Step-by-Step Guide to Fundamental Analysis of Stocks for Retail Investors

Fundamental stock analysis is important to investors with medium-long term returns in mind. Fundamental analysis of stocks is not just a daily price adjustment, but a deeper stock market analysis by enabling an investor to determine the actual quality of a company by evaluating its financial position, business prospects, and market position. Fundamental analysis for investors helps in evaluating companies listed on the global stock exchange.

This article explains the meaning of fundamental analysis in the stock market, its key purposes, the procedure of applying it, its application in investment and a practical example to make the concept easier for beginners.

What Is Fundamental Stock Analysis?

Fundamental analysis refers to a method of assessing the value of a stock by examining both financial and non-financial aspects of a firm to determine whether its market price reflects its intrinsic value. The core concept of fundamental analysis is intrinsic value. According to the definitions provided by many economists, investors using fundamental analysis aim to calculate the fair value of a company based on  financial statements, growth projections and industry outlook. When market value is less than intrinsic value, then the stock is considered undervalued and when it is higher, it is regarded as overvalued.

This approach contrasts with technical analysis which focuses on market patterns and price charts. The fundamental analysis of the stock market is concerned with long-term outcomes hence suitable for investors seeking sustainability in their portfolios.

Where to Find the Fundamentals of the Company?

The first step in fundamental analysis of stocks is to gain access to valuable financial statements and reports connected to a company. Securities and Exchange Board of India (SEBI) mandates companies to submit and make fundamental documents available to the public in the exchanges where they are listed on the global stock exchange. Most of the stock fundamental analysis websites and stock market websites have quarterly reports, year-end reports, company announcements, and other helpful research about companies. This information is also accessible on the company website after you Open Trading Account or use your Demat Account. Some trading sites or brokers provide investors with key financial ratios and earnings of a company.

Why is it Important to Study Fundamental Analysis?

The following are the main reasons why investors need fundamental analysis of stocks in investment:

Determining the Fair Value of Stock

Investors can analyse earnings, revenue, assets and liabilities through stock market analysis to determine whether a stock is worth buying, including identifying expensive stocks in India.

Find Good Investment Opportunities

Instead of following short-term market trends, fundamental analysis for investors can help locate solid companies that have excellent growth potential in the long term.

Support Portfolio Diversification

It allows investors to evaluate different industries such as energy, technology, and healthcare in order to control risk and returns in the fundamental analysis of the stock market.

Promote Rational Decision-Making

Data-driven stock market analysis can allow investors to stay calm throughout upheavals in the market and avoid making emotional decisions

Establish the Long-term Strategy Basis

Institutional and long term investors rely heavily on fundamental analysis before investing through their Demat and trading accounts.

What are the Important Fundamental Analysis Steps?

The key steps of how to conduct fundamental analysis of stocks are as follows:

1. Economic analysis

Macroeconomic indicators: Analysts consider the macroeconomic indicators such as GDP, inflation rates, unemployment rates, interest rates, and fiscal and monetary policies of the government that influence the global stock exchange. All of these factors assist in comprehending the general economic situation under which a company operates and how economic shifts can impact business outcomes and investor emotions.

Industry Analysis: This involves examining the industry in which a firm is operating, industry trends, competition, regulation, entry barriers, customer demand and the overall growth potential of the industry as part of stock market analysis.

2. Company analysis

Financial statements: This will deal with the balance sheet, income statement and cash flow statement to trace the financial health and performance of the company in fundamental analysis of stocks.

• Balance sheet: It provides an overview of the assets, liabilities, and shareholders’ equity of the company at a given time, which helps in determining the financial stability.
• Income statement: This statement shows the revenues, expenditures, and profits of the company over a period of time, which reflects its operational efficiency, and profitability.
• Cash flow statement: It describes the cash inflows and outflows of the operating, investing, and financing activities and it shows how the company uses the cash effectively.

Ratios and metrics: Significant financial ratios and measures are used to evaluate various areas of performance and the financial health of a company in fundamental analysis for investors.

• Liquidity ratios evaluate the ability of the company to meet its short-term commitments.
• Profitability ratios determine the profitability of the company.
• Efficiency ratios measure the efficiency with which the firm uses its assets.
• Leverage ratios give us an idea of how the company relies on debt.
• Valuation ratios can help to show whether a stock is overpriced or underpriced, including expensive stocks in India.

Growth analysis: Examining previous growth trends in revenue, earnings and cash flows and forecasting potential future growth in fundamental analysis of stock market.

Management quality: Analyze the qualifications, experience, leadership, and vision of the management team.

Competitive position: Evaluate the competitive strength, market share, and unique value proposition of the company.

