Fundamental analysis of studying and understanding a stock involves understanding the business of a company. We try to find out what product or service the company is in, customer base, pricing power, quality of management, competition, the financial performance of the company, sector analysis (the company belongs), government policies, etc. Fundamental analysis is an in-depth analysis of the Company, Sector/Industry, and Economy (E-I-C Analysis).
The main aim of studying the fundamental analysis is to determine the “fair value” of stock and identify whether a stock is undervalued to the fair value or overvalue than the fair value for deciding to buy or not buy that stock.
Fundamental analysis consists of a systematic series of steps to examine the investment environment of a company and then identify opportunities. Some of these are:
In the growth investing approach to fundamental analysis, the investor tries to find such companies, which are expected to witness very high growth in business performance in the future. Once the investor has chosen such a company, buy its shares. The investor expects to benefit from the future high growth of the business of the company.
An investor, who follows the growth investing approach of fundamental analysis, would like to study a company like any other business. The investor would focus on a company’s product, target market, distribution channel, customers, management, financials, etc. The investor wants to know the strength and sustainability of the business of a company in the long term. The aim here is to find a company that is going to increase its earnings, market share, pricing power, differentiated product, or service in the future. Such a company is preferred for large investors, which ultimately results in re-rating. Such a company price to earnings (PE) ratio will result in multi-times of their earning in valuation.
In Value investing, the approach of fundamental analysis is to find the fair value of the share of a company. Analyzing the various business and financial factors, and calculating the fair value of such share, also compares it with the current market price (CMP) of such stock. If the investor figures out the current stock price of the company are lower than the fair value of its stock and buy the shares of such a value company. The investor expects to good return from the rising price of such stock. When the market discovers the discount in the stock value and increases the stock price to its fair value.
The value investing approach would focus on finding the fair value of the company. Investors focus on the assets quality and earning potential of the companies. Then tries to find whose stocks are priced at a discount to the fair value. The deeper the discount can find, the better it is!
Some other Styles of Investing include:
Index funds – Investing proportionately to match index such as Nifty 50.
Momentum investing – Investor identifies momentum in any asset class and will invest till momentum last in any country/index etc.
Yield investment – In this style of investing, the fund manager generates above the market or benchmark index income.
Structured investment: In this style, the investment is made to suit the specific/exact risk and reward parameters of the investor using sophisticated investment tools and financial products.