Fundamental analysis is a method used by investors to find out the company’s financial health. Actual value of the stocks to determine future growth of the company. Fundamental analysis includes financial statements, Profit and loss statements and Economic data of the company to assess overall financial health of the company.
The final goal of Fundamental analysis is whether the stock is undervalued,overvalued or fairly priced. In technical analysis we focus more on chart patterns and market trends.
Why Fundamental Analysis is Important ?
By accessing fundamentals of companies we make decisions on investment whether we can buy,sell or hold the accessing stock.
By Evaluating companies Business Model,Profitability and Future growth,Then we make a view on a company’s Real Worth or we can say fundamental analysis of companies.
- We will find undervalued stocks that can rise in future by accessing their fundamentals.
- Avoid Overpriced stocks.
- Make long term investments based on companies fundamentals and future growth.
Key Elements in Fundamental Analysis
- Quantitative Analysis
Quantitative analysis depends on the financial statements of the companies. Then we Examine financial health of the company. The main 3 financial statements are below
- Income Statements:- It shows the companies revenue,expenses and profit over time. It helps investors to evaluate companies future growth and profit Margin.
- Balance Sheet:- Balance sheet provides companies Asset,Liabilities and shareholders Equity. It shows whether the company has enough Resources to Manage Operations and expand its Business. And pay debt if they have any.
- Cash Flow Statements:- It shows how cash flows in a company in or out.
Positive cash flow indicates that the company is generating enough cash to maintain or grow its business while negative cash flow could be a warning for the Business.
2. Qualitative Analysis
Qualitative analysis are Non Measurable things that can impact on companies future
Performance like
a. Business Model:- How Company launch their new product, how much they are
Earnings, How smooth their operations are going on.
b. Industry and Market Conditions:- Investors access factors such as market
demands, competition and industry trends for companies future Aspects.
c.Management Quality:- Investors look CEOs future outlook towards company,his
Education,his past experience to running company and his strategic and governance
Practice.
d.Economic Environment:- Companies future can also be affected from Marco Economics
factors like Inflation,Interest Rate. Interest Rate may affect more if they are in heavy debt.
Key Financial Ratios used in Fundamental Analysis
- P/E ratio:- P/E ratio is compared to a company’s stock price to its earnings per share. It is a measure of how much investors are willing to pay for each rupee of earnings. A high P/E Ratio indicates that stock is overvalued and Low P/E ratio indicates that stock is undervalued.
P/E Ratio= Market Price Per Share/Earnings Per Share
- P/B Ratio:- P/B Ratio Compares the market value of its company stocks to its book value.This Ratio helps investors to determine that stock is undervalued or overvalued.
P/B Ratio:- Market Price per share/Book Value Per Share
- Return On Equity:- ROE means how effectively a company uses shareholders equity to generate profits. A High ROE indicates that a company is generating high returns on the investments made by its shareholders.
ROE= Net Income/ Shareholders Equity
- Debt to Equity Ratio:- D/E Ratio is used to evaluate companies financial leverages and it is calculated by companies total liabilities to its shareholders equity.
A High D/E ratio indicates that a company is heavily dependent on debt to finance its operations which could be risky.
D/E Ratio:- Total Liabilities/Share Holders Equity
- Earnings Per Share Ratio:- EPS means companies profit allocated to each outstanding share of stocks.
Formula:- EPS= Net Income/ No of outstanding shares
Main Points to Remember in Fundamental Analysis
- Understand the Company:- understand the company’s business model, Market strategy Future growth and competitive advantages from other companies and having any future threat from other companies.
- Analyze Financial Statements:- Analyze the company’s financial statements like Balance sheet, Profit and Loss Statements,Cash Flow and see how smoothly they are running their business or taking any debt to operate their business.
- Evaluate Financial Ratios:- FInd out P/E,P/B and D/E Ratio to compare the company’s performance quarterly or yearly and also find how their competitors are performing, so that you can find out the actual value of shares(undervalued or overvalued).
- Future of Company:- Review on the past performance of their product, Quarterly results and whether the product demand is increasing or decreasing, so that we can find out the future outlook on the company.
Limitation of Fundamental Analysis
- Time Consuming:- To analyze companies whole financials and everything about the company it takes time.
- Assumption:- Sometimes we make assumptions on future growth,Product Quality and Trust on Management that they are not doing anything wrong that can harm companies value.
- Market Sentiments:- Stock Prices are not always driven by fundamental analysis sometimes market sentiments,News or some External factors can run stocks especially in short term. So always try to go into Investing.
Conclusions
Fundamental Analysis is the main thing if you are investing your hard earned money in the long term.you have to analyze companies all financial statements, future outlook of company, promoters background and their values.
Sometimes your Analysis is not working but trust on your analysis and practice more and more to study the fundamentals of the company and In the longer term you can surely make a fortune in the stock market.
Happy Investing/Trading!!!
