What is fundamental analysis of stocks? How can it help while making investment decisions?

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Recent reports from depositories like National Security Depository Limited (NSDL) and Central Depository Services Limited (CDSL) state that there has been a monthly influx of around one million new investors in the stock market over the last year. With a high number of investors looking for opportunities in the stock market to buy stocks every month, it becomes imperative for you as an investor to be a step ahead and take profitable decisions.

One skill that could help you is to learn fundamental analysis of stocks. Fundamental analysis of Indian stocks could make you more aware of the companies in which you plan to invest. You may also find new companies to invest in, ones that are performing well.

What is a fundamental analysis of the stock market? 

Fundamental analysis of stocks is an analysis carried out by an investor on the performance of a company. How the company is performing financially, how is its business environment – all these factors form a critical component of stock fundamental analysis. Such an analysis helps in assessing the operational efficiency of a company, its potential for growth, and earning profits.

Valuation of stocks 

Arriving at the fair price of stocks is at the crux of fundamental analysis. Some of the techniques used for valuation of stocks are listed below:

Present value models – In this model, future profits of the company are discounted at a specific rate to arrive at the present value of money.

Multiplier models – Here, the market price of the competitors is considered, after which the same is extrapolated onto the concerned company to arrive at its valuation.

Asset-based valuation – In this case, the market value of a company’s liabilities is subtracted from its assets to arrive at a valuation.

Types of fundamental analysis 

Fundamental analysis of stocks may be categorised into quantitative and qualitative. Quantitative analysis is pure number crunching. Qualitative analysis pertains to elements that may not be readily visible but are critical for understanding the inherent health of an organisation.

Determinants of quantitative fundamental analysis of stocks as under:

Cash flow statement

This shows the cash position of a company. The cash flow can be categorised into three types.

  1. Daily cash inflow and outflow, which is incurred while running the business operations.
  1. There may be cash flow due to investment in new resources, the sale of equipment, or any other assets. Ideally, companies need to generate positive cash inflow from operations and conduct their investment activities from them.
  1. Cash paid or received on account of issuance of securities or borrowing.

Profit and loss account

This shows the revenue versus expenses and the profit earned by the company for a specific period. The profit and loss account shows the position of the company in its core business.

Balance sheet

The company’s income, assets, liabilities, debt, equity participation of promoters for a particular period are all revealed from balance sheets. As an investor, you need to ascertain that revenues generated from assets outweigh the liabilities.

Elements of qualitative fundamental analysis 

Leadership

The performance of the company depends on how leaders who form the core management group go about conducting their business.

Governance

Corporate laws and bylaws govern the different policies to be adopted by the company, adherence to the same is a positive quality.

Model of business

This pertains to what business the company is in and how it conducts the business. If the business flow ensures inward cash flow, it may be a profit-making proposition.

Competitive edge

Staying ahead of the competition through brand equity, cost-effective manpower resources are positive signs in a company’s performance.

Learning how to carry out fundamental analysis of stocks in India could help you to make informed investment decisions on which stock to buy based on your short term and long term financial goals. If carrying out such an analysis seems difficult, it is prudent to reach out to a financial advisor that could help you by curating bespoke investment plans based on your risk appetite and financial goals.