What is fundamental analysis in the stock market ? – Complete guide for success in 2024

Fundamental analysis is one of the methods of analyzing stocks, apart from technical analysis and sentiment analysis.

But before that, let’s understand that there are three major factors involved in determining the price of a stock:

• Sentiments
• Liquidity
• Fundamentals

Fundamental analysis is a method of finding out the true value of a stock by closely examining a company’s financial reports. It’s a method that helps investors understand how much a stock is truly worth, which is called its intrinsic value.

What is meant by fundamental analysis?

Fundamental analysis is a way to figure out how much a stock is really worth. It’s a method of determining the intrinsic value of a stock, also known as fair market value. It looks at a bunch of things like financial records, outside influences, events, and what’s going on in the industry. It’s important to know that a stock’s true value doesn’t change overnight.

Fundamental analysis is like looking into the financial health of a company to figure out how much its stock is really worth. Analysts look at everything from how well the economy is doing to how skilled the company’s management is. They then compare their findings to the current price of the stock. If they think the stock is worth more than what it’s selling for, they might say it’s undervalued. But if they think it’s worth less, they might say it’s overvalued. The goal is to help both investors and traders make smart decisions about buying or selling stocks.

Who is called the father of fundamental analysis?

Benjamin Graham is often called the father of ‘fundamental analysis.’ He came up with this term back in 1928.

Who uses fundamental analysis?

Investors use fundamental analysis for longer-term trades, relying on various financial factors in their decision-making process.

Why fundamental analysis is important?

Fundamental analysis has been the foundation for value investors who have created massive wealth through the stock market. It helps to determine the true value of stocks and assists investors in making informed decisions about buying or selling them. Although prices might fluctuate based on supply and demand in the short term, as soon as an investor finds the price below the intrinsic value, the probability of their buying the stock at that price level becomes very high, hoping that the price of the stock will increase. They will be investing with a long-term perspective.

Basically, if the current market price is lower than the intrinsic value, then the stock is said to be undervalued. If the current market price is higher than the intrinsic value, then the stock is said to be overvalued.

How to do fundamental analysis of stocks?

Fundamental analysis means checking many things to see if a company’s stock is a good investment. This includes looking at how well the industry is doing, what’s happening politically, any important news, and the company’s financial records. If the signs are bad, like if the company isn’t making much money or if the industry is struggling, the stock price might go down. But if things look good, like if the company is making a lot of money or has a strong position in the industry, the stock price might go up.

What are the different types of fundamental analysis?

There are two main types of fundamental analysis: qualitative and quantitative.

1. Qualitative Analysis – It focuses on the quality of things like management, brand, products, financial performance, and the company’s board, as well as its position within its sector. It’s more about opinions and how do you feel about the company or its products. Basically, It takes non-quantifiable aspects into the consideration.
2. Quantitative Analysis – It is all about the numbers. It looks at the data from financial statements to make assessments. It’s more objective because it’s based on facts and figures. It takes quantifiable things into the consideration such as earnings, sales, cash flow, various ratios etc.

Both qualitative and quantitative analysis are important. You can’t just focus on one and ignore the other. They both give you different but equally valuable insights into a company’s performance.

Fundamental analysis can be done in two ways:

1. Top-down approach – With the top-down approach, investors first look at the big picture, like how the economy is doing overall, before they focus on specific companies.
2. Bottom-up approach – The bottom-up approach is all about starting with individual companies. Investors look at things like how well the company is doing financially and what makes it stand out from others.

6 easy steps for doing fundamental analysis

Below are the 6 steps to conduct fundamental analysis:

1. Understanding the Company: Start by getting to know the company’s basics like what it does, what it sells, who it sells to, and what makes it stand out from its competitors. This gives you a good foundation for deeper analysis.
2. Using Financial Ratios: Key financial ratios are like tools that help you to check how well the company is doing financially and how it’s performing. Things like how much profit it makes compared to its sales, how easily it can pay its bills, and how efficiently it uses its assets can tell you a lot about its financial health. By using key financial ratios like earnings per share (EPS), price-to-earnings (P/E), debt-to-equity, and return on equity (ROE), investors can assess a company’s financial health and potential for investment.
3. Looking at Past Financial Results: Take a look at the company’s financial history to see if it’s been doing well over time. Look for signs of steady growth in sales, better profits, and smart spending habits. This can give you clues about how well the company might do in the future.
4. Studying the Competition: Find out who else is in the same business as the company you’re interested in. See how they’re doing financially, what products they offer, and how they’re competing. This helps you understand where your company stands in the market.
5. Checking Debt Levels: Take a look at how much debt the company has compared to others in the same industry. Too much debt can be a problem if the company can’t afford to pay it back, so it’s important to compare.
6. Looking at Future Potential: Think about where the company might be headed in the future. Consider things like trends in the market, new technologies, and changes in the law that could affect its business. Also, check out any plans the company has for growing and expanding.

By following these steps, you can get a good idea of whether a company is a smart investment for you, and whether its overvalued or undervalued. It’s all about looking at the numbers and thinking about what they mean for the company’s future. This comprehensive analysis enables investors to make informed decisions about whether to invest in the company.

ALSO READ– What is the P/E Ratio in the Stock Market? – An Easy-to-Understand Guide

Advantages and Disadvantages

Advantages

1. It gives investors insights about the financial health of a company.
2. It provides investors with a long-term perspective on the price.
3. It helps in value investing by providing the intrinsic value of stocks.

Disadvantages

1. Analyzing financial data and qualitative aspects of a company is very time-consuming
2. It’s not easy for a beginner to analyze financial data, but with time, it gets better.
3. It can be affected by market sentiments.

Difference between fundamental analysis and technical analysis?

1. Technical analysis focuses on past price and volume data to predict future price movements, while fundamental analysis evaluates intrinsic value based on economic, financial, and qualitative factors.
2. Technical analysis primarily uses price and volume data, along with technical indicators, while fundamental analysis relies on company financial statements, economic data, and qualitative information.
3. Technical analysis is often used for short to medium-term trading, while fundamental analysis is primarily used for long-term investing.
4. Technical analysis employs a systematic approach based on patterns and trends in price data, while fundamental analysis considers a wide range of factors affecting a company’s performance and valuation.
5. Technical analysis assumes that past price movements repeat in the future, while fundamental analysis assumes that a security’s intrinsic value will eventually be reflected in its market price.
6. Technical analysis does not rely on news or external events. It’s all about charts and only charts, while fundamental analysis is greatly affected by news and events.

Conclusion

When you’re thinking about long-term investments, start with fundamental analysis of stocks. This method helps in finding the intrinsic value of stocks and identifying good companies with significant growth potential. By considering both financial and non-financial factors, investors can make informed decisions for their investments, particularly in value investing. When combined with technical analysis, fundamental analysis can lead to fruitful investment decisions.