When we start our journey in the stock market, we often come around two important words: Technical Analysis and Fundamental Analysis.
Often many experts believe that both are necessary and both of them go hand in hand with each other, to make profits and stay profitable you need to know both phases of the market namely technical and fundamental analysis.
Fundamental analysis tells us everything about the company, its financial, management and others. After analyzing these factors, investing in a company is one method among investors.
Let us see all about fundamental analysis whether it is an attractive method or not and we will see its strengths and weaknesses as a trader or investor’s tool in picking the right stock.
What is fundamental analysis:
The fundamental analysis includes examining the main and key indicators that dictate the prosperity and progress of the company and the sector. It is an approach of valuing the company on the basis of its in-depth study of the market, the sector and of course the company itself. We as the investor use these data to determine the intrinsic value of the underlying stock that we are researching about and then according to the current scenario of the market, industry or the sector we decide to make an investment in the company or not.
Through fundamental analysis we can determine if the stock of the company is undervalued or overvalued and by tracing its past performance we can also predict the future performance of the company’s stock. If this analysis is done correctly and successfully we can uncover the possibility of investment before the market has recognized it and we can ride our way towards huge profits.
Approaches of fundamental analysis
When doing a fundamental analysis of a company we check and consider many tools like for example:
- At the market level we can check the microeconomic indicators in place which tell us and reflect about the market scenario
- At the sector / industry level we might check demand and supply of the whole industry in the possible future it might include checking the average P/E ratio of the sector along with classifying it (ex: classifying it as a labor intensive or extensive, money intensive or extensive sector) to further clarify your analysis so that chances of making mistakes gets reduced
- Finally at the company level, fundamental analysis involves checking and examining the record books, balance sheet, its results(quarterly or yearly), management and its potential competitors.
P.S it might be a great idea to analyze and keep a track of its competitors as it will help us to determine the performance of our company and give insights in a better way.
Fundamental analysis covers all the factors and events that significantly influence the performance of the company, the sector and the stock market as a whole. It is based on event studies, benefits to investors such as dividends, cash flow and cash reserves, and many more factors which evaluate the fundamentals of the whole company.
While analyzing the company there are two main approaches
The first approach is the top – bottom, its first phase involves the gathering of information of the market indicators, then analyzing the activities of the sector and finally gazing on the specific indicators of the company.
The second approach bottom – top is the exact opposite of the above mentioned as it starts with company and ends with the market sentiments / indicators
A great way of starting a fundamental analysis would be by analyzing its profit and profit generating capability, although this isn’t the only indication but it is a very important one as it can help you detect a very profitable trade.
Advantages of fundamental analysis
- One of the most important features of this analysis is the fact that it takes in account all the events happening adhering to the market and the company and its sector. It’s not based solely on the price action and the volume of trades
- Although it is a very wide range of data which might be rather more complicated but also provides us with a better and comprehensive outlook on the market, the fundamentalists rely on the basic principle of demand and supply.
- All the tools and indicators we talked about till now are publicly available on many websites and the financial statements of the company are released by them so gathering of the information is quite easy.
- Fundamental analysis is good for a long term investment based on the long term trends, as it helps in understanding and realizing the intrinsic value of the company’s stock.
Disadvantages of fundamental analysis
- The analysis is based on the information that is held by all the major participants of the market so it doesn’t bring any significant benefit.
- The information provided by the fundamental research is complex and its interpretation differs for each and every individual depending largely on their skills.
- Fundamental analysis of a stock gives great insights about the stock but it still can not give us or pinpoint the best moments of entry and exits for the stock in the market.
- Although fundamental analysis is a great tool if not the best for a long term investment, but it can not help traders looking for a short term movement and gains.
Fundamental analysis is a great way of judging a stock by its intrinsic value by taking the criterias and factors like P/E ratio, P/B ratio, cash flow and any more indicators and factors. It gives us an in depth see through of the company’s profile and financial position which is important in the long run.
But it lacks to provide us with necessary details which dictate the price movement in the short term such as price action, trade volume, etc. while technical analysis is based mainly on trade volume, chart patterns and price actions it provides an entry exit point and predicts price movement but fails to recognise the worth of the stock. Whereas fundamental analysis gives us the worth of the company but fails to give short term gains.
It is safe to believe that a fundamental analysis is a great tool for investors looking to park their money for a long term, but it is not so attractive to a trader who is looking for short term wealth gains.
To get a fair image of the market and the stock, it is recommended to use both fundamental analysis and its counterpart technical analysis to gain better results for any kind of investor or a trader.
Both fundamental and technical analysis goes hand in hand with each other to provide the best gains, entry and exit points and predicts the future scope of the stock.
At last even Rakesh jhunjhunwala revealed that the wealth is created by long term investments made by him due to the fundamental analysis of the companies.