In today’s fast-paced business world, companies are constantly striving to achieve higher valuations to stand out from their competition. The race for high valuations is intense, and it has become difficult for investors like you and me to understand the true valuation of a business.
So, how can we determine a company’s intrinsic value?
Don’t worry, here’s where fundamental analysis comes into play!!!
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What is Fundamental Analysis?
Fundamental analysis is like going on a treasure hunt for hidden gems in the stock market. Imagine sifting through financial statements, industry trends, and economic conditions in search of that rare diamond in the rock that has the potential for exponential growth.
In simple terms, fundamental analysis is a method used for understanding the true value, i.e., the intrinsic value, of a company. This method uses various factors to determine the worth of a stock. Investors need to have a deep understanding of fundamental analysis to be able to find that rare diamond in the stock market.
Fundamental analysis is used not only for understanding a company’s intrinsic value but also for various factors like its financial position, industry overview, etc.
Let’s understand each in detail:
1. Helps understand the financial position of a company.
Understanding the financial position of a company is crucial for investing. When analyzing a company, we generally evaluate several financial ratios to understand the profitability and sustainability of the business. This helps us make informed decisions about buying and selling stocks.
When doing fundamental analysis, we also need to check on the competitors, which will help us identify the true financial value of the business compared to its competitors.
2. Helps Understand the Industry
Fundamental analysis is not limited to companies. We also analyze the industry to which the company belongs. For instance, when analyzing a pharma company like Zydus Lifesciences Ltd., we also need to analyze the industry trends of the pharmaceutical industry. In this manner, we get an overview of the industry and can analyze the stocks accordingly.
But why is industry analysis important?
Let’s understand this with an example of the hospitality industry. Before COVID hit India, the industry was performing exponentially well, as were the stocks of the industry. However, the lockdown and COVID crises had a severe impact on the industry, which also affected the growth of companies like Oyo and IHCL.
Hence, industry analysis is a crucial part of fundamental analysis.
3. Helps find undervalued stocks
As investors, we are all constantly looking for undervalued stocks in growing industries. And since fundamental analysis is a game of valuation, it can make our work easy.
Once we have identified the true value of the company, we can then easily determine whether it’s undervalued or overvalued. If the market price is significantly lower than the true value, the investment may be considered undervalued. On the other hand, if the market price is significantly higher than the true value, the company may be considered overvalued.
However, whether undervalued or overvalued, it’s important to do further research and due diligence for better decisions making.
4. Helps Understand the Economy
Economy analysis is an important and the very first step of fundamental analysis. We need to understand the overall economic conditions of a country or region where the company operates before investing. This includes factors such as gross domestic product (GDP), inflation, and interest rates, as these can have a significant impact on a company’s revenue and profitability. We also need to consider whether the government’s actions are in favor of or against the industry.
For instance, government schemes like the FAME policy support the EV (electric vehicle) industry, whereas the tax policies for capital gains on cryptocurrencies are significantly affecting the crypto market in India.
Types of Fundamental Analysis
Fundamental analysis can be mainly divided into two types: qualitative analysis and quantitative analysis.
The qualitative analysis mainly focuses on the non-financial attributes of a business. This mainly includes the brand value, goodwill of the company, customer loyalty, customer feedback, etc. It also evaluates whether the management is able to run the business efficiently or not. We can identify the long-term sustainability of a company using qualitative analysis.
Quantitative analysis mainly uses numerical data to evaluate a business. This includes financial ratios like return on investment (ROI), P/E ratio, etc. As we are using financial ratios, this type of analysis helps us understand the financial position of the business and determine whether a company is undervalued or overvalued.
So, what type of analysis of more important?
Here’s a thing to remember both qualitative and quantitative analysis is important to make an informed investment decision. While quantitative analysis provides a more objective and data-driven approach, qualitative analysis allows investors to understand the management, industry trends, and other factors that could impact the company’s future performance.
Does fundamental Analysis work?
Many new-age investors and traders believe fundamental analysis is outdated. However, here’s something to remember: to understand a company’s true intrinsic value, fundamental analysis is the best approach. Though it’s time-consuming and requires a lot of effort, the outcomes are valuable if implemented correctly.
As discussed before, fundamental analysis provides us with key insights into the market and helps us understand industry trends. This can enable us to analyze several stocks in the industry and make a wise investment decision with proper analysis.