What is fundamental analysis of a stock?

Before investing in any stock, you must know the basic details about the company.

If you invest in a loss-making company, you end up in loss. In India, 95% of people who invest and trade end up losing their money.

Decision-making is the most important aspect in the share market. But how do you make decisions?

When you invest your money, you must know about the company by conducting some research. These researches are technically called fundamental analysis of a stock.

What you will learn in this article?

In this article, you will learn the basics of fundamental analysis, how to pick a stock, and the technical terms you must consider before selecting a stock.

There are hundreds of reasons for a stock to perform well or not perform well. I am covering the 10 most important tips to analyse a company or a stock. By the end of the article, I hope you will gain knowledge about analyzing a stock. So let’s get into the topic.

Basics of Fundamental analysis

1.Global Economy and Nation's Economy

2.About your sector

3.Reputation

Before you start to invest in the share market, you must know how the global economy is performing and how well your nation is performing. If the world economy or your country's economy is not doing well, you will end up losing money even if you invest in a good stock.

For example, in 2019 and 2020, the entire global economy did not perform well due to the COVID-19 pandemic. Another typical example is Sri Lanka, where the entire nation's economy failed in 2023, leading to a huge crash. So, the global economy and your nation's economy contribute significantly to the value of your stock.

This is another important thing to consider before making a decision. You must know what kind of business the company is engaged in and how well the sector is performing throughout the country and worldwide. You should not invest in a company that operates in a loss-making sector.

I will give you some examples. Example 1: We all know the world is moving towards alternative energy sources and transitioning to pollution-free green energy. This means the world is moving away from coal energy. So, companies operating in coal mines and related sectors may not perform well in the future.

Example 2: Another excellent example is electric vehicle (EV) motors. We all know that electric cars are the future, and sooner or later, they will dominate the world. If you invest in a company that deals with petrol or diesel vehicles, they may not have great potential in the future.

So, understanding a sector is a very important aspect of investing. Therefore, try to conduct research about the company and its sector before making a decision.

After analyzing the economy and the sector, you must consider the company's reputation.

Before analyzing the statistical data, you must know who you are dealing with. So, you should research who owns the company and who the CEO is.

It is very important to know if the company doing legitimate business and does not involve any fraudulent activity.

Is the company's chairman a good person? What kind of brand value do they have among the people? What do people think about the company—is it viewed positively or negatively? How long have they been doing business in this sector?

You should also search for customer, client, and employee opinions of the company on social media or Google. If everyone speaks poorly about the company, you should consider that a red flag.

On the other hand, if the company has a good reputation among people, you can consider it a green flag.

For example, companies like TATA, Reliance, and Infosys have good reputations in the Indian market, while companies like PayTM and Adani Enterprises have a negative impression among people.

Analysing technical terms

4. Promoter's holding

Promoter's holding refers to the percentage of shares held by the company owner, chairman, or other top executives.

In simple terms, it indicates how much ownership control they have over the company. If the promoters own a higher percentage of shares, it typically suggests they have confidence in the company's future performance and profitability.

Conversely, if the promoter's holding is less than 50%, it may indicate that the company's top executives don't have strong belief in the company's prospects.

You can find this data by analyzing the company's balance sheet, which is usually available through a Google search. However, some companies, like Larsen and Toubro (L&T) and Infosys, may be exceptions to this pattern.

6. P/E ratio

You may come across or hear the term P/E ratio from financial experts. P/E ratio stands for Price to Earnings ratio. The P/E ratio is calculated by dividing the market value per share by earnings per share. There are numerous online calculators available to find the P/E ratio, and you can also find this data in the balance sheet.

What is the use of the P/E ratio? The P/E ratio helps determine whether a stock is undervalued or overvalued. Sometimes, even a poorly performing company may see its stock price rise due to positive global economic and sector performance. To ascertain if the company is truly performing well, you should examine the P/E ratio.

If the P/E ratio is too high, it indicates that the stock is overvalued, meaning people are buying the stock rather than selling, causing the stock price to increase. Companies with high P/E ratios tend to undergo corrections sooner or later, so it is not recommended to invest in such stocks.

