The major impetus for people venturing into stock market investment is to generate wealth. Most of us tend to have financial goals be it long term financial goals like buying a dream house or retirement goals or short term goals like going for a vacation. All these require funds and that’s where stock market investment comes as a viable solution. They help you generate that wealth in the long run so that you can meet your goals.
But the stock market in itself is dynamic and ever-changing and hence you need to know about the stocks you’re going to invest in. When you have a clear picture of the stocks only then you can invest in them with a peace of mind. This is where the fundamental analysis of stocks can help you.
What is the fundamental analysis of stocks?
Fundamental analysis refers to the process of looking at the company or the business at its basic fundamental level. With fundamental analysis, you study the macro to micro-economic factors and measure the effectiveness of the company. This helps form an opinion on the financial health of the company and find out more about the actual financial conditions of them. This gives insight into whether the stock of the company is undervalued or overvalued giving you an opportunity to stake claims on the right opportunity. Fundamental analysis is not only limited to stocks but can also be used for bonds and derivatives.
Why should you perform fundamental analysis of a company’s stock?
When it comes to investing in stocks of a company there are plenty of queries that arise in our mind. It’s pretty normal to have those queries as you’d be investing your hard-earned money in the market and everybody seeks some sort of assurance for it. For say, you may have queries regarding whether the company is making the right decisions towards its future goals or not. It is of utter importance that a company is on the path of the right direction as that severely affects the value of the company in the market. You’d want to invest in a company that tends to increase in value with time.
Another important factor is whether the company is taking the right care of its employees or not? The onus is that only if the company is taking the right care of its employees can it take the right care of its shareholders. Similarly, you may have reservations about the product and services of the company and would want to know in detail about these. The economic moat showcases whether the company stands a chance to cater to the masses and build a ground for itself in the market in the long run. All these thoughts and reservations are why fundamental analysis for investors is important.
Fundamental analysis of a company helps you to know whether the investment is a good deal to opt for or not, whether the financials of the company showcase the right direction or not. It seeks the intrinsic value of the share and provides a comparative to whether the shares are undervalued or overvalued.
How to perform fundamental analysis of stocks?
Fundamental analysis takes into consideration the factors that affect the economy of the company. There are two ways you can perform the fundamental analysis of stocks as (i) Quantitative Analysis and (ii) Qualitative Analysis. The quantitative analysis looks at the aspect of hard numbers which allows you to measure different components like revenue, profits, and assets with precision while the qualitative analysis looks at the aspect of checking out the brand name recognition, proprietary technology, patents, company’s key executives and more.
We here will look at the steps by which you can learn fundamental analysis of stocks and use it to your advantage. Read along.
Start by having a look at the company
The first step when it comes to fundamental analysis is to take a hard look at the company. You should start by seeing the business model of the company and the way its revenue is generated. Seek the basis on whether their model can last for the long haul as only a company with a future trajectory can help provide wealth generation options. When it comes to fundamental analysis for investors, they also tend to cast an eye to the management as that will showcase a good deal of information on whether you should invest in the company or not.
Take a look at the financial statements of the company
Next up you can take a look at the financial statements of the company as it will provide the hard numbers that will define whether the company truly exists on the good line or not. Take a look at the balance sheet, income statement, and cash flow statement. The balance sheet will help you to have a look at the company’s assets and liabilities while the income statement will define the company’s sources of income and expenses. The cash flow statement will showcase the level of cash flow of the company during a certain period of time. These three statements will paint a complete picture of the company’s financial work.
Check the financial ratios
Financial ratios are of the best ways to foresee a company and its financial status. They are a pretty powerful thing and something that even the likes of Benjamin Graham, ‘The Father of Value Investing’ endorsed. Financial ratios alone may not depict the full picture when you put it into use in tandem with the comparative ratios from other companies in the industries, a fuller picture will come forth. Here are some of the financial ratios that you can use for:
- Liquidity Ratios: Liquidity ratios are one of the major ways to find out about the financial status of the company. It showcases the liquid assets of the company and its ability to convert the assets into cash as and when required for. There are two ratios you can opt for under liquidity ratios as (1) Current Ratio: Current Assets/ Current Liabilities (2) Quick Ratio: Quick assets/ Current liabilities
- Profitability ratios: This aspect looks at the financial performance of the company and showcases efficiency about the company and its operation model. Here are some of the profitability ratios: (1) EBITDA Margin: EBITDA/ Total Revenue (EBITDA stands for Earnings before Interest, taxes, depreciation, and amortization) (2) Return on Equity: Net Profit/ Shareholder’s fund * 100 (3) Return on Capital Employed: Profit before Interest & Taxes/ Capital Employed
- Price to Earnings Ratio (P/E Ratio): P/E Ratio looks at the company’s current share price upon earnings per share.
- Price to sales ratio (P/S): This ratio looks at the company’s stock price upon its revenue.
Fundamental analysis of the stocks is an important aspect that every potential investor should conduct if they want to invest in the market with the assurance of generating wealth. The market is often dynamic in nature but if we do our homework then there are plenty of good deals to be found. Fundamental analysis helps to provide that opportunity to find whether investing in the said company is right or wrong.