Fundamental analysis

Fundamental analysis
Source: Tavaga

Fundamental analysis is the analysis of market performance by analyzing a company’s (or a security’s) inherent and future prospects and valuations.

How is the Fundamental analysis done?

Analysts refer to data such as annual reports, customer feedback, ratings on financial health, information about the overall industry the company belongs to, company communication, and shareholders’ and stakeholders’ concerns to determine what is the intrinsic price of the company’s stock. 

It is then compared with the prevailing market price of the company’s stock to glean whether it is overpriced or underpriced and whether to hold or sell accordingly.

Various financial ratios such as debt-equity ratio in order to know the necessary expenses of the company, Quick ratio in order to determine the liquidity position of the company, return on equity in order to understand returns that have been generated in relation to net income, etc. are calculated to assess the performance of the company on various factors. 

Solvency ratios, liquidity ratios, and profitability ratios are calculated.

Why is fundamental analysis important?

It is essential as it helps to know the intrinsic value of the company. It helps an investor to know whether the share price of the company is undervalued or overvalued. For ex.: –  Price-earnings ratio helps to compare the current share price with the share price that should be. If the share price is undervalued, it is profitable to buy that stock, and if it is overvalued, it is beneficial to sell that stock.

It helps to know whether the money invested has generated enough returns or not for a company. It helps in the analysis of various qualitative and quantitative factors.

It helps to know the financial soundness of the company. These ratios are calculated with the help of Balance sheet, Income Statements, and various other reports which are fundamental to the functioning of the company.

What is the difference between technical analysis and fundamental analysis?

Technical analysis is based on the price movements in various charts such as candlestick charts and helps to know when to enter or exit the market. In contrast, fundamental analysis is based on the financial statements of the company. It helps to know the intrinsic value of a company. 

Components of fundamental analysis
Source: Tavaga