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What is fundamental analysis and how to do it?
There are two primary methods used to research and analyze securities and make investment decisions: fundamental analysis and technical analysis. We already have discussed technical analysis earlier. In this post, we will delve into the details of fundamental analysis. We will try to understand what is Fundamental Analysis, and how you too can do it. With some study and practice, you should be all ready to go.
- There are two primary methods used to research and analyze securities and make investment decisions: fundamental analysis and technical analysis.
- In fundamental analysis, you evaluate a security by using economic, financial, qualitative and quantitative factors to determine its intrinsic value.
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 Vs. Technical Analysis:
Technical analysis uses past data of a stock to predict future price movements. Fundamental analysis instead looks at economic and financial factors that influence a business. So, let’s dive into the details of how fundamental analysis and technical analysis differ.Technical analysis uses past data of a stock to predict future price movements. Fundamental analysis instead looks at economic and financial factors that influence a business. So, let’s dive into the details of how fundamental analysis and technical analysis differ.
- The first step to technical analysis starts with charts, whereas in fundamental analysis it starts with the company’s financial statements. In fundamental analysis, you will have to determine a company’s intrinsic value by looking at its income statement, balance sheet and cash flow statement. Intrinsic value of a stock can be determined by discounting the value of future projected cash flows to the net present value. If the stock trades below the company’s intrinsic value, you can invest in it. But, technical analysts believe that a stock’s price already reflects everything that has or could affect a company.
- The time horizon in fundamental analysis is often long-term, as opposed to a short-term approach taken by technical analysis. By the approach of fundamental analysis, you should wait for a long time before a company’s intrinsic value is reflected in the stock market. In technical analysis stock charts can be delimited in weeks, days, or even minutes.
- Technical analysts and fundamental analysts have very different goals in their minds. Technical analysis will demand that you identify many short- to medium-term trades where you can earn a profit, whereas fundamental analysis demands you to make long-term investments.
How to do Fundamental Analysis of Stocks:
- Understand the company
It is very important that you understand the company in which you intend to invest. It will give you further insight as to how the company is performing, whether the company is taking right decisions towards its future goal, and whether you should hold or sell the stock. Visiting its website and learning about the company, its management, its promoters and its products is a good way to mine such information.
- Study the financial reports of the company
Once you are done understanding the company, you should start analysing its financials such as balance sheet, profit-loss statements, cash flow statements, operating cost, revenue, expenses etc. You can evaluate its compounded annual growth rate (CAGR), sales and if the net profit has been increasing for the last 5 years, it can be considered a healthy sign for the company.
- Check the debt
Debt is an important factor – one which can bring down a company’s performance. A security cannot perform well and reward you if it has a huge debt of its own. It is recommended that you avoid companies with huge debt. Always try to find a company to invest which has debt:equity ratio of less than 1.
Find the company’s competitors
The company you want to invest in must be one of the best among its peers. Try to find a company which is performing better than the other companies. It should have better future prospects, upcoming projects, new plant etc.
Analyse the future prospects
Fundamental analysis is most effective when you want to stay invest long term. Invest in those companies whose product will still be useful 15-25 years down the line.
- Review all the aspects time to time
Do not invest in a company and forget about it. Stay updated about the company you have invested in. You should be updated about all its news and financial performance. Sell the security if there is a problem in the company.
- You can read some books on fundamental analysis or value investing to increase your knowledge and master in it.
- You should follow the steps given to do fundamental analysis properly.
- You have the option of choosing among fundamental and technical analysis to invest according to your need, expertise, and ease of understanding.