors influences the perspective of each investor differently. Therefore a proper analysis is important to predict its future growth.

 

The following are some of the qualitative factors:

• The business model of the company.
• Quality of products and services offered by the company.
• Management of the company.
• Competitive edge in the market.
• Growth and expansion plans of the company.
• The brand image of the company.
• Creativeness in product innovation and research.

In the qualitative analysis we thoroughly study the company’s background to make a better investment decision. Giving your hard-earned money to someone for further investment is like giving your trust to someone with an expectation that it will be taken care of in the future. Similarly in investing that satisfaction comes terms of wealth creation, of the investor.

Personal judgment:

Now, while studying quantitative analysis it is essential to realize that each investor in the market has their opinion. If a particular share is a good investment for some investors it may be a bad investment for others.

This is where personal judgment plays a key role in the decision of the final investment.

Note: Everyone is selling, selling is an art..!!

Everyone is selling one thing or the other thing in the market. Financial media sell the stocks already performing well from the past times. The anchors and analysts on financial media try to create an authority and try to sell what they are getting paid off. I still remember me going to the bank for some financial advice and they tried selling me a product they can hit their targets with. Hopefully my manager’s advice saved me up.

Therefore, you need to be extremely cautious before getting into any deal.

2. Quantitative Analysis.   

Under this, we study those factors of the business which can be measured and expressed in quantitative terms. Its inference is the same for all the investors.

For example:

During COVID -19, the demand for pharmaceutical products especially disinfectants rises heavily in the market. This causes a huge investment in the pharmaceutical sector.

 

Now in the above situation, all the changes can be measured in quantitative terms, also its influence on every investment decision will be the same. Unlike the qualitative analysis where investors have to make decisions based on their judgments.

 

Factors considered in quantitative Analysis are as follows-

1] Financial statements of the company:  

Financial Statements are summarised statements of accounting records prepared at the end of an accounting process. It is a medium of communicating accounting information to internal and external users. It comprises 3 statements that are as below:

• Balance Sheet
• Income Statement
• Cash flow Statement

2] Financial Ratios: 

Financial ratio analysis is a process of determining and expressing the relationships between the items of financial statements. It helps in providing more understanding of the performance and current financial position of an enterprise. Thus, it is a technique of analyzing financial statements by computing ratios.

These ratios help in acknowledging the financial health and the profitability of the company while making an investment decision.

For Example:

• Price to Earnings Ratio.
• Debt to Equity Ratio.
• Return on Assets.
• Return on Equity and many more.

Approaches to do Financial Analysis. 

Investors can start the analysis using any of the approaches.

1. Top-down approach:

In the top-down approach, the investor starts the analysis from the top of the pyramid given above. Investors first consider the health of the global or overall economy. Later, they analyze the local economy and identifies the industries and sectors of the economy offering the best investment opportunities.

 

Once, the growing industry is determined, the investor assesses potential opportunities within the identified industry and finally selects the most promising stock.  

2. Bottom-up approach:

Alternatively, there is a bottom-up approach where the investor begins their search with the study of the local economy. They directly jump on the individual stocks that may be performing better than the overall industry.

Later, they move up the table and study the global economy. Analysts here primarily concentrate their focus on the potential companies earning and their financial metrics to gain a better understanding of its operations.

Bottom line:

In order to avoid mistakes, one needs to know about the share market.

Also Read:

An Introduction To The Share Market

Well, one should have more practical exposure to avoid common mistakes in the stock market. An initial investor should always focus on learning more by making small and step by step investments. Also simultaneously analyzing both quantitative and qualitative factors precisely to build a good portfolio.

Above all, one should be patient and have a belief in one’s abilities and should avoid rumors and other people’s advice.

If you find it helpful surely write back to us by writing in the comment box below.

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