Fundamental analysis is a method of measuring a security's intrinsic value by examining related economic and financial factors.
In this blog, we will discuss 5 basic parameters which we should analyze while doing fundamental analysis.
As an investor, our first aim should be to analyze the products and services offered by the company.
No matter what analysis and forecast we do, it is the sale of products and services that helps the company grow.
Analysis of all the products offered, their market share, competitors in the market are some of the important points to keep in mind while doing fundamental analysis.
The second step is to analyze the industry in which the company is operating.
Industry analysis helps us to know the position of our company in the markets. What threats it is facing and what opportunities are present in the industry.
Entry and exit barriers, disruption possibilities by new startups, etc are very important points to look into.
We have to forecast the growth of the industry in the future also. When the industry will expand, companies in that industry will also grow.
Specific tax regulations, government interference, and international competition should also be considered.
It is the most important step in doing fundamental analysis.
In this step, we look at the sales number, profit growth, operating profit margins, etc.
These numbers and trend analysis helps us to understand the past and possible future of the company financially. Steady growth in sales and operating profit margins can lead to better growth going forward too.
One important thing to be kept in mind while doing ratio analysis is that all the companies have different characteristics, some are a capital intensive business for eg. Cement, Auto and some are not for eg. IT industry, etc.
So it's always better to compare different companies in the same sector to get to a logical conclusion.
After analyzing the company and its financials, the next thing to look for is valuation.
Even if the company is good at all parameters, we must be acquiring it at a reasonable or fair price.
There are many ways to get an idea about the valuation, the simplest one being the P/E ratio analysis method.
We can see the trend of the P/E ratio during the last 5-10 years and get an idea about the median P/E at which the company trades.
Another method used for valuation is DCF ie. Discounted cash flow method. In this method, we try to discount all the future cash flow that a company can generate from its business.
Both the methods can only assume the valuation, no method can precisely predict it.
So it is always better to make sure that the company and industry are good and they have a chance to grow further, so we can add it to our portfolio in a staggered manner.
No company can grow if there exist any corporate governance issues.
Sooner or later, bad corporate governance destroys shareholder's wealth as well as the underlying business.
There have been many examples in the past about misappropriation of funds, fudging the books of the company, keeping private interest in front, etc.
Any company grows only when the interest of Financial institutional investors are present, FII’s are always concerned about the corporate governance issue.
We should try to avoid small companies, as news about them are rarely present on the public platforms.
On the other hand, popular names are followed by media houses regularly.
So keeping all the 5 qualitative measures in check, we can find companies that will perform better than the rest in the future.