Fundamental analysis is most often used when determining the quality of long-term investments in a wide array of securities and markets
There are many factors that affect the price of a stock in the securities market. Sentiments, liquidity, technical are some factors that affect price. But above all, the most important factor that influences the price of a share in the share markets is the fundamentals of the company.
WHAT IS FUNDAMENTAL ANALYSIS?
Fundamental analysis, in accounting and finance, is the analysis of a business’s financial statements; health; and competitors and markets.
Fundamental analysis is a method of determining a stock’s real or “fair market” value.
If the current market price is lower than the fair value (also called intrinsic value), then the company is said to be undervalued and vice versa.
For stocks, fundamental analysis uses revenues, earnings, future growth, return on equity, profit margins, and other data to determine a company’s underlying value and potential for future growth. All of this data is available in a company’s financial statements
WHY FUNDAMENTAL ANALYSIS IS IMPORTANT?
Fundamental Analysis is essential because it provides consistent and reliable information. With the help of fundamental analysis, we can evaluate a security’s intrinsic value. The discounted cash flow model is a common valuation method used to determine a company’s intrinsic value.
The ultimate goal of fundamental analysis is to quantify the intrinsic value of a security.
WHO USES FUNDAMENTAL ANALYSIS?
The majority of investors who want to evaluate long-term investment decisions start with a fundamental analysis of a company, an individual stock, or the market as a whole. Fundamental analysis is the process of measuring a security’s intrinsic value by evaluating all aspects of a business or market.
1. LONG-TERM INVESTORS
These people are willing to hold onto their positions for the long term unless there is any serious problem associated with the company. They are very patient investors who don’t care about the short-term volatility in the stock price.
2. FINANCIAL ADVISORS
These people render financial service and also give stock advice to their client in terms of what and when to buy and sell the securities.
3. VALUE INVESTORS
They look for stocks where there is mispricing in the market i.e. price and value doesn’t match. They try to identify companies which are extremely beaten down or the stocks which market is avoiding at the current juncture.
Here is a guide on Value investing : Value investing Guide from a Value investor
4. FUND MANAGERS
These guys work in the big fund houses (insurance company or a pension fund) who manages a huge pool of money. Since they have a very big role to play and a large amount of capital is at stake, so they have a team of qualified professionals who conduct in-depth stock research.
WHAT IS THE DIFFERENCE BETWEEN TECHNICAL AND FUNDAMENTAL ANALYSIS?
Fundamental analysis evaluates stocks by attempting to measure their intrinsic value. Fundamental analysts study everything from the overall economy and industry conditions to the financial strength and management of individual companies. Earnings, expenses, assets and liabilities all come under scrutiny by fundamental analysts.
Technical analysis differs from fundamental analysis, in that traders attempt to identify opportunities by looking at statistical trends, such as movements in a stock’s price and volume. The core assumption is that all known fundamentals are factored into price, thus there is no need to pay close attention to them. Technical analysts do not attempt to measure a security’s intrinsic value. Instead, they use stock charts to identify patterns and trends that suggest what a stock will do in the future.
TOOLS FOR FUNDAMENT ANALYSIS
The tools required for fundamental analysis are extremely basic, most of which are available for free. Specifically you would need the following:
- Annual report of the company – All the information that you need for FA is available in the annual report. You can download the annual report from the company’s website for free
These are some of the factors you’ll want to identify in an Annual report:
- Earnings per share (EPS): Neither earnings nor the number of shares can tell you much about a company on its own, but when you combine them, you get one of the most commonly used ratios for company analysis. EPS tells us how much of a company’s profit is assigned to each share of stock. EPS is calculated as net income (after dividends on preferred stock) divided by the number of outstanding shares.
- Price-to-earnings ratio (P/E): This ratio compares the current sales price of a company’s stock to its per-share earnings.
- Projected earnings growth (PEG): PEG anticipates the one-year earnings growth rate of the stock.
- Price-to-sales ratio (P/S): The price-to-sales ratio values a company’s stock price as compared to its revenues. It’s also sometimes called the PSR, revenue multiple, or sales multiple.
- Price-to-book ratio (P/B): This ratio, also known as the price-to-equity ratio, compares a stock’s book value to its market value. You can arrive at it by dividing the stock’s most recent closing price by last quarter’s book value per share. Book value is the value of an asset, as it appears in the company’s books. It’s equal to the cost of each asset less cumulative depreciation.
- Dividend payout ratio: This compares dividends paid out to the stockholders to the company’s total net income. It accounts for retained earnings—income that is not paid out, but rather, retained for potential growth.10
- Dividend yield: This, too, is a ratio—yearly dividends compared to share price. It’s expressed as a percentage. Divide dividend payments per share in one year by the value of a share.
- Return on equity: Divide the company’s net income by shareholders’ equity to find its return on equity. You might also hear this expressed as the company’s return on net worth.
2. Industry related data – You will need industry data to see how the company under consideration is performing with respect to the industry. Basic data is available for free, and is usually published in the industry’s association website
3. Access to news – Daily News helps you stay updated on latest developments happening both in the industry and the company you are interested in. A good business newspaper or services such as Google Alert can help you stay abreast of the latest news
It needs to be remembered that fundamental analysis is not just about quantitative valuations but also factors intangibles like management quality, corporate governance standards and the disclosure levels. It is only when you manage to combine all these factors that you get a reasonable benchmark to value the companies. Technical or news flows can only give you short term trends in the market. For long term value, you still need to some serious fundamental analysis.