Fundamental Analysis
• Introduction
• Investor’s mindset
• Annual report reading
• P&L statement
• Balance sheet
• The cash flow
• The financial ratio
• Investment due diligence
• Equity research
• DCF primer
• Notes
1.1 – Overview
Fundamental Analysis (FA) is a comprehensive method of business analysis. It becomes crucial to comprehend a firm from multiple angles when an investor wants to invest in it for the long term (let’s say 3 to 5 years). It is crucial for an investor to focus on the underlying business success rather than the daily, short-term noise in the stock prices. In fact, A fundamentally sound company’s stock prices often increase over time, generating wealth for its investors.
However, Such instances abound in the Indian market. One can consider businesses like Infosys Limited, TCS Limited, Page Industries, Eicher Motors, Bosch India, Nestle India, TTK Prestige, etc. as a few examples. For more than ten years, each of these businesses has produced an average compounded annual growth return (CAGR) of above 20 percent. To give you an idea, at a 20 percent CAGR, the investor would double his money in around 3.5 years. The wealth growth process moves more quickly a higher the CAGR. Some businesses, like Bosch India Limited, have produced CAGRs close to 30%. You may therefore envision the size and rate at which money might be created if one were to invest in fundamentally sound businesses.
Here are long-term charts of Bosch India, Eicher Motors, and TCS Limited that can set you thinking about long-term wealth creation. Do remember these are just 3 examples amongst the many that you may find in Indian markets.
You could be thinking at this point that I am prejudiced because I only show charts that are visually appealing. You might be curious to see what Suzlon Energy, Reliance Power, and Sterling Biotech’s long-term charts would look like.
Undoubtedly, These are only three of the many money destroyers you could encounter in Indian markets.
Separating investment-grade businesses that build money from those that destroy it has always been the trick. All investment-grade businesses share a few distinguishing characteristics that make them unique. Similarly, all wealth destroyers share a few characteristics that are obvious to a discerning investor.
By assisting you in recognizing these characteristics of organizations that create wealth, fundamental analysis is a strategy that provides you the confidence to invest for the long term as well.
1.2 – Can I be a fundamental analyst?
You can be, of course. It is a frequent misperception that only those with backgrounds in commerce and chartered accounting can be effective fundamental analyzers. This is completely untrue. To make sure that 2 and 2 equal 4, a fundamental analyst adds them together. You’ll need the following core abilities to work as a fundamental analyst:
- Recognizing the fundamental financial statements
- Learn about industries from which enterprises operate.
- Addition, subtraction, division, and multiplication are fundamental arithmetic operations.
At last, The goal of the Fundamental Analysis module is to make sure you acquire the first two skill sets.
1.3 – I’m happy with Technical Analysis, so why bother about Fundamental Analysis?
Firstly, You can quickly and easily make short-term returns using technical analysis (TA). It aids in market timing for better entry and exit. However, TA is a poor strategy for generating wealth. Only wise long-term investment decisions can lead to wealth. However, your market approach must incorporate both TA and FA.
Let’s imagine a market participant decides in 2006 to invest his money in Eicher Motors after determining it to be a fundamentally sound stock to do so. You can observe that between 2006 and 2010, the stock’s movement was comparatively minimal. Only in 2010 did Eicher Motors begin to actually move forward. This also suggests that between 2006 and 2010, an FA-based investment in Eicher Motors did not generate any substantial returns for the investor. It would have been wiser for the market participant to engage in short-term trading at this time. The investor can place short-term trading bets with the use of technical analysis. Therefore, as part of your market strategy, both TA and FA should coexist. In reality, this introduces us to a crucial capital allocation method known as “The Core Satellite Strategy”.
A market participant, let’s say, has a corpus of Rs. 500,000. This corpus can be divided into two halves that aren’t equal; for instance, the split could be 60 to 40. The essential strength of the 60 percent of capital, Rs 300,000, can be invested for a long time. The core of the portfolio is made up of this 60% of the investments. The core portfolio should expand by at least 12 to 15 percent CAGR on an annual basis.
weighing in You can use Rs. 200,000, or 40% of the total, for active short-term trading on stocks, futures, and options utilizing technical analysis. Every year, the Satellite portfolio should produce an absolute return of between 10% and 12%.
1.4 – Tools of FA
The majority of the basic tools needed for fundamental analysis are free to use. You would require the following specifically:
- The business’s yearly report The yearly report contains all the data you require for FA. The annual report is freely downloadable on the business’ website.
- Industry-specific data To determine how the company under consideration is performing relative to the industry, you will require industry data. Basic information is normally supplied for free on the website of the industry’s association.
- Having access to news You may keep up with the most recent advancements in your industry and the firm you are interested in with the help of Daily News. You may stay informed by using Google Alert or a decent business publication.
MS Excel – While not free, MS Excel can be very beneficial for simple computations.
One can create a basic analysis that can compete with institutional research using just these four tools. You can take my word for it when I claim you don’t need any other equipment to conduct sound fundamental research. In reality, the goal is to maintain the research rationale and clear even at the institutional level.
CONCLUSION
- First of all, Investments with a lengthy time horizon are made using fundamental analysis.
- Next, Wealth is created by investing in a firm with strong fundamentals.
- An investment-grade company can be distinguished from a junk company using fundamental analysis.
- There are some characteristics that all investment-grade companies share. Similarly, all rubbish removal businesses have characteristics.
- Analysts can recognize these qualities with the aid of fundamental analysis.
- As part of your market strategy, technical analysis and fundamental analysis should coexist.
- One doesn’t need any specialized knowledge to become a basic analyst. All that is needed is a little bit of business savvy, some common sense, and elementary math.
- A wise market strategy is to allocate money using a core-satellite technique.
- The majority of the basic tools needed for FA are free to use and are available online.
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