How to Do Fundamental analysis of a company? 5 Best Ways

Imagine you’re standing in front of a crowded marketplace, filled with vendors calling out for your attention. You’re not quite sure where to start – there are so many options, each with their own promises of riches and prosperity. This is what it can feel like to invest in the stock market, especially if you’re new to the game.

But fear not! Fundamental analysis is like a trusted guide that can help you navigate through the maze of choices and choose companies that meets your criteria and delivers profitable return on investment.

In this blog, we’ll take a closer look at how to do fundamental analysis step-by-step, so that you can confidently navigate the stock market and achieve your financial goals. So, let’s begin our journey toward becoming a smart investors!

Reviewing the Financial Statements

Reviewing a company’s financial statements is an essential part of conducting fundamental analysis. The financial statements provide in dept analysis of a company’s financial health and position, which can help you assess its intrinsic value and make informed investment decisions. The key financial statements to review are the income statement, balance sheet, and cash flow statement. Let’s understand each in detail:

Income Statement

The income statement provides a snapshot of a company’s profitability over a specific period, such as a quarter or a year. It shows how much revenue a company has generated, the expenses it has incurred to generate that revenue, and its resulting net income or loss.

By breaking down revenue and expenses into specific categories, such as sales revenue, cost of goods sold, and operating expenses, the income statement helps you gain insight into the company’s financial performance and identify trends and areas of strength or weakness.

Furthermore, analyzing the income statement can provide you with valuable information to evaluate a company’s profitability over time and compare it to its competitors. This information can help you make informed decisions about whether to invest in a particular company.

Here’s how a income statement looks:

This is an Income Statement of Tata Consultancy Services LTD which is a top IT company globally and is a part of the Tata group.

Balance Sheet

Balance Sheet is a crucial Financial Statement to analyze when doing company analysis as a part of fundamental analysis. It shows us what the company owns (assets), what it owes (liabilities), and what’s left over for shareholders (equity).

Assets refer to the resources that a company owns or controls and can include items such as cash, investments, accounts receivable, and property. Liabilities represent the company’s obligations or debts to creditors and can include items such as accounts payable, loans, and taxes payable.

By analyzing the balance sheet, you can determine the company’s ability to meet its financial obligations, assess its liquidity and solvency, and identify its sources of capital.

Furthermore, comparing the company’s balance sheets over time can provide insight into its financial performance and growth trajectory. By tracking changes in assets, liabilities, and equity, you can identify trends, evaluate financial decisions, and make informed investment decisions.

Here’s the balance sheet of TCS to help you understand it better:

Cashflow Statement

The cash flow statement tracks the inflow and outflow of cash in a business over a specific period of time. It is divided into three sections: operating, investing, and financing activities.

The operating section of the cash flow statement shows us how much cash a company has generated or used in its day-to-day operations. It reflects the inflows and outflows of cash from a company’s core business activities, such as sales, purchases, and payments to suppliers and employees.

The investing section shows us how much cash the company has spent or received from buying or selling its assets, such as property, plants, and equipment. The financing section shows us how much cash the company has received or paid for its financing activities, such as issuing or repurchasing stock or paying dividends.

When delving into the details of the cash flow statement, you can uncover a lot about a company’s ethics and financial reporting practices. It can reveal whether the company is presenting an accurate picture of its financial performance or trying to manipulate its income statement to show inflated revenues, where their reported sales and revenue don’t align with their actual cash inflows.

By looking at the actual cash inflows and outflows, you can gain a better understanding of a company’s liquidity and its ability to meet its financial obligations. Ultimately, analyzing the cash flow statement is a crucial step in evaluating a company’s financial health and making informed investment decisions.

Here’s the cashflow statement of TCS.

Examine Company’s Management

Examining a company’s management is a crucial part of company analysis. It involves evaluating the skills, experience, and integrity of the management team responsible for driving the company’s operations and growth.

One way to assess the management team is by reviewing their track record of achieving business objectives, implementing effective strategies, and creating shareholder value. You can also examine their experience in the industry and their ability to adapt to changing market conditions.

