Fundamental Analysis 102

I had to call this 102 because I have already dealt with ‘what if fundamental analysis’ in the past. Also FA starts with knowing that there is a PnL, B/Sheet, MDA (Management discussion and Analysis) to start with. Of course there are ratios to be calculated, cash flow statement to be seen…etc. Now let us move to the next step.

When it comes to making investment decisions, you have to be guided by more than just your gut instincts. Properly used and implemented effectively, fundamental analysis is the most useful way to determine whether a company is a good investment choice. People like Warren Buffett, Peter Lynch, Vallabh Bhansali, Rakesh Jhunjhunwala, Naren Sankaran, Prashant Jain,….have all reached great heights by using FA as the first step. So even if you don’t have a finance background, this is a good place to start.

When it comes to share price analysis (largely mean whether to buy or sell, and at what price), there are two main schools of thought: Fundamental analysis and technical analysis. Fundamental analysis is about using published information about a company’s business to try to find the real value of a share, while technical analysis is in favor of looking at the way pure market factors will affect a share’s price  movement. TA looks at the price – volume relationship and uses past data to predict future movements.

Why is it called fundamental analysis? It can be fundamental to your ability to make money in the equity market!!

When you take a look at a company’s fundamentals, you are trying to judge its corporate health.

Financial statements are integral to fundamental analysis since they provide you with the numbers you’ll make use of in your analysis. Please see the posts that I have done on Accountancy and Investing series.

But numbers are not everything. It is just the starting point in fundamental analysis. In addition to quantitative performance measures, companies provide investors a lot of qualitative information as well. In every public company’s annual report, management has an opportunity to explain their performance (or lack thereof) over the past year as well as plans for the future. This is called MDA – Management Discussion and Analysis! Do have a look at that – preferably for the past 2/4 years to see if they have done what they have said that they will do. Also see if they have taken responsibility for what has happened. Have they taken the blame or blamed the whole world for what went wrong!

When you hear about a company’s fundamental performance, its share price is not what we are talking about! In FA, performance refers to the efficiency with which a company moves toward its goals. It also sees whether the company is focused in its asset allocation – is it allocating to what it says in the MDA and Directors’ report. The degree of that performance is what we use to categorize a company as healthy or a waste of our time and effort in pursuing out goals. Depending on what criteria you’re looking at, performance can be measured in a number of ways. Ability to generate a profit is a good and sensible measure and a great starting point to go ahead with even looking at a company.

However, if you want to be more specific in your assessment, you can be.

If you want to check the performance of certain assets, then you would want to look at a metric like return on assets (ROA).

If you want to see if the debtors are paying on time, you could see the debtors turnover ratio.

There are several numbers and ratios that can be used to gauge a company’s performance.

Metrics like the price-to-earnings ratio, earnings per share and gross margin are all useful in determining a company’s relative health.

But remember, those are just the starting points 🙂

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