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What is fundamental analysis in equity investing

ICICI Securities 16 Apr 2021 0 COMMENT

Equity investing could be easy and rewarding if you do your analysis right. How do you decide what stock you want to buy or sell? And most importantly, how do you know if the value of the stock is appropriate? Many factors affect the price of a stock, of which the fundamentals of the company are most crucial.

The intrinsic value of a company’s stock can be measured through fundamental analysis.

Let us first understand what is Fundamental Analysis:

Fundamental analysis is the method of measuring the intrinsic value of a stock to determine whether a stock is valued correctly in the market.

Fundamental analysts carry out the analysis by observing the financial statements, valuation ratio and other qualitative parameters. This is mainly done to find the intrinsic value and a long-term valuation of a stock. However, that’s not all, as fundamental analysis also involves analysing non-financial data like management, industry outlook, government policies, etc.

Factors considered in the process of Fundamental Analysis

Fundamental analysis involves understanding three broad spheres - Economy, industry, and company-specific factors. Economic factors include current economic phase, various economic indicators like interest rate, GDP growth rate, etc. Industry and company-specific factors considered during fundamental analysis include technological development, management and leadership, availability of cash-flow, optimal utilization of resources and other necessary financial parameters

Economic, Industry and company-specific factors can be further classified as Qualitative and Quantitative Factors. Here’s the meaning of the two factors:

Qualitative Factors

Qualitative factors are “fundamentals that cannot be quantified”. It is the analysis of intangible elements such as the quality of the management of the company, their reputation in the market, their business model, corporate governance, etc. These characteristics are highly subjective but are equally critical in helping companies achieve their underlying potential.

Quantitative Factors

Any factor that can be measured with numbers is referred to as a quantitative factor. Quantitative factors mostly deal with financial performances and other business metrics. It involves analysis of financial statements, competition, industry growth, market penetration, among other parameters.

These factors, together with qualitative analysis can give investors a full insight into the anticipated worth of the company in the near future.

Fundamental analysis is one of the two significant methods of market analysis, with the other one being “Technical Analysis.”

Technical Analysis vs. Fundamental Analysis

  • Fundamental analysis is used to identify the intrinsic value of a stock. In contrast, technical analysis is often carried out to identify the right time for entering or exiting the market.
  • Fundamental analysis is usually recommended to a long-term position trader, whereas technical analysis is appropriate for a swing trader or a short-term trader.
  • While technical analysis only analyses the past data, fundamental analysis focuses on both past and future growth prospects.
  • Fundamental analysts predict the future price of a stock based on profitability and the company’s performance in the future. On the other hand, technical analysts predict the future value based on stock charts that helps in identifying patterns and trends, suggesting how the stock could move in the near future.

Benefits of Fundamental analysis

Fundamental analysis is a vital tool that should be used before investing in equity.

The analysis helps investors develop a thorough understanding of the nature of the company’s business. Investors realize the critical revenue and profit drivers behind a company and can better evaluate its relevance in the future. Furthermore, the fundamental analysis provides a long-term view of the market rather than just establishing entry and exit points, as this analysis seeks to assess the value of an asset.

As an investor, one need not become an expert in fundamental analysis. Majority of good broking houses have Research Analysts who research and value stocks basis fundamental analysis. It helps to review and understand these reports before taking a decision. A knowledge about fundamental analysis help in better understanding such reports and stock valuations.

You can reach out to experts or study yourself for more information on fundamental analysis and how it works.

Disclaimer: ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470. I-Sec is a SEBI registered Research Analyst having registration no. INH000000990 . The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon.