Firstly, Many of the Stock Market Investors might love to know what is Fundamental Analysis. How it actually works. So in this blog, we are going to learn what is Fundamental Analysis and How to Calculate the Fair Value of a Stock using Fundamental Analysis
- Definition of Fundamental Analysis
- Parameters of Fundamental Analysis
- Quantitative and Qualitative Analysis
- Major Ratios of Fundamental Analysis
- How to do Fundamental Analysis
- Advantages and Disadvantages of Fundamental Analysis
Definition of Fundamental Analysis
In short, Fundamental Analysis is a method measuring the intrinsic value of a financial instrument. Moreover, the Performance of the company is examined and the intrinsic value is found. Because in this method, we examine the related economic and financial factors of the financial instrument.
The end goal of this analysis is to know if the financial instrument is undervalued or overvalued. We will be discussing more about the Fundamental Analysis of Stocks.
Usually, Analysts start analyzing the economic factors first. Secondly, analyze the particular industry or sector in which they are interested. Finally they some undervalued and potentially good stocks in that industry and invest in them.
Parameters of Fundamental Analysis
The important part of the fundamental analysis is the Balance Sheet. while doing fundamental analysis, it contains all the assets and liabilities of a company. We will discuss all the important terms in the balance sheet
- Share Holders Funds – These are the funds by the promoters of the company have started the business. The Company Starts with this Core Fund.
- Reserves & Surplus – Money kept aside from the profits is knows as Reserves & Surplus. This term is called other equity. The higher Reserves & Surplus the higher it is better.
- Non-Current Liabilities – The Non-Current Liabilities are paid after a period of one year. Examples are long term bank loans, debentures, etc.,
- Current Liabilities –The Current Liabilities are paid within a period of one year are known as Current Liabilities. Examples are short term bank loans, etc.,
- Non-Current Liabilities – All types of assets which cannot be liquidated within a period of one year are known as Non-Current Liabilities.
- Current Liabilities – All types of assets which can be liquidated within a period of one year are known as Current Liabilities.
- Inventory – It is the variety of items in which the businessman deals with. For example, in the inventory of a garment shop, there are various types of cloths
- Trade Receivable – A Customer from whom the money is to be received for a happened trade is known as Trade Receivable. Normally it occurs when there is a credit sale of goods or services.
- Cash & Cash Equivalent – Cash in Hand, Cash in Bank Account are treated as cash and cash equivalent
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Profit & Loss Statement
It is one of the important parameters in fundamental analysis, it contains all the details about profit and loss of the company
Cash Flow Statement
It includes the free cash in the hands of the company which is free to use, usually, when there are low credit sales there are more chances of high cash flow, here the higher the positive cash flows higher the better, negative cash flow is a bad sign.
Quantitative and Qualitative Analysis
- Economy Analysis – It is part of Quantitative Analysis. The economic factors such as GDP growth, Repo rates are taken into consideration, Cash Reserve ration, Statutory Liquidity Ratio, etc., If all these factors are positive then the whole economic factor is considered as positive
- Industry Analysis – In this part of the analysis, we check the government policies. whether they are in favor of the company or not, if the industry is cyclical or not, where it should be doing its business throughout the year, and also it is important to know in which cycle is the company now, such as whether is it in the birth phase, growth phase, saturation phase or declining phase
- Company Analysis – Here we analyze the past of the company and also its performance and behavior and predict its future performance
- Management Analysis – Here we see the management of the company whether it is doing good or not. Many of the experts believe this as the most important parameter because no matter how luxurious the car is the driver should be good or else the car will be met with an accident.
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Major Ratios in Fundamental Analysis
P/E Ratio – The P/E Ratio means how many times of the earnings of the share you are ready to pay for a particular share. For example, let us take a share which earns 10/- per year and its present value is 200/- then the pe ratio of the share will be 20 means you are ready to pay 20 times of the earnings of the share
EPS – Earnings per share is also one of the important parameters, where we can know how much the share earns in a period of one year.
Book Value – Book value of a share is the value which is in the records of the company, usually, the book value of the shares is lower than their current market price due to demand and supply.
P/B Ratio – Price to Book Value Ratio is how many times of the book value are you ready to pay to buy the share, for example, the book value of the share is 10/- and the current market price of the share 150/- so the price to book value will be 15 because it is trading 15 times more than its book value
Major Ratios (Sector wise)
Banking / NBFC Sector
- We should neglect the debt to equity ratio because their main business model is to make money and lend it
- Operating Cashflows can also be negative in this type of industry
- Moreover, the inventory turnover ratio is irrelevant in this industry.
- We should always see their NPA whether they are rising or decreasing, here lower the NPA is better
- We also should consider the CASA ratio; this is good if the ratio is higher
- Net Interest Margin is also another important ratio, it is good if it is higher.
- In this type of industries, Inventory Turnover Ratio is also important, higher the ratio is higher the better
- Order Book should be checked for the companies in this sector because higher the orders are higher the better.
How to do Fundamental Analysis
Fundamental analysis, as explained previously, gives you the true value of a stock. Firstly, this intrinsic value of a stock is the present value of expected future cash inflows from that stock. Because this is what the process of fundamental analysis results in.
The fair value represents the potential price of a company. If the market value is the same or lower than fair value, then you should buy the stock and wait. Use a fundamental report to get the fair value.
There are 5-6 steps that will be helpful to analyze the fundamentals of a company.
- Understand the company first
- Closely study the financial reports of the company.
- Find the company’s competitors/rivals and study them.
- Use the financial ratios for initial screening
- Analyze the company’s future prospects.
- Check the company’s debt and compare it with rivals.
By studying such fundamental indicators, you begin in a good way.
Advantages of Disadvantages of Fundamental Analysis
The advantages of fundamental analysis
- It is useful for long term investing approach
- Gives a view of the complete financial aspects of a company
The disadvantages of fundamental analysis
- Financial data is required and cannot be analyzed by all
- Involves a lengthy and complex process so patience is key
If you Have Interest in Technical Analysis Click Here
In short, Fundamental Analysis is a method measuring the intrinsic value of a financial instrument. The Performance of the company is calculated and the intrinsic value is found. In this method, moreover, we examine the related economic and financial factors of the financial instrument.
Balance Sheet, Cash Flow Statement, Profit & Loss Statement, and also Ratios are some of the essential parameters of Fundamental Analysis.
Moreover Balance Sheet contains Shareholders Funds, Liabilities and Assets
Profit & Loss Statement has all the details of Profit & Loss of the Company.
The ratios such as P/E, EPS, Book Value and also P/B ratio are considered to be important
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