Trading in stocks can be a rewarding experience, but like anything good in life, it comes with its own set of risks. This is why investors are regularly advised to evaluate the risks involved and perform a fundamental stock analysis before trading them. The term ‘fundamental analysis’ is a broad one that comprises several techniques and principles within it, all with the same objective of identifying the reasonable market value of the stock.
The fundamental analysis of stocks is the process of identifying a stock's ‘real value'. The process involves thoroughly analysing the company's financial statements, such as its profit & loss statements, income earned, balance sheet, and cash flow reports, to assess its financial health, profitability, and growth prospects. Additionally, the fundamental analysis considers broader economic factors, such as industry trends, interest rates, macroeconomic indicators like inflation, etc.
There was a recent IPO boom when the market was flooded with startups going public. The market conditions also supported this rush. However, many of those IPOs failed to live up to their expectations. There are many reasons for this, but one of the foremost was overvaluation. Many of those companies were valued way more than the actual worth of this stock. So, many investors purchased at the IPO price, and when the recent market correction happened, the prices dropped significantly, wiping out thousands of crores of investors’ wealth.
You can avoid falling into such a situation by first conducting the fundamental analysis of the stocks that you wish to invest in and determining beforehand if they are worth their current market price.
Here are some other benefits you can enjoy through this process:
By providing a comprehensive understanding of a company's financial health and growth potential, fundamental analysis of stocks will help you make informed investment decisions that align with your investment objectives and risk tolerance.
There are two main types: Quantitative Analysis and Qualitative Analysis.
Quantitative Analysis uses financial statements (like income statements, balance sheets, and cash flow) and accounting metrics to evaluate a company's financial health, performance, solvency, and growth prospects. Financial ratios used to compare a company's financial performance to its peers and industry benchmarks, such as the price-to-earnings ratio (P/E ratio) and price-to-book ratio (P/B ratio), are all part of Quantitative Analysis.
Qualitative Analysis is more subjective and involves evaluating a company's non-financial factors, such as industry trends, competitive landscape, management quality, brand value, and overall business strategy.
To achieve a wholesome stock analysis, you must use quantitative and qualitative analysis principles. The subsequent recommended steps include;
The output of the fundamental analysis is used to make informed investment decisions. You can identify undervalued stocks that offer a higher earning potential or find overvalued stocks to stay away from. You can also identify a company's growth prospects and assess its financial health.