A complete guide to the basics of fundamental analysis!
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Fundamental analysis is a stock valuation method that uses financial and
economic analysis to predict the movement of stock prices.
The fundamental information that is analyzed can include a company's
financial reports, and non-financial information such as estimates of the
growth of demand for products sold by the company, industry comparisons,
and economy-wide changes, changes in government policies etc..
General Strategy
To a fundamentalist, the market price of a stock tends to move towards it's
http://www.indiahowto.com/basics-fundamental-analysis.html 27/04/2010
A complete guide to the basics of fundamental analysis! Page 2 of 5
“real value” or “intrinsic value”. If the “intrinsic/real value” of a stock is
above the current market price, the investor would purchase the stock
because he knows that the stock price would rise and move towards its
“intrinsic or real value”
If the intrinsic value of a stock was below the market price, the investor
would sell the stock because he knows that the stock price is going to fall
and come closer to its intrinsic value.
All this seems simple. Now the next obvious question is how do you find out
what the intrinsic value of a company is? Once you know this, you will be
able to compare this price to the market price of the company and decide
whether you want to buy it (or sell it if you already own that stock).
To start finding out the intrinsic value, the fundamentalist analyzer makes
an examination of the current and future overall health of the economy as a
whole.
After you analyzed the overall economy, you have to analyze firm you are
interested in. You should analyze factors that give the firm a competitive
advantage in it’s sector such as management experience, history of
performance, growth potential, low cost producer, brand name etc. Find out
as much as possible about the company and their products.
Do they have any “core competency” or “fundamental strength” that puts
them ahead of all the other competing firms?
What advantage do they have over their competing firms?
Do they have a strong market presence and market share?
Or do they constantly have to employ a large part of their profits and
resources in marketing and finding new customers and fighting for market
share?
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A complete guide to the basics of fundamental analysis! Page 3 of 5
After you understand the company & what they do, how they relate to the
market and their customers, you will be in a much better position to decide
whether the price of the companies stock is going to go up or down.
Having understood the basics of fundamental analysis, let us go into some
more details.
When investing in the stocks, we want the price of our stock to rise. Not
only do we want our stock price to rise, we want it to rise FAST! So the
challenge is to figure out: which stock prices are going to rise fast?
Some stocks are cheap and some are costly. Some are worth Rs.500 and
some are even worth 50paise. But the price of the stock is not important.
The price of the stock does not make a stock good to buy. What is important
is how much the price of the stock is likely to rise.
If you invest Rs.500 in one stock of Rs.500 and the price goes up to Rs.540
you will make Rs.40. However, if you invest Rs.500 in a 50paise stock, you
will have 1000 stocks. If the price of the stock goes up from 50paise to Rs.1,
then the Rs.500 you invested is now Rs.1000. You made a profit of Rs.500.
If you understand this, you can see that the price of the stock is not
important. What is important is the rise in the stock’s price. More specifically
the “percentage” rise in the stock price is important.
If the Rs.500 stock becomes worth Rs.540, then that is a 8% rise. This 8%
rise only makes us Rs.40. On the other hand when we invest the same
Rs.500 in the 50paise stock and the stock price goes up to Rs.1, it is a 100%
rise as the stock price has doubled. This 100% rise makes us Rs.500.
The point is that when picking a company, we are interested in a company
whose stock price will rise by a large percentage.
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Please note: Looking at the above paragraphs, it may seem like a good idea
to buy all the really cheap 50paise and Rs.1 stocks hoping that their price
will rise by 100% or more. This sounds good, but it can also be really really
bad some times! These really small stocks are very volatile and unless you
know what you are doing, do NOT get into them.
However, the point to be noted is that we are interested in stocks that will
have the highest % rise in the stock price. Now the question is, how do you
compare stocks. How do you compare a stock worth Rs.500 to a stock worth
50paise and figure out which one will have a higher percentage rise.
How do you compare two companies that are in different fields and
different industries? How do you know which one is fundamentally strong
and which one is week?
If you try to compare two companies in different industries and different
customers it is like comparing apples and elephants. There is no way to
compare them!
So fundamental analysts use different tools and ratios to compare all sorts
of companies no matter what business they are in or what they do!
Next let us get into the tools and ratios that tell us about the companies and
their comparison....
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Table Of Contents
1. What are stocks?
2. Why do companies issue stocks?
3. What causes stock prices to change?
4. What are the Sensex and the Nifty?
5. 3 important things that every investor MUST remember!!
6. How to decide which stocks to buy?
7. Basics of fundamental analysis!
8. Earnings per share (EPS) ratio and what it means?
9. Price to earnings (P/E) ratio and what it means?
10. PEG ratio and what it means?
11. Inflation and how it silently eats your money!
12. Brokerage and taxation…
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