Almost everyone today knows about investing in stocks and its potential for financial benefits. However, a major percentage of people who invest in stocks and other money market assets like futures, options, derivatives etc. think of investing as a guessing game where they can make huge profits by guessing the prices and trends correctly. But this assumption is miles away from the actual reality about the stock market and investing. Investing in stock market requires financial aptitude to do the fundamental analysis of the company in which you want to invest. Investing require careful data analysis of the historic trend of price and demand of the company in which you want to invest. A thorough understanding of fundamental analysis will not only help you in understanding the current financial condition of the company but will also help in finding the intrinsic value of the asset in which you are planning to invest.
What is Fundamental Analysis?
Fundamental analysis can be understood as an analysis which is aimed at evaluating the factors which impact the value of a stock. It is an approach which helps in evaluating financial aspects like financial health, liquidity, profitability, solvency, and position with respect to industry peers. Technical analysis is aimed at inspecting previous price movements and trading patterns which gives insights only about the fluctuations of the stock’s price listed in the market. However, it is fundamental analysis of a stock which gives the information whether a stock is overvalued or undervalued with the help of analysis of financial statements and ratios of a company for a particular time period.
Components of Fundamental Analysis
Fundamental analysis is basically divided into analysis of aspects like economic analysis, industry analysis, and company analysis which are covered in qualitative analysis, quantitative analysis, economic and industry analysis. These aspects cover analysis of a company’s financial statements, financial ratios, and economic analysis of sector to gain insights about valuation, profitability and liquidity, and solvency.
Let us dive deep to understand these analytic aspects and their impact in decision making in investing.
- Qualitative Analysis
Qualitative analysis involves evaluating the non-numeric aspects of a company, such as:
- Management Team: Leadership plays an important in success of any company and sustainability. Its experience and vision of the leadership of a company which drives a company forward towards success. Hence it becomes crucial to analyse the track record, expertise and strategic excellence of a company’s executives and leadership.
- Business Model: Understanding business model is a crucial aspect in qualitative analysis of a company as a business model is a reflection of a company’s revenue streams, targeted market, and competitive edge. Companies which have strong brands or patented technologies usually have higher possibility of succeeding in the market.
- Industry and Market Position: Market position is an important indicator of a company’s competitive stance in the industry with respects to its peers. Market position of a company is also an excellent indicator of a company’s profitability as a company with a better market position with respect to its competitors will have a larger customer base and hence will be a better investment as compared to a company which is struggling in the market.
2. Quantitative Analysis
Quantitative analysis includes the analysis of a company’s financial data which is numerical analysis of a company’s various financial statements like income statement, balance sheet, and cash flow statement. Quantitative analysis helps in making strategic decisions about investments.
- Income Statement: Income statement helps in providing insights about a company’s revenue, expenses and profits in a specific time frame. These insights help in evaluating various metrics like revenue growth, net profit margin and earnings per share which are essential in evaluating profitability of the investment decision.
- Balance Sheet: Income statement is linked with the aspect of profitability. But we know making an investment in some company requires more than just insights about the aspect of profitability. An excellent source of insights regarding the financial stability and liquidity is its balance sheet. Balance sheet of a business for a specific period provides information about a company’s assets, liabilities, and equity. The information provided by a company’s balance sheet is helpful in evaluating ratios like debt-to-equity ratio and current ratio which enables the investors to gain complete knowledge about a company’s financial stability and liquidity.
- Cash Flow Statement: A company which is generating cash flow will be able to generate profit and pay its shareholders. We can clearly observe the correlation between the ability of a company to pay its shareholders and its ability to generate cash flows. This information can be found in a company’s cash flow statement which is an indicator of the ability to generate cash from its operations with present assets.
3. Economic and Industry Analysis
A majority of population of investors aim at maximizing profits which is not a bad practice but their strategies collapse with changes in the economy. The ability to speculate the impact the changes in the macroeconomic factors helps in adjusting the investment portfolio and reduces the risk of loss with the investment.
- Macroeconomic Factors: Every company comes under a sector and every sector is impacted by variations in the economy. Macroeconomics of a country deals with factors like interest rates, GDP, inflation etc. These factors can have positive or negative impacts on the business and hence on the stock prices of a company. A growth in GDP of an economy means increasing income and spending capability and hence push a retail company’s growth whereas a declining economy with higher interest rates can impact a company’s stock price negatively. A careful analysis of these factors can help an investor in deciding investment strategy and position related to stocks.
- Industry Trends: Impact of changes in economy on various sectors is similar to changes in productions of various crops with variation in rainfall, where production of some crops will decrease and some will increase. In a similar manner different industries give different response to changes in economy. Understanding these trends can help investors in adjusting their investment portfolios by reallocating the funds in sectors which are expected to grow due to the changes in economy.
Conclusion
Having a deep understanding of fundamental analysis can definitely provide you a strategic edge in making investments. By systematic analysis of quantitative, qualitative, economic factors, and industrial trends you can create a robust and stable portfolio which will not only provide substantial gains as per your financial goals but will also provide safety against the economic variations.
