How does fundamental analysis work?

Fundamental analysis is done with the aim of predicting future performance of a company. It is based on the theory that market price of a security tends to move towards its 'real value' or the 'intrinsic value.' So when the intrinsic value of a security is higher than the security’s market value, it represents a time to buy. On the other hand, when the value of the security is lower than its market value, investors should sell it.

Steps in fundamental analysis are as follows:

1. Macroeconomic analysis, that involves considering commodities, currencies, and indices.

2. Industry sector analysis that involves the analysis of companies which are a part of the sector.

3. Situational analysis of the company.

4. Financial analysis of a company.

5. Valuation

Valuation of any security is done through the discounted cash flow (DCF) model, that takes into consideration the following:

1. Dividends which is received by investors

2. Earnings or the cash flows of a company

3. Debt, that is calculated by using debt to equity ratio and current ratio (current assets/current liabilities)

Fundamental Analysis Tools

• Earnings per Share

  The overall earnings of a company are not in itself a useful indicator of a particular stock's worth. Low earnings and low outstanding shares could be more valuable than high earnings along with a high number of outstanding shares. The Earnings per share is much more practical information than earnings by itself. Earnings per share (EPS) is arrived at by dividing the net earnings by number of outstanding shares.

   

   

• Price to Earning Ratio

  The Price to Earnings Ratio (P/E) indicates the relationship between stock prices and company earnings. It is computed by dividing the share price by the Earnings per Share. The P/E indicates how much investors are willing to pay for a particular company's earnings. A high P/E can mean that the company is overpriced or it could also mean that investors are expecting the company to continue growing and generate profits. A low P/E can mean that investors are wary of the company or it could also indicate a company that majority of the investors have overlooked.

  In both cases, further analysis needs to be done to determine the accurate value of a particular stock.

   

   

• Price to Sales Ratio

  When a company is having no earnings, there are other tools that help investors judge its worth. New companies in particular mostly have no earnings, but that does not indicate that they are bad investments. Price to Sales ratio (P/S) is very helpful for judging new companies. It is calculated by dividing the market cap (stock price times the number of outstanding shares) by the total revenues. Another method is to divide the current share price by sales per share. P/S ratio indicates the value that the market places on sales. Lower the P/S, better the value.

   

   

• Price to Book Ratio

  Book value is calculated by subtracting liabilities from assets. Value of a growing company would always be greater than book value owing to the potential for future revenue. The P/B ratio is the value that the market places on book value of the company and is calculated by dividing current price per share by book value per share (i.e. book value / number of outstanding shares). Companies having a low P/B are good and often chosen by long term investors who see the company’s potential.

   

   

• Dividend Yield

  Certain investors look for stocks that are able to maximize dividend income. Dividend yield is helpful for determining the percentage return that a company pays in form of dividends. Dividend yield is calculated by dividing annual dividend per share by stock's price per share. Generally the older & well-established companies pay a higher percentage, and such companies also have a more consistent dividend history as compared to younger companies. 

Fundamental Analysis - Benefits

1. The intrinsic value of a security can be identified using fundamental analysis

    

    

2. It also helps in identifying long-term investment opportunities, as it involves real- time data.

Fundamental Analysis - Drawbacks

1. Since there are too many economic indicators and extensive macroeconomic data, it can confuse novice investors.

    

    

2. The same set of information based on macroeconomic indicators may have varied effects on same currencies at different times.

    

    

3. It is useful only for long-term investments. 

Nice........

The fundamental analysis approach listed here can really come in handy for stock market investors. Stock market investment is ridden with risks and if investors can do a fundamental analysis of a company’s stock, they may be able to maximize gains and minimize losses by predicting its future performance.

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Penny stocks

The thing with fundamental analysis of stocks is that it can be very time consuming and its meant for people with active interest in the stock market. To sort that challenge, I suggest you try out money works for me.  It follows the principles of fundamental investing and everything is nicely sorted out there. They give the intrinsic value of stocks in the stock market and the color code for whether the stock is good, OKOK or bad.

GREAT POST!!!!!!!!!!!!!!!   

One needs to evaluate only 6-7 parameters for identifying good companies.  Too much information overload will kill ones decision making ability. 

- Indian markets went up over positive global sentiments backed by the Chinese stock market rally. Chinese markets responded positively to the series of steps taken by their government in order to reduce volatility from the stock markets and push economic growth. China introduced "circuit breaker" system for indexes which was missing earlier. The Chinese government has also decided to reduce tax rates in order to push consumption within an economy

- Another reason for the markets to cherish is the probable decision of government on removal of STT (Securities Transaction Tax) from the F and O markets. Recently a report has been tabled by a select committee, in which a suggestion has been made to abolish STT from the market. This may turn out as a big relief for the domestic as well as for foreign investors.

- Steel shares led rally in metal and mining stocks after media reports suggested that an Indian government body has found evidence that rising imports of hot-rolled steel products pose a threat to the domestic industry. The  Government might take some steps in order to support domestic steel producers by increasing duty on imported steel; this will make imported steel expensive and will become in-competition in domestic markets.

- Tata Power Company rose 4.17% after the company announced that the company is setting up a defense production facility at Vemagal in Karnataka today, 8 September 2015. Over the next one year, Tata Power will make an investment of Rs 450 crore in this unit.

- However, the long term economic view is still weak as Chinese export data fall by 6.1% for the month of August. Japanese economy contracted by 1.2 percent in the quarter ended in June. The decline in the Japanese economy is less than the real estimates. US Federal Reserve will have its policy meeting (FOMC Meeting) on September 16 and 17, 2015. Going by the current global macroeconomic indicators, Fed might delay its rate hike till next quarter. European markets cherished high export and import data of Germany. Germany is the biggest economy of the Eurozone.

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