As the world rapidly evolves, it is crucial for companies to adapt to changing demands and trends in their respective industries. A prime example of this is Nokia, which failed to pivot its business strategy and adapt to the rising popularity of smartphones, ultimately losing its position as a leading phone brand.

In addition to a company’s ability to adapt, it is also important to consider the political and legal background of its management. This includes evaluating their understanding of regulatory environments and their ability to navigate complex legal frameworks. A management team with a strong grasp of the political and legal landscape can effectively manage risks and capitalize on opportunities.

Other factors to consider when analyzing a company’s management include their financial acumen, leadership style, and their ability to attract and retain top talent. Ultimately, a strong and competent management team is a critical component of a company’s success, and their performance should be thoroughly evaluated when making investment decisions.

Company’s Valuation

Evaluating a company’s valuation is like peeling back the layers of an onion – it reveals the true essence of the company. It refers to the process of determining the true value of a company, based on its financial performance, assets, liabilities, and market conditions.

There are several methods for valuing a company, including discounted cash flow (DCF) analysis, price-to-earnings (P/E) ratios, and price-to-book (P/B) ratios. DCF analysis involves forecasting a company’s future cash flows and discounting them back to their present value, while P/E and P/B ratios compare a company’s current market price to its earnings or book value.

It’s also important to consider external factors that can impact a company’s valuation, such as economic conditions, industry trends, and competitive landscape. Additionally, a company’s valuation can be influenced by its growth potential, management team, and overall reputation in the market.

By evaluating a company’s valuation, you can make informed decisions about whether a company is overvalued or undervalued and determine the potential return on investment. Valuation is the most essential component of company analysis that should be thoroughly researched and analyzed.

Financial Ratios

In the world of investing, analyzing a company’s financial health is crucial to making informed decisions. One effective way to do this is by examining financial ratios, which provide insight into a company’s performance and potential for growth. Financial ratios can reveal important information such as profitability, liquidity, debt levels, and efficiency.

There are many financial ratios that can be calculated, including liquidity ratios, profitability ratios, efficiency ratios, and leverage ratios. Liquidity ratios help assess a company’s ability to meet short-term financial obligations, while profitability ratios measure a company’s ability to generate profits. Efficiency ratios assess how well a company uses its resources to generate revenue, and leverage ratios evaluate a company’s debt and financial leverage.

Ratios like the current ratio, debt-to-equity ratio, and return on equity can help investors evaluate a company’s financial stability, while the gross profit margin and operating profit margin can provide insight into its profitability. By analyzing these ratios, investors can gain a better understanding of a company’s financial position and make informed decisions about potential investments.

Growth Prospects

What we’ve been discussing so far is crucial in analyzing a company’s growth prospects. By evaluating a company’s management, financial ratios, and valuation, you can gain valuable insights into its potential for future growth. However, there are other factors to consider as well.

Additionally, assessing a company’s market position, competitive landscape, and growth strategy can help to identify opportunities for expansion and revenue growth.

Understanding a company’s growth prospects is essential in determining its long-term viability and potential for profitability. Examining a company’s customer base and their satisfaction can also provide insight into potential areas for improvement and growth.

Company Analysis

In a world where the stock market can feel like a maze of numbers and buzzwords, fundamental analysis is like a compass that helps you navigate towards the true value of a company.

By reviewing financial statements, diving deep into management practices, and analyzing growth prospects, you can gain a real understanding of what makes a company tick. It’s like peeling back the layers of a company to reveal its true essence.

But it’s not just about the numbers. Fundamental analysis is about getting to know a company’s story, its strengths and weaknesses, and how it fits into the wider economic landscape. It’s about looking beyond the surface level and getting a real sense of what makes a company unique.

Of course, it’s not a one-size-fits-all approach. You need to tailor your analysis to the specific industry and company you’re evaluating and keep an eye on external factors that could impact its performance. But with a rigorous approach to fundamental analysis, you can increase your chances of making smart investments that will pay off in the long run.

So, if you’re looking to navigate the stock market with confidence, make fundamental analysis your compass, and let it guide you towards the investments that will help you achieve your financial goals.