Fundamental Analysis: Meaning, Types & Factors
Stock markets can be complex and confusing for new traders and investors. In order to get around these complexities and find out the true value of a stock, you can take help of two methods, namely fundamental analysis and technical analysis.
Fundamental analysis is all about analysing and carefully studying a company’s business with the aim of earning profits in long run. The major objective of this study is to understand whether a stock is overvalued or undervalued according to present market circumstances. Let’s study different factors of this concept in greater detail.
What Is Fundamental Analysis?
It is a process of evaluating a stock or asset’s financial, qualitative, quantitative and economic parameters to understand its intrinsic value. After studying all these parameters, you may quantify the intrinsic value of that particular security.
After quantifying the intrinsic value of a particular security, you can compare it with its prevailing market price. This analysis also helps in getting an idea about the company’s future trajectory, which in turn, assists you in making appropriate investment decisions.
In simpler words, the primary purpose of fundamental analysis is to identify the actual value of an asset. After knowing about its true value, you can further conclude whether it is overpriced or underpriced.
What Are the Types of Fundamental Analysis?
Here are two primary categories of fundamental analysis:
- Quantitative Analysis
As the name suggests, it relies on a company’s numbers like profits, revenue, sales, cash flows, etc. You need to rigorously study the company’s balance sheet, annual reports and other data that is publicly available to carry out the analysis. Under this, you will be closely analysing various ratios and numbers to get an idea about the entity’s overall financial health.
- Qualitative Analysis
The second category involves studying all qualitative indicators or parameters. Under this, you need to study the company’s goodwill, top management, brand recognition or value, consumer outlook towards the company, and recognition in competitive markets. This analysis is much harder than a normal quantitative analysis; this is because there is no set formula for measuring and studying these parameters.
How to Carry Out Fundamental Analysis of a Stock?
The two ways you can use to fundamentally analyse the company are:
- Top Down Approach
Under this approach, you would need to initially study various macroeconomic factors influencing the economy and industry. After this, you need to analyse various market conditions and finally evaluate the company’s management and microeconomic factors.
- Bottom Up Approach
Under this approach, you are required to first study a company’s performance by going through its annual reports and balance sheet. After this, take into consideration macroeconomic factors like the health of the overall industry and the economy.
In simpler words, we can say that the top-down approach first considers the macroeconomic factors and then studies the business fundamentals. On the other hand, the bottom-up approach will first consider business fundamentals and move ahead targeting macroeconomic indicators.
What Are the Different Components of Fundamental Analysis?
You can carry out the fundamental analysis of a stock by analysing the following components:
- Understand the Company and its business model
First step is to understand the company in which you wish to put your money. This will help in getting more clarity and enable you to arrive at correct conclusions. You can visit the website of the company or study its annual reports to do so.
- Study Financial Statements
The next step involves carefully carrying out rigorous analysis on the company’s financial statements. You will have to go through balance sheets, cash flow statements, and profit & loss statements to get an idea about the company’s financial health.
- Check Debt Obligations
After this, you should look at the company’s debt obligations. It is crucial as debt plays an important role in ascertaining financial stability. The amount and type of debt that a company has should be assessed thoroughly.
- Analyse Company’s Competitors
Companies work in an interconnected and competitive environment. Therefore, it becomes important to check their competitors to know where the company stands in terms of performance.
Finally, you will have to consider the future outlook of the company. For this, you would need to indulge in the long-term assessment of the company’s financial health and business/industry outlook.
Fundamental analysis is an efficient method of understanding a company’s intrinsic value. You also get a picture of the financial health of the company by analysing its financial statements.
Frequently Asked Questions
What are the primary components of fundamental analysis?
The three primary components of fundamental analysis are economic analysis, industry analysis and company analysis. It is a comprehensive concept that encompasses knowledge of economics and finance.
Are there any tools for fundamental analysis?
Yes, there are certain tools for fundamental analysis of stocks like screeners, government reports on the economy and industries, company’s financial statements, brokerage research reports, etc.
What are important components of qualitative analysis?
The important components of qualitative analysis are understanding the nature of the business, quality of earnings, corporate governance, market position, etc.
What is the benefit of fundamental analysis?
One of the primary benefits of fundamental analysis is that you will get to know long-term trends and the future prospects of the company depending on its current and past performance.