3. Qualitative factors

Long-term sustainability and reputation of the company are examined by analysing business model, brand strength, corporate governance, regulatory environment, and market conditions as part of stock market analysis.

4. External factors

Political conditions, technological development, social, and environmental factors can influence the functioning of the company and its perspectives on the global stock exchange.

Combining these aspects, fundamental analysts aim to determine the real value of stock of a company’s stock and make sound investment decisions using fundamental analysis of stocks.

What are the Types of Fundamental Analysis tools?

Classification of Fundamental Analysis Tools is given below:

Earnings Per Share (EPS): EPS is used to show the amount of profit that a company makes per share. The high value of EPS indicates that the firm is performing well in fundamental analysis of stocks.

Price-to-Earnings (P/E) Ratio: This shows that a share is either underpriced or overpriced relative to the earnings of the company in fundamental analysis of stock market.

Return on Equity (ROE): ROE is used to determine the efficiency with which the owners of a company utilise the money to make more profit in fundamental analysis for investors.

Price-to-Book (P/B) Ratio: This implies whether the company is overvalued or undervalued through stock market analysis.

Beta: Beta is a measure of the risk of a stock. A high beta indicates that the price is highly volatile on the global stock exchange.

Price-to-Sales (P/S) Ratio: This indicates the price that the investors are paying for the sales of the company. A lower ratio is normally good in the fundamental analysis of stocks.

Dividend Payout Ratio: This shows the amount of profit the firm shares with its shareholders.

Dividend Yield: This represents the extra return (dividend) you receive on holding the share.

Estimated Growth in Earnings (PEG): PEG reflects the potential future growth rate of the company. A smaller PEG is an indicator of higher growth of the price in fundamental analysis of the stock market.

These tools are helpful in determining how fundamental analysis for investors can be used in investing and how fundamental analysis of stocks works.

How to Apply Fundamental Analysis in Investing?

Fundamental analysis of stocks is not merely about numbers, it is about turning knowledge into actions:

• Buy low-priced stocks trading below the intrinsic value 
• Sell overpriced stocks with limited upside.
• Select good long-term growth stocks with high cash flows and controllable debt.
• Diversify portfolios according to risk tolerance using Demat accounts. 

Quantitative and Qualitative Fundamental Analysis

It is sometimes difficult to define the fundamentals as it includes all aspects that are involved in the financial health of a company in fundamental analysis of stock market. This involves the number of things such as revenue and profit, and also such measures as market share and quality of management. These are normally categorized into two parts such as quantitative and qualitative.

Quantitative: data that may be expressed using a number, figure, ratio or formula in stock market analysis.

Qualitative: is concerned with quality, standard or nature of something but not its quantity.

Know the difference between Technical Analysis and Fundamental Analysis

Technical analysis is very different to fundamental analysis of stocks which tries to predict prices by looking at historical market data such as price and volume. Technical analysis is based on price trends and movements, frequently represented on charts, in order to create indicators and spot patterns.

The difference between Fundamental Analysis and Technical Analysis is given below:

What are the Examples of Fundamental Analysis?

We will discuss the process of fundamental analysis of stocks with an example.

• Company ABC is a company that an investor wants to invest in. The goal of the investor before making the investment is to conduct a basic analysis of the company using fundamental analysis for investors.
• To do so, the investor will look through the financial statements and ratios using a stock fundamental analysis website.
• The ratios evaluated include the P/E ratio and the P/B ratio, which are compared with the competitors and the industry average to establish whether a firm is overpriced or underpriced in stock market analysis.
• The financial statements are evaluated to measure cash flow, EBITDA, assets, liabilities, and profitability.
• The investor will also explore the business model of the company and its market position to understand its competitive advantage on the global stock exchange.
• Fundamental analysis also includes the study of the industry in which the company is operating, the economic environment and other factors such as tax and trading policies.

What are the Advantages and Disadvantages of Fundamental Analysis?

Pros

• Fundamental analysis is a useful tool that can be used by long-term investors to assess the financial health and value of a company through fundamental analysis of stocks.
• It helps investors make more informed decisions based on numerous internal and external factors using fundamental analysis for investors.
• Investors are able to determine the undervalued companies through fundamental analysis of the stock market and this will help them to improve their portfolio.

Cons

• The fundamental analysis requires a lot of research and analysis thus taking a lot of time in stock market analysis.
• Since the fundamentals cannot be measured fully, emotional factors can influence decision-making.
• Financial statements and company fundamentals might be complex to interpret and analyse, which is a challenge to investors who are not adequately informed.

Conclusion

Fundamental analysis of stocks is an essential instrument to investors because it helps to get deep insights into a company’s financial health, business model and external environment. The use of fundamental analysis for investors would prove of great benefit to long term investors who aim at investing in companies that are fundamentally strong.