With thousands of companies listed on stock exchanges, how should you decide which ones to invest in? To begin with, there will be a few names that you would have in mind. Then there is the market-cap-based classification to help you narrow down the choices. You will look at the trading volume of the stock, its historical performance, the financials, etc. and also hear what your friends and analysts have to say about it.
When you study a stock for investment purposes, there are two broad methods you can apply – technical analysis and fundamental analysis. Technical analysis is the use of statistical tools and data to analyze a stock.
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Fundamental analysis is a study of the financial and economic aspects that affect a company's stock and business. It is a well-rounded approach that considers the qualitative as well as quantitative factors affecting the stock.
Fundamental analysis is used to estimate the intrinsic or fair value of the security. You can find out if the stock is presently trading at a fair price and how can the price move in the future. It also uses important financial and economic indicators to assess the company’s business and financial health. The management style, growth prospects, strengths and weaknesses, etc. can be estimated by using fundamental analysis.
As explained, fundamental analysis is a combination of macroeconomic factors like the economy, the industry, the company’s market, etc. and micro-economic factors like the company’s financials, management, management style, etc. Accordingly, fundamental analysis is done through qualitative analysis and quantitative analysis.
Qualitative analysis – It analyses the broader dynamics around the stock. The reputation of the company, its market presence and size, competitor’s analysis, consumer behaviour, etc. are the factors that are scrutinised as a part of qualitative analysis.
Quantitative analysis – While qualitative analysis looks into the subjective aspects, a quantitative analysis considers the measurable indicators of the company. You will be looking into the company’s quarterly results, its balance sheets and income statements, financial ratios and cash flows, debt position and promoter’s holding, etc.
Here are some of the exercises typically carried out as a part of fundamental analysis.
Company analysis – It includes a look at the company’s business and financial performance, the steps it has taken towards business growth, its management, promoters, product lines, subsidiary companies, litigations and operational issues, etc.
Financials – It involves a look at the company’s financial and income statements, cash flow statements, sales performance, profitability and growth in the last few years.
Debt position – Ensuring that the company has a healthy debt-equity ratio is important. A more in-depth look will require a study of the nature of debts, time left for repayment, collaterals attached, the utilisation of the debts, etc.
Competitor analysis – You must also look at the company’s main competitors, their growth in recent years, their future plans, competitive advantage, etc.
To further understand fundamental analysis, a look at its difference from technical analysis helps.
Fundamental analysis gives a complete insight into the company and its stock. It is a recommended exercise for investors who are looking to make long-term investments and earn high returns. Fundamental analysis can help you identify stocks that are undervalued and have the potential to generate high returns over the long term. You can use a CAGR calculator to estimate the returns you could expect from these stocks.
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