Fundamental Analysis

Fundamental analysis is a method to determine the health of the financial statements and focuses on the strengths and weaknesses of the underlying company and is unconcerned about daily price movements and volume variations.

What is fundamental analysis of stocks?

It is a method in which analysis of past records of assets, earnings, products, sales, management, markets and law concerning the production and distribution of goods and services of the company is done to predict future trends in these indicators, which in turn affect a company's future.

With this a company's intrinsic value is estimated and compared with the probable future value to determine whether its present share price is undervalued or overvalued.

Fundamental Analysts buy undervalued stock and sell them when they become overvalued.

If your trading style is long term investment, that is buy and hold or value investing, select your stocks by doing a fundamental analysis of the company.

How do you do it?

  • Get the answers to these questions.
  • What company is it?
  • What product do they make or what services do they give?
  • Is there growing demand for their products and services?
  • Who are their competitors?
  • How efficient are they?
  • How good is the management?
  • What is their share of capital? Is the capital mostly borrowed money or share holders money?
  • Are they honest enough to give real numbers in their financial statements?
  • Are they spending more than normal for administration and remuneration?
  • How healthy is their balance sheet?
  • What is their EPS and PE ratio?
  • What is their net worth?
  • How is the dividend record?
  • Is the political condition favorable to the company?
  • How does the import/export law affects them?
  • Etc; etc; etc;

If you get answers for all these questions, then you are doing fundamental analysis.

Based on the latest information, if the answers that you get are conducive and positive, then you may invest in that company.

The point is to find a good company which has high return on capital and high earnings yield, and buy them at bargain price. In other words buy undervalued companies which have high intrinsic value.

This point is very humorously simplified in The Little Book That Still Beats the Market (Little Books. Big Profits) written by Joel Greenblatt

'Getting Started In Value Investing' is a book written by Charles S.Mizrahi in 2007. This is a very simple but highly informative book on Value Investing. Click the link to know the details of the book.

I also suggest you to read, “The Intelligent Investor” by Benjamin Graham, Jason Zweig, and Warren E. Buffett

What are the limitations of fundamental analysis?

Forecast of future market price depends on forecast of future fundamental indicators, which depends on the forecast of present fundamental indicators, which depends on the data provided by the company, which you receive late and which may not be 100% true.

The perception and estimation of a data varies from person to person. PE ratio of 15 may be good as per one analyst and it may not be good as per another analyst.

Since this process involves huge and varieties of data, only big companies can afford it. For a small investor it is not worth the time. By the time you get all the relevant data, it is already old and the market has already reacted to it.

Company owners, CEOs, directors and their relatives and friends have first access to the company information. If something good is happening in the company all the above people are already accumulating the stock. Similarly these are the people who dump their stock first in case of any adversity in the company.

I and you will always be late comers to enter the market by fundamental analysis. Many times by the time we complete the analysis, major portion of the reaction is already over or a little is left for us. Many times we will help them to buy back their shares or unload their accumulated stock.

Many of you might have already experienced the following. After a company's result announcement, in spite of good result the price of the stock keeps falling. This is because with the first information all the above insiders would have accumulated a heavy quantity of stock which will be distributed to the late coming buyers.

Reverse happens with the bad result announcement.

Either you may buy the result of analysis from the big analyst companies or give a big margin.

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