If you really want to analyze stocks for investment, especially long-term, then you must know the basics to analyze a stock. For doing a fundamental analysis of the stock, all you need is some basic information about stocks and the company.
Becoming a pro in the stock market means sticking with the basics and get in and out of the market at the right time. Let’s first begin with the definition of fundamental analysis of a stock;
Fundamental analysis of a stock is used to determine the financial and business health of a company. It’s always important to perform a complete fundamental analysis of the stock before investing if you are planning for a long-term investment.
Beginners sometimes mix up the fundamental analysis with ‘Technical analysis’. Well, technical analysis is a sympathetic approach to find the entry and exit time stock for intraday trading or the short term. So, in the technical analysis, we look into charts, trends, and patterns.
However, fundamental analysis is the proper tool to get an in-depth look at a company and invest in that firm’s stock, which can give you good returns year after year.
So, we can say that fundamental analysis is a method of measuring a stock’s intrinsic value by examining related economic and financial factors. For this, you need to have a basic understanding of economics and finance.
If you are to do a fundamental analysis of a stock, you’ll study the factors that can affect the stock’s value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company’s management.
Before getting into the factors for doing the fundamental analysis of a stock, let’s briefly pick up the concept of fundamental analysis for a better understanding.
Investors use various types of stock analysis to determine whether a stock is correctly valued within the broader market. The basics of fundamental analysis are to express the originality of a stock and its price. If you’re a fundamental analyst, you would go through the stock from a macro to micro perspective.
The concept of fundamental analysis can easily be applied to any other security.
Let’s take an example of this. For instance, if you are to buy a bond from the market, you can perform fundamental analysis to evaluate bond’s value by examining the economic factors such as interest rates and the overall state of the economy, then studying information about the bond issuer, such as potential changes in its credit rating.
For stocks, the fundamental analysis uses revenues, earnings, return on equity, dividends, profit margin, future growth, and other statistics that determine a firm’s underlying value and potential for future growth. This data is pretty easy to find. What you have to do is just open the company’s website and go to the financial statements link. There, you’ll find all the required data.
The end goal of fundamental analysis is that investors can compare a stock’s current price in order to see whether the stock is undervalued or overvalued. And, the returns it will reap in the future!
The Basics of a company
The first and the most important thing is that you understand the company in which you are investing. If you cannot know what company you’re investing in, you won’t be able to decide whether the stock of that company will perform well or badly, it’s pure basics.
So, you need to have enough knowledge about the company in order to decide if you will be holding or selling the stock. So, it is important for you to understand the company. The simplest way to do is by making quick notes about the company by asking questing like what are its products and services, who are leading the company.e., founders and executives, management efficiency, and competitors, etc.
The easiest way to do this is by visiting the website of the company. There you can find all the relevant information, including products and services, top-level management, and financial statements.
Following this brief inspection of the company, if you understand the core of the firm, then you’re ready with the rest of the fundamental analysis of that company.
Once you’re done with the initial screening of the company, next you need to check the financials of the company, which include the balance sheet, profit-loss statements, cash flow statements, and comments of executives in the financial reports.
Some of the key financial metrics to look for which include revenue or sales, net profit, margins, and earnings per share. Comparing these factors with the last five years can be good enough to anticipate the upcoming results, excluding other economic factors.
Following that, you need to check the other financial indicators like operating cost, expenses, assets, liabilities, etc. There are financial risk ratios to measure risk, which include profitability ratios, liquidity ratios, solvency ratios, and valuation ratios. Another key factor to check is the total debt of a company.
It’s simple if you’re on an enormous debt you’ll not be able to fulfill your wants or maybe sometimes basic needs and you have to repay the debt and also pay the interest amount on the borrowed money before anything else. The same is the case with a company. The company cannot perform well and reward its shareholders if it has an enormous debt.
There are two key ratios to examine debt which include Debt-to-Equity (D/E) ratio and the Total-Debt-to-Total-Assets ratio.
The debt-to-equity (D/E) ratio is used to evaluate a company’s financial leverage and is calculated by dividing a company’s total liabilities by its shareholder equity. Whereas, Total-debt-to-total-assets is a leverage ratio that defines the total amount of debt relative to assets owned by a company.
The debt-to-equity ratio is an important metric used in corporate finance. In simple words, it reflects the ability of shareholder equity to cover all outstanding debts in the event of a business downturn. While total-debt-to-total assets ratio reflects the company’s leverage with that of other companies in the same industry. So, if the ratio is higher, it means that the leverage is higher. In simple words, it means investing in such a company’s stock is full of risk.
Always remember this thumb rule, invest in stocks of those companies with a debt-to-equity ratio of less than one. You can use this ratio in the initial screening of stocks or else check it while reading the financials of a company. Last but not the least, in this fast-moving world of technology, always consider the future prospects of the company while examining the investments of that company.
Therefore, always invest in a company with strong long future prospects. Select only those companies whose products or services will still be used twenty years from now.