A complete guide to the basics of fundamental analysis!

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Fundamental analysis is a stock valuation method that uses financial and

economic analysis to predict the movement of stock prices.

The fundamental information that is analyzed can include a company's

financial reports, and non-financial information such as estimates of the

growth of demand for products sold by the company, industry comparisons,

and economy-wide changes, changes in government policies etc..

General Strategy

To a fundamentalist, the market price of a stock tends to move towards it's

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“real value” or “intrinsic value”. If the “intrinsic/real value” of a stock is

above the current market price, the investor would purchase the stock

because he knows that the stock price would rise and move towards its

“intrinsic or real value”

If the intrinsic value of a stock was below the market price, the investor

would sell the stock because he knows that the stock price is going to fall

and come closer to its intrinsic value.

All this seems simple. Now the next obvious question is how do you find out

what the intrinsic value of a company is? Once you know this, you will be

able to compare this price to the market price of the company and decide

whether you want to buy it (or sell it if you already own that stock).

To start finding out the intrinsic value, the fundamentalist analyzer makes

an examination of the current and future overall health of the economy as a

whole.

After you analyzed the overall economy, you have to analyze firm you are

interested in. You should analyze factors that give the firm a competitive

advantage in it’s sector such as management experience, history of

performance, growth potential, low cost producer, brand name etc. Find out

as much as possible about the company and their products.

Do they have any “core competency” or “fundamental strength” that puts

them ahead of all the other competing firms?

What advantage do they have over their competing firms?

Do they have a strong market presence and market share?

Or do they constantly have to employ a large part of their profits and

resources in marketing and finding new customers and fighting for market

share?

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After you understand the company & what they do, how they relate to the

market and their customers, you will be in a much better position to decide

whether the price of the companies stock is going to go up or down.

Having understood the basics of fundamental analysis, let us go into some

more details.

When investing in the stocks, we want the price of our stock to rise. Not

only do we want our stock price to rise, we want it to rise FAST! So the

challenge is to figure out: which stock prices are going to rise fast?

Some stocks are cheap and some are costly. Some are worth Rs.500 and

some are even worth 50paise. But the price of the stock is not important.

The price of the stock does not make a stock good to buy. What is important

is how much the price of the stock is likely to rise.

If you invest Rs.500 in one stock of Rs.500 and the price goes up to Rs.540

you will make Rs.40. However, if you invest Rs.500 in a 50paise stock, you

will have 1000 stocks. If the price of the stock goes up from 50paise to Rs.1,

then the Rs.500 you invested is now Rs.1000. You made a profit of Rs.500.

If you understand this, you can see that the price of the stock is not

important. What is important is the rise in the stock’s price. More specifically

the “percentage” rise in the stock price is important.

If the Rs.500 stock becomes worth Rs.540, then that is a 8% rise. This 8%

rise only makes us Rs.40. On the other hand when we invest the same

Rs.500 in the 50paise stock and the stock price goes up to Rs.1, it is a 100%

rise as the stock price has doubled. This 100% rise makes us Rs.500.

The point is that when picking a company, we are interested in a company

whose stock price will rise by a large percentage.

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Please note: Looking at the above paragraphs, it may seem like a good idea

to buy all the really cheap 50paise and Rs.1 stocks hoping that their price

will rise by 100% or more. This sounds good, but it can also be really really

bad some times! These really small stocks are very volatile and unless you

know what you are doing, do NOT get into them.

However, the point to be noted is that we are interested in stocks that will

have the highest % rise in the stock price. Now the question is, how do you

compare stocks. How do you compare a stock worth Rs.500 to a stock worth

50paise and figure out which one will have a higher percentage rise.

How do you compare two companies that are in different fields and

different industries? How do you know which one is fundamentally strong

and which one is week?

If you try to compare two companies in different industries and different

customers it is like comparing apples and elephants. There is no way to

compare them!

So fundamental analysts use different tools and ratios to compare all sorts

of companies no matter what business they are in or what they do!

Next let us get into the tools and ratios that tell us about the companies and

their comparison....

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Table Of Contents

1. What are stocks?

2. Why do companies issue stocks?

3. What causes stock prices to change?

4. What are the Sensex and the Nifty?

5. 3 important things that every investor MUST remember!!

6. How to decide which stocks to buy?

7. Basics of fundamental analysis!

8. Earnings per share (EPS) ratio and what it means?

9. Price to earnings (P/E) ratio and what it means?

10. PEG ratio and what it means?

11. Inflation and how it silently eats your money!

12. Brokerage and taxation…

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