What is fundamental analysis?
Srujani Panda / 04 Jan 2012
Fundamental analysis is the examination of the underlying forces that affect the well being of the economy, industry groups & company. As with the most analysis, the goal is to derive a forecast and profit form the future price movements. At the company level, the fundamental analysis, the fundamental analysis may involve examination of the financial data, management, business concept and competition. At the industry level, there might be an examination of supply & demand forces for the product offered. For the national economy, the fundamental analysis might focus on economic data to assess the present & future growth of the economy.
To forecast the future stock prices, fundamental analysis combines economic, industry & company analysis to drive a stock’s current fair value & forecast future value. If fair value is not equal to current stock price, the fundamental analysts believe that the stock is either over or under valued and the market price will ultimately gravitate towards fair value. Fundamentalists do not need to the advice of the random walker and believe that markets are weak form efficient. By believing that prices do not accurately reflect all the available information, the fundamental analysts try to capitalize perceived price discrepancies.
What are the general steps to the fundamental evaluation?
Though there is not even one clear-cut method, a breakdown is presented below in the order an investor can proceed.
This method employs a top-down approach that start with the overall economy and then works down from the industry groups to specific companies. As a part of the analysis process, it is important to remember that all information is relative. Industry groups are compared to other industry groups and companies against other companies. Usually, companies are compared with others in the same group. For instance, an automobile manufacturer (Ashok leyland) would be compared with the another automobile manufacturer (Telco), and to an oil company (ONGC).
A. Economic Forecast
First & formast of the top-down approach would be an overall evaluation of the general economy. The economy is like the tide and various industry groups & individual company are like boats. When the economy expands, more industry groups and companies benefit and grow. When the economy declines, most sector and companies usually suffers. Most economists like economy expansion and contraction to the level of interest rates. Interest rates are seen as leading indicator for the stock market as well. When the scenario for the overall economy is developed, an investor can break down the economy into its various industry groups.
B. Groups Selection.
If the prognosis is for an expanding economy, then certain groups are likely to benefit more than others. An investor can narrow the filed to those groups that are best suited to benefit form the current & future economic environment. If the most companies are expected to benefit from an expansion, then the risk in equity would be relatively low and an aggressive growth-oriented strategy might be advisable. A growth strategy might involve the purchase of technology, biotech, semiconductor & cycle stocks. If the economy forecast is to contract, an investor may opt for a more conservative strategy and seek out stable income-oriented companies. A defensive strategy might involve the purchase of consumer staples, utilities and energy-related stocks.
To assess industry group’s potential, am investor would want to consider the overall growth rate, market size, and it’s importance to the economy. While the individual company is still important, it’s industry groups is likely to exert just as much, or more, influence on the stock price. When the stock moves, they usually moves as groups; there are very few lone guns out there. Many times it is more important to be in the right industry than in the right stock!
C. Narrow within the group
As soon as the industry groups is chosen, an investor would need to narrow the list of companies before proceeding to a more detailed analysis. Investor are usually interested in finding the leaders and the innovators within a group. The first task is to identify the current business and competitive environment within a group as well as the future trends. It is better to know the answer of the following question before moving to the next step. How do the companies rank according to market share, product position and competitive advantage? Who is the current leader and how would changes within the sector affect the current balance of power? What are the barriers to entry? Success depends on an edge, be it marketing, technology, market share or innovation. A ‘comparative analysis’ of the competition within a sector serves as the basis to identify those companies within an edge, and those most likely to keep it.
D. Company Analysis
With a shortlist of companies, an investor might analyze the recourse and capabilities within each company to identify those companies that are capable of creating & maintaining a competitive advantage. The analysis could focused on selecting companies with a sensible business plan, solid management and sound financials.
(i) Business Plan
The business plan, model or concept forms the benchmark upon within everything is built. If the plan, model or concept stinks, there is little hope for the business. For a new business, the question may be: Does its business makes sense? Is it feasible? Is there a market? Can a profit be made? For an established business, the question may be: Is the company’s direction clearly defined? Is the company a leader in the market? Can the company maintain leadership?
(ii) Management :-
In order to execute a business plan, a company requires top-quality management. Investor might look at management to assess their capabilities, strengths and weaknesses. Even the best-laid plans in the most dynamic industries can go to waste with bad management. Alternatively, even strong management can make for extraordinary success in a mature industry. Some of the question to ask might include: How talented is the management team? Do they have a track record? How long have they worked together? Can management deliver as per their commitment? If management is a problem,
If you want to stay updated with the share market news today, keep a close watch on the indian stock market today with real time movements like sensex today live and overall stock market today trends. Investors tracking ipo allotment status, ipo news today, or the latest ipo india can also follow daily updates along with bse share price live data. Whether you are learning how to invest in stock market in india, preparing for a market crash today, or searching for the best stocks to buy in india, insights on top gainers today india, top losers today india, trending stocks india and long term stocks india help in making informed investment decisions.