If you still want to invest in an overvalued stock because you believe it is a good company, you should wait for the correction to occur and then invest when the stock reaches a more reasonable price.

As legendary investor Warren Buffett said, the best investment idea is to buy a stock at a fair price. Therefore, you should avoid purchasing stocks that are overpriced.

A stock with a P/E ratio of less than 18 is considered a safer investment, while a ratio between 18 and 25 is considered a fair price. Anything above that is considered an overvalued stock.

5. Company's Debts

You should assess the level of debt a company has. All companies typically have debts as they borrow money from banks for new projects and business endeavors. It's natural for a company to have debts.

However, if a company has excessive debts, it may not be a good investment opportunity. But how do you determine if a company's debt level is normal or excessive?

On the balance sheet or through a Google search, look for a term called Debt to EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). For example, Debt to EBITDA of TCS.

I won't delve into technical terms too much, but if the Debt to EBITDA ratio is more than 3%, it indicates that the company has too much debt, which is a red flag for investment.

7. Past Performance

Analyzing the past performance of a company is also an important aspect of fundamental analysis.

You should have the last 3 to 5 years' balance sheets of a company, which you can find on Google. Look at factors such as net income after taxes, debt to equity ratio, return on investment (ROI), and dividend yield.

If you observe that the net income has increased every year, along with a consistent dividend yield and ROI, and a stable debt to equity ratio, it indicates that the company is strong in its fundamentals.

Additionally, examine the candlestick chart of the company and observe the percentage increase in share price every year. If you find consistent profits over the past 6 years and the current price is fair, it may be a good opportunity to invest in that company.

Keep in mind that there are thousands of technical terms and data available to analyze a company's past performance. I have highlighted some important data points for analysis.

As you gain more knowledge and experience in this field, you can explore other technical terms such as operating costs, standalone and consolidated reports, PEG ratio, etc., for a more accurate analysis of a company.

Other Important Analysis

8. Competitors

When you invest in a company, you become a partner in that company, which means if the company fails, you may lose your investment.

Therefore, after conducting research on your chosen stock, it's essential to analyze the stocks of competitors. Understanding the companies you are competing with is crucial.

Analyze both competitors and industry leaders. If you find that competitors have better projects and brighter futures, you should take this into consideration before making an investment decision.

If you find a good stock, you should search for a better one. If you find a better stock, you should aim for the best one.

For example, when Paytm launched in India around the same time as Google Pay, its main competitor was Gpay. Since Paytm was up against a formidable competitor, it struggled to compete and ultimately faced challenges in retaining its business in India.

9. Latest News and Upcoming projects

Developing a habit of reading financial news every day plays a vital role in an investor's life.

Many of us may not have an educational background related to finance or economics, making it challenging to start as an investor as a beginner.

However, it's not an impossible task. Consistently reading financial news and watching programs related to finance can help you better understand economics.

Staying updated every day in this field is crucial, and you must read news about the company you are considering investing in.

Mainstream media or the company's official website often announce the company's future projects. If a company has a clear vision for the future, it is more likely to generate profits

.Following mainstream media and financial experts on social media can help you stay updated with relevant information.

10. Perfect plan and execution

You should have a clear vision before investing, as everyone does not have the same financial background.

Some individuals may have limited funds to invest, while others may be able to invest larger sums over a longer period. It is essential to formulate a proper plan before investing.

Decide whether you will invest in the stock market or other investment options such as gold, bonds, or mutual funds.

If you opt for the stock market, determine whether you will invest in a single sector or multiple sectors.

Once you've selected the sectors, decide how many companies you will invest in and allocate your funds accordingly. Consider which companies will receive more significant investments.

Decide on the amount of money you will invest each month and determine the duration for holding your stocks.

Having a well-defined plan and clear vision before investing is crucial for success.

Important links

Conclusion

I hope this article provides you with some knowledge about investing. Please use it as a reference and conduct your own research before making any investment decisions. Remember, you are investing your hard-earned money, so it’s essential to invest it wisely. If you have any doubts or need clarification about our content, feel free to contact us. Thank you for reading the article, and have a great day!

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