Introduction to Fundamental Analysis

Many people invest in stocks. But not many are aware of whether they are buying stock at the right price or not. This is where fundamental analysis comes into the picture. Fundamental analysis helps you understand whether it's worth buying the stock at the current market price or not. It helps you understand the true worth of stock on the basis of the company’s financial health, market scenario, and economic conditions.

If you want to invest for the long term, then you have to analyse the company’s performance in various aspects. You can do this with the help of fundamental analysis basics. In this blog, we will study in detail about fundamental analysis. But first, let’s understand what fundamental analysis is.

What is Fundamental Analysis?

Fundamental Analysis is a method used to determine the intrinsic value of a stock by examining the financial and economic factors. Here, you don’t track daily stock movements but focus on studying the underlying business of the company.

Fundamental analysis helps investors understand whether the stock is undervalued, overvalued, or fairly priced. The fundamental analysis basics include studying the company’s financial statements, i.e., income statement, balance sheet, and cash flow statement. These help in determining important details like revenue growth, profit margin, debt level, etc.

Apart from numbers, fundamental analysis also considers qualitative factors. This includes the company’s management quality, brand strength, competitive strength, and future growth aspects. Fundamental analysis is useful for long-term investors who aim to build wealth.

What are the Different Types of Fundamental Analysis?

Fundamental analysis is divided into two main categories, i.e., Quantitative Analysis and Qualitative Analysis. Quantitative analysis makes use of statistical methods to analyse financial data and identify investment opportunities. Qualitative analysis, on the other hand, refers to the non-quantifiable data. It takes into consideration various qualitative factors, such as management quality or brand reputation, that can impact the company’s performance.

Key Components of Fundamental Analysis

There are three major components of Fundamental Analysis: -

Economic Analysis

Analysing various economic factors is an important part of fundamental analysis. Here, various factors are taken into consideration that impact the micro as well as macro-economic environment. Some of the key factors taken into consideration for economic analysis are Gross Domestic Product (GDP), interest rates, trade policies, and monetary policies. External factors like government policies, geopolitical events, and taxes are also considered.

Industry Analysis

The industry analysis requires you to analyse the performance of a particular industry. When you research the industry, you should take into consideration its past performance, current situation, and future trajectory. Industry analysis also includes identifying major players, areas of growth, and key risk factors that impact the industry.

Company Analysis

The company’s financial performance is analysed through its financial statements and ratios. It also includes the analysis of qualitative factors like the company’s competitive edge, management ethics, and governance. Here, the major goal is to understand if the company is able to generate sustainable earnings in the long term or not.

How to do Fundamental Analysis of a Stock?

Fundamental Analysis helps you understand the true value of a company by examining various factors. If you are still worried about how to do fundamental analysis of a stock, then here are the steps that you need to follow: -

1. Understand the Company

Firstly, you will have to start with understanding the company. For this, you must learn about the business model, management structure, and industry position.

2. Check Economic Factors

Take into consideration the GDP growth of the country, inflation rates, and industry trends that can impact the company.

3. Study Financial Statements

Start studying the financial statements of the company. You can do this by analysing the company's income statement, balance sheet and cashflow statement. Look for defining trends in revenue, expenses, profit, assets, and liabilities. Cash flow analysis will reveal how efficiently cash is used in the business, which is very important to sustain operations.

4. Calculate Key Ratios

Make use of financial ratios like P/E Ratio (Price to earnings), EPS (earnings per share), ROE (return on equity), and D/E (debt-to-equity). This helps in assessing the company’s financial health.

5. Analyse the Annual Reports

Firstly, you need to read the CEO's letter carefully. This will make you familiar with the company's vision, priorities and leadership mindset. Also, review the business description to understand how the company is making money. Finally, you need to study the Management’s Discussion and Analysis (MD&A) to gain deeper insights.

For this, you can start by reading the CEO’s letter. You shall review the business description and also understand the Management’s Discussion and Analysis (MD&A) Section.

6. Analyse Competitive Advantage

To understand a company’s competitive advanatge, you will need to analyse how it differs from its competitors in terms of product, pricing, brand value, cost efficiency, etc. A SWOT analysis can help you how to evaluate a company. Identify the company's Strengths (loyal customers, strong brand), Weaknesses (high costs), Opportunities (industry growth, innovation), and Threats (intense competition, regulations).

7. Check the Debt levels

Check how much debt the company has and compare it with its competitors. When a company has too much bad debt on its balance sheet, it is not a good sign.

8. Consider Future Prospects

Analyse how much growth potential and market opportunities the company has.

9. Check Economic Factors

Take into consideration the GDP growth of the country, inflation rates, and industry trends that can impact the company.

10. Review On a Regular Basis

Monitor the company's performance and update your analysis on a regular basis.

Tools for Fundamental Analysis

In order to conduct fundamental analysis, one needs the right tools. These tools will provide deeper insights into the company’s finances and its market position. Here are the major resources that you can use: -

Financial Databases

Financial databases are a great source of information. It gives you quick access to the company’s data and market trends. Some of the popular ones are Yahoo Finance, Google Finance, Bloomberg, etc. Through this database, you can find important numbers like Earnings per share (EPS) and Price -to-Earnings Ratio (P/E).

Annual Reports

Annual reports of the company help you understand the company better. One can think of it as a kind of report card for the company. In this report, you can look for Chairman’s Message, Business Description, Risk Factors, MD&A, etc. These reports can help you identify unusual risks and/or legal issues.

Industry Publications & Brokerage Reports

Industry publications, trade journals and brokerage research reports will give you valuable insights about industry trends, competitive landscape and technological changes. Brokerage reports add depth by offering earnings forecasts, valuations and expert analysis. All these sources can help you derive a company's current position and future growth potential.

Conclusion

Fundamental analysis serves as a strong foundation to make informed and confident investment decisions. It makes investors focus on the company’s real financial health, business model, and long-term growth potential. By studying a company’s revenues, expenses, assets, and liabilities, investors get a clear picture of the stock’s true worth.