How To Do Fundamental analysis of stocks in 2021? | Brief Explanation

Fundamental analysis of the stock market

Fundamental analysis (FA) is a method of measuring the intrinsic value of a security by examining related economic and financial factors. Fundamental analysts study anything that can affect the value of the security, such as the state of the economy and industry conditions, from microeconomic factors such as the effectiveness of a company's management.

fundamental analysis
Fundamental Analysis of stocks

The ultimate goal is to arrive at a number that an investor can compare the security with the current price to see if the security is undervalued or overvalued.

This method of stock analysis is considered in contrast to technical analysis, which estimates the direction of prices through analysis of historical market data such as price and volume.

key takeaways

a) Fundamental analysis is a method of determining the actual or "fair market" value of a stock

b) Fundamental analysts search for stocks that are currently trading at prices that are higher or lower than their true value.

c) If the fair market value is higher than the market price, the stock is considered undervalued and a purchase recommendation is made.

d) In contrast, technical analysts ignore the fundamentals in favor of studying the stock's historical price trends.

Understanding Basic Analysis

All stock analyzes try to determine whether the security has true value within the broader market. Fundamental analysis is typically performed from a macro to a micro-point of view to identify securities that are not correctly priced by the market.

Analysts typically study the strength of a specific industry before focusing on the performance of the individual company to arrive at the overall state of the economy and then the fair market value for the stock.

Fundamental analysis uses public data to evaluate the value of a stock or any other type of security. For example, an investor can perform a fundamental analysis by looking at economic factors such as the interest rate and the overall state of the economy on the value of the bond, then
  Studying information about a bond issuer, such as a possible change in its credit rating.

For stocks, the fundamental analysis uses revenue, earnings, future growth, return on equity,

Profit margin, and other data to determine a company's underlying value and potential for future growth. All this data is available in a company's financial statements (more on that later).

Investment and Fundamental Analysis

An analyst works to create a model for determining the estimated value of a company's share price based on publicly available data. This value is only an estimate, the analyst's educated opinion, of what the company's share price should be compared to the currently traded market price. Some analysts refer to their estimated price as the intrinsic value of the company.

If an analyst calculates that the stock's value should be significantly higher than the current market price of the stock, they may publish a buy or overweight rating for the stock. This serves as a recommendation for investors who follow that analyst. If the analyst calculates a lower intrinsic value than the current market price, the stock is considered overvalued and a recommendation to sell or underweight is issued.

Investors following these recommendations will be expected to buy stocks with favorable recommendations as such stocks should be more likely to grow over time. Similarly, stocks with unfavorable ratings are more likely to fall in value. Such stocks are added to the existing portfolio as exits or "short" positions.

This method of stock analysis is considered in contrast to technical analysis, which estimates the direction of prices through analysis of historical market data such as price and volume.

Quantitative and qualitative fundamental analysis

The problem with defining the term fundamentals is that it can cover anything related to the economic wellbeing of a company. They explicitly include numbers such as revenue and profit, but they can include anything from a company's market share to the quality of its management.

Different fundamental factors can be divided into two categories: quantitative and qualitative. The financial meaning of these terms is not very different from their standard definitions. Here's how a dictionary defines the terms:

1) Quantitative - "Related to information that can be displayed in numbers and quantities." 

2) Qualitative - "Relating to the nature or standard of a thing, rather than its quantity." 

In this context, quantitative fundamentals are hard numbers. They are measurable characteristics of a business. This is why financial statements are the biggest source of quantitative data. Revenue, profit, assets, and more can be measured with great precision.

The qualitative fundamentals are less tangible. These may include the quality of the company's key executives, recognition of its brand-name, patents, and proprietary technology.

Neither qualitative nor quantitative analysis is inherently superior. Many analysts consider them together.

Qualitative fundamentals to consider

There are four main fundamentals that analysts always consider in relation to a company. All are qualitative rather than quantitative. they include:

i) Business model: what exactly does the company do? It is not as simple as it seems. If a company's business model is based on selling fast-food chicken, is it making its money this way? Or is it just on royalties and franchise fees?

ii) Competitive Advantage: The long-term success of a company is driven largely by its ability to maintain and retain a competitive advantage. Powerful competitive advantages, such as Microsoft's domination of Coca-Cola's brand name and personal computer operating system, create a moat around a business that allows it to keep competitors at bay and enjoy growth and profits. When a company can gain a competitive advantage, its shareholders can be well rewarded for decades.

iii) Management: Some believe that management is the most important criterion for investing in a company. This makes sense: even if the company leaders fail to execute the plan properly, the best business model is doomed. Although it is difficult for retail investors to meet and truly evaluate managers, you can check the corporate website and check the resumes of the top brass and board members. How well did they perform in previous jobs? Have they been taking off many of their stock shares recently?

iv) Corporate Governance: Corporate governance describes policies within an organization that reflect the relationships and responsibilities between management, directors, and stakeholders. These policies are defined and laid down in company laws and regulations, as well as in the company charter and its bye-laws. You want to do business with a company that operates ethically, fairly, transparently, and efficiently. Note in particular whether management respects shareholder rights and shareholder interests. Ensure that their communications to shareholders are transparent, clear, and understandable. If you don't get it, it's probably because they don't want you.
It is also important to consider a company's industry: customer base, market share among firms, industry-wide growth, competition, regulation, and the business cycle. Learning about how the industry works will give an investor a deeper understanding of the financial health of the company.

