What is the Fundamental Analysis of Stock and Why it is important? A Complete Guide to understand it better

Analysis of any share is mainly done in two ways namely Fundamental Analysis and Technical Analysis. Since you can select shares by any of these two analyses, sometimes confusion arises about whether to select stocks through both these analyses or to take advantage of any one method to gain profit from the stock market. To reach the final decision, you must know about both methods of analysis. Here in this article we will discuss about the fundamental analysis of any stock or share while the Technical Analysis of stock is already discussed in another blog.


What is the Fundamental Analysis of stock or Shares?

Fundamental analysis is used by investors for selecting the stock for long-term investments. Here, investor research and study the future of any company and how profitable it is based on its business environment and financial performance. By analyzing these aspects, we as an investor will decide whether or not to invest in the shares of that company. In fundamental analysis, the intrinsic value of the stock is calculated or anticipated by evaluating using economic, financial, qualitative, and quantitative factors. 

A detailed study and analysis are done to know about the:

  • The overall economic state of the economy
  • The key strengths of the specific company and the industry
  • The financial performance of the company since years of operation

All these things will be combined to reach a fair market value for the stock.

Tools used in Fundamental Analysis?

While doing the Fundamental Analysis of any stock, there are some important documents that are taken into consideration. And these are Annual Report, Profit and Loss statement, Balance Sheet, and Cash Flow statement. You don’t have to worry because Fundamental Analysis uses publicly available financial data to evaluate the value of an investment. All this information is made available on the official website of the company and on the Stock Exchange website.

What is the Need for Fundamental Analysis

The main objective of doing a fundamental analysis is to evaluate the intrinsic value of the company or stock and compare it with the current market price of the stock, thereby finding if the stock is undervalued or overvalued. The basic need for us while going through this process is to assess the general efficiency and profitability of the company by studying its operations, future growth, and profit-making potential. If the fair market value is lower than the market price, the stock is deemed overvalued, and the recommendation might be not to buy or to sell if the stock is held.

What is the Intrinsic Value of any stock?

Intrinsic value is the anticipated or calculated value of a company, with the help of the process of fundamental analysis. Intrinsic Value includes all the tangible and intangible factors in its calculation. It is also called the real value of the stock and it is not necessarily to be the same as the current market value of that stock. One of the major thinking behind fundamental analysis is that the current price of any stock does not tell about the real or intrinsic value of the company when we are doing analysis with the help of financial data.

Types of Fundamental Analysis

Fundamental analysis is of two types—Qualitative and Quantitative 

Quantitative analysis tries to gauge the important, and quantifiable aspects of the performance of a company. Here the information used in doing this type of analysis can be shown in numbers, figures, ratios, or formulas. Hence the information is converted into various Ratios, and those ratios help us to anticipate the future of the company.

In Qualitative analysis, the quality of the company is checked and quality depends on many factors like the nature of the business, management, legal issues with the company, etc. Sometimes, it is also informally referred to as a Hygiene check of any company.

How to do a Fundamental Analysis of Stocks

Fundamental Analysis is a very wide subject and it is not pure mathematics that can be covered easily. But yes, there are important parameters that we must understand as part of this to proceed with our investment in the stock market:

Must know the ABC of the company

Knowing the ABC of the company means, we must understand about the stock or company in which we are planning to invest. It will make your investment belief stronger in that stock because you will be looking at how the company is performing, and what is the future prospectus of the company. Once you are firm about the performance of the stock and its future growth potential, you can decide whether to invest in that stock or not. It is very easy to do by visiting the official website of the company and reading about its management, financials, etc.  

Financial Reports of the company

Once you are gone through the first step of knowing the ABC of the company, you should start looking for the various financial reports of the company such as balance sheets, profit-loss statements, cash flow statements, operating costs, revenue, expenses, etc. Every company publishes these reports post audit for its investors free of cost and uploads them on their official websites. Alternatively, you can access the reports through the website of the stock exchange like NSE/BSE as well.

You should search for some important financial ratios and numbers like CAGR, Net Profit, and Sales and make your investment decision after looking at these numbers. If compounded annual growth rate (CAGR), and net profit have been increasing for the last 5/10 years, it can be considered a healthy sign for the company.

Check the debt of the company

You must search for the Debt part in the financial sheets of the company because Debt is an important factor that can drag down a company’s performance. A company cannot do well and reward you as an investor if it has a huge debt of its own. It is highly recommended that you should avoid such companies having huge debt. Always try to find a company to invest in which has a debt: equity ratio should be of less than 1.

Who are the competitors

In today’s world, if you have to sustain then you have to compete. Competition is huge in every domain and to grow in the future, you should remain ahead of your competitors.  So, the company you select for investment must be one of the best among its peers. Find a company that is performing better than the other companies. 

What is the future of the company?

Nobody wants to lose money in the stock market and it is the same for investors and companies. No, any company wants to remain an underperformer and create negative profits. Fundamental analysis is an effective tool or method when you are selecting a stock for long-term investment. Invest in those companies whose products and services will still be useful over a period of time in the future.

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The Bottom Line

Fundamental analysis is a method used to find out whether a stock is over- or undervalued by the market. It takes various factors like the financial ratios, competition among the market, industry and its future potential, and the company’s conditions into consideration. If you are a long-term investor, then you must know how to check the fundamentals of the company. But, if you are a short-term investor, then Technical Analysis of stocks is there to help you.

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