It is said that when even the Autowala starts giving you stock tips, a boom in the market has set in. But how reliable are such tips? Stockbrokers, analysts, and business news sites provide such tips without any reasoning on a day to day basis. As a responsible and safe investor, you surely don't want to invest in a company like Aertotyne Ind. from 'Wolf of the Wall Street', whose HQ is just a small garage in a backyard but has a very high price in the market. Here comes the role of fundamental analysis. While technical analysis gives you a probable buying or selling price levels, fundamentals help you become sure about the growth and sustainability of the company itself.
According to Investopedia fundamental analysis (FA) is, "a method of measuring a security's intrinsic value by examining related economic and financial factors. Fundamental analysts study anything that can affect the security's value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company's management."
What do the fundamentals of a company involve?
While analyzing the company fundamentally there are a lot of qualitative and quantitative parameters that an investor has to go through thoroughly.
Qualitative Parameters
- Management Discussion and Analysis.
- Report on Corporate Governance
- Auditors Report
- Investors call and presentations
- Corporate Announcements
- Company leadership
- Situational, Industrial and Macroeconomic Factors
-Micheal Porter's five forces
Quantitative Parameters
- Profit and Loss Accounts
- Cash Flows
- Notes to Accounts
- Financial Ratios
Such parameters provide a detailed view of the financial strength and growth prospects of a company.
Why is Fundamental Analysis Necessary?
It is very important to know the intrinsic value of the company that you want to invest in. The market value of a company is very different from its intrinsic value. Calculating its intrinsic value helps to identify whether the company is overvalued or undervalued.
Fundamentals provide a basis to develop confidence and trust in the company. A fundamentally strong company is bound to show growth in the long run. However, a weak company may do well in the short run but has very low growth prospects in the long run.
For example, during the 2008 financial crisis, all the major banks were overperforming at the stock market and providing returns like never before. This showed a very positive picture of the market which led to a pool of new investors investing in real estate and bank stocks. However, there were analysts who dug deeper into the financials of banks to realize that most of the mortgage-backed securities were way too risky and did not have proper collateral in place. Hence, such a fundamental analysis of companies helped analysts to predict the stock market crash well in advance.
How to analyze a company on the basis of fundamentals?
Fundamental Analysis is a wide subject and cannot be explained in detail in only one blog post. In order to know more about how to read the financial statements, dig for information, target price analysis, etc. we will soon be updating our blog with tutorials and reports.
Stay tuned for more updates on fundamental analysis.
P.S. intrinsic value refers to an investor's perception of the inherent value of an asset, such as a company, stock, option, or real estate.
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