Financial statement: quantitative fundamentals to consider

A financial statement is the means by which a company discloses information related to its financial performance. Followers of fundamental analysis use quantitative information derived from financial statements to make investment decisions. The three most important financial statements are the income statement, balance sheet, and cash flow statement.

i) Balance sheet

The balance sheet represents the record of assets, liabilities, and equity of the company at a particular time. The balance sheet is named by the fact that the financial structure of a business is balanced in the following way:

                     Assets = Liabilities + Shareholder Equity

Assets represent the resources that the business owns or controls at a given point in time. This includes items such as cash, inventory, machinery, and buildings. The other side of the equation represents the total value of financing used by the company to acquire those assets. Financing comes as a result of liabilities or equity. Liabilities represent debt (which must be paid back in due course), while equity represents the total value of money that owners have contributed to the business - including retained earnings, a Gain made in previous years. is.

 ii) Income details

While the balance sheet takes a snapshot approach in examining a business, the income statement measures a company's performance over a specific time frame. Technically, you can have a balance sheet for a month or a day, but you will only report quarterly and annually to public companies.

The income statement presents information about revenue, expenses, and profits generated as a result of the operation of the business for that period.

iii) Statement of Cashflows

A statement of cash flows shows a record of a business' cash flow and outflow over a period of time. Typically, a statement of cash flows focuses on the following cash-related activities:

Cash from Investment (CFI): Cash used to invest in property, as well as income from the sale of other businesses, equipment, or long-term assets

Cash from Financing (CFF): Cash issued and borrowed from funds

Operating Cash Flow (OCF): Cash generated from day to day business operations

The cash flow statement is important because it is very difficult for a business to manipulate its cash position. There is much that aggressive accountants can do to manipulate earnings, but it is hard to fake cash in the bank. For this reason, some investors use the cash flow statement as a more conservative measure of a company's performance.

Concept of Intrinsic value

One of the primary assumptions of fundamental analysis is that the present value from the stock market often does not fully reflect the value of the company supported by publicly available data. A second assumption is that the value reflected from the company's basic data is more likely to be close to the stock's true value.

Analysts often refer to this imaginary real value as intrinsic value. However, it should be noted that this meaning of the phrase internal use is somewhat different in-stock valuation than it means in other contexts such as options trading. Option pricing uses a standard calculation for intrinsic value, although analysts use various complex models for the stock to arrive at its intrinsic value. There is not a single, generally accepted formula for arriving at the intrinsic value of a stock.

For example, say a company's stock was trading at $ 20, and after extensive research on the company, an analyst determined that it should be valued at $ 24. Another analyst does equal research but determines that it should cost $ 26. Many investors will consider the average of such estimates and believe that the intrinsic value of the stock may be near $ 25. Often investors consider these estimates highly relevant information because they want to buy stocks that are trading at prices well below these intrinsic values.

This leads to a third major assumption of fundamental analysis: in the long run, the stock market will reflect fundamentals. The problem is, no one knows how long "long" really is. It can be day or year.

This is the fundamental analysis. By focusing on a particular business, an investor can estimate the intrinsic value of a firm and find opportunities to buy at a discount. When the market catches the fundamentals, the investment will stop.

Criticism of fundamental analysis

The greatest criticism of fundamental analysis comes mainly from two groups: proponents of technical analysis and believers of the efficient market hypothesis.

1) Technical Analysis

Technical analysis is the second primary form of security analysis. Simply put, technical analysts base their investments (or, more accurately, their trades) only on the price and volume movements of the shares. Using charts and other tools, they trade at speed and ignore the basics.

One of the core principles of technical analysis is that the market discounts everything. All news about a company is already in stock. Therefore, stock price moves give more insight than the underlying fundamentals of the business.

2) Efficient market hypothesis

However, adherents to the efficient market hypothesis (EMH) are generally in disagreement with both fundamental and technical analysts.

The efficient market hypothesis states that it is essentially impossible to beat the market through fundamental or technical analysis. Since the market efficiently prices all stocks on a continuum basis, any opportunity for additional returns is quickly taken away by many market participants, making it impossible for anyone to outperform the market in the long term. goes.

Examples of fundamental analysis:

Take the Coca-Cola Company for example. When examining your stock, an analyst must look at the stock's annual dividend payout, earnings per share, P / E ratio, and various other quantitative factors. However, no analysis of Coca-Cola is complete without taking into account its brand identity. Anyone can start a company that sells sugar and water, but some companies are known to billions. It is hard to put a finger on what a Coke brand deserves, but you can be sure that it is an essential component contributing to the continued success of the company.

Even the entire market can be evaluated using fundamental analysis. For example, analysts looked at the S&P 500 fundamental indicators from July 4 to July 8, 2016. During this time, the S&P reached 2129.90 after the release of positive jobs reports in the United States. In fact, the market just missed a new record high, falling to a May 2015 high of 2130.82.3. The economic surprise of an additional 287,000 jobs in the month of June 4 increased the value of the stock market, particularly on July 8, 2016.

However, there are different views on the actual value of the market. Some analysts believe the economy is growing for a bear market, while other analysts believe it will continue as a bull market.

Read Also- Top 10 Books Every Investor Should Read In 2020 

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