Fundamental Analysis

Last Updated on June 9, 2022

Fundamental analysis is the comprehensive review and analysis of both micro and macro-economic factors which might affect the value of the securities in capital markets. The review consists of an analysis of the factors of the overall economy of a country, industry, and the company which influences the value of securities.

Investment decisions are made on the basis of the result of the analysis. Generally, fundamental analysis is made by the security analysts to determine the intrinsic value of the business and its financial strength. On the basis of these business values investment for long-term is made.

Approach to Fundamental Analysis

Basically, the fundamental analysis consists of two main approaches i.e. Top-down approach and the Bottom-up approach.

Top-down approach

This approach applies when the security analysts begin analyzing first the economy of the country, then industry analysis and company analysis. So, basically, the perspective is to start with the large section and then descend to the smaller sections.

Top-Down Approach

Bottom-up approach

On the contrary, this approach applies when the security analysts begin with company analysis, industry analysis, and economic analysis. Here the perspective is to start with a smaller sections and then ascend to the larger section.

Bottom-Up Approach

In both the approaches wide range of factors influencing the economy, industries and the companies are studied and analyzed.

Factors Affecting Economy

1. Gross Domestic Product (GDP)

2. Consumer Price Index (CPI)

3. Inflation

4. Interest Rates

5. Government Policies

6. Employment/Unemployment Rates

7. Capital Markets

8. Tax Rates

9. Global Influence

10. Market Sentiments

The economy of a country can be affected by a broad range of factors and the analysis depends upon the objective and choice of the analysts.

Factors Affecting Industries

1. Availability of Raw materials

2. Nature of Product

3. Industry Life Cycle

4. Industry Structure

5. Government Policies

6. Competitors

7. Cost Structure

8. Climate

9. Technology

10. Availability of Workforce

There are numerous factors that might affect the industries or particular industries. The analysis of the various factors depends upon the objectives and choice of the analysts.

Factors Affecting Company

1. Availability of Resources

2. Capital Structure

3. Financial Performance

4. Competitors

5. Credit Cycle

6. Management of the Company

7. Work Culture

8. Growth Rate

9. Corporate Social Responsibility

10. Business Risks

Company analysis is the main component of the fundamental analysis as security analysts will be able to estimate the intrinsic value of the business and its stocks. The depth of analysis depends upon the objective, financial knowledge, and understanding of the analysts.

Fundamental Analysis Types

Basically, fundamental analysis is divided into two types i.e.

a. Qualitative

b. Quantitative

Qualitative analysis

It is based upon the judgment and understanding of the security analyst. This type of analysis is made to understand reasoning and performance on the basis of ones on the ability to define a particular aspect. These aspects cannot be defined in numeric values so, the assessment solely depends upon reasoning and judgment.

Examples: goodwill in the market, management quality, customer satisfaction, corporate governance, ease of access in the industry, growth expectations, stakeholders wealth creation, etc.

Quantitative analysis

It is based upon numeric values. Historical data is collected from the financial statements of the company and from other published sources. On the basis of these collected data, comparative analysis and predictions will be made to review the economic conditions, industry, and company performance.

Fundamental analysis for stocks

A quantitative analysis of a company is made means the security analysts are examining the company’s historical data and past performance to find out the intrinsic value of the company’s stocks. On the basis of evaluation analysts will be able to determine whether the share price of the company is undervalued or overvalued and on that basis investment in the company’s stocks is made.

There are many ways to evaluate the performance of the company. Some are as follows:

1. Ratio Analysis

2. Review of Profit and Loss statement

3. Review of Company’s Balance Sheet

4. Cash-flow and Fund-flow Statement Analysis

5. Dupont Analysis

6. Variance Analysis

7. Annual Growth Rate (AGR) & Compound Annual Growth Rate (CAGR)

Conclusion

Fundamental analysis is made to facilitate long-term investment decisions. The whole analysis of the economy, industry, and company consumes a significant amount of time and understanding in areas of finance, statistics, economics, and mathematics is required. As a result of the analysis, an intrinsic value of the business has been derived that help to make long-term investment decisions.

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1 thought on “Fundamental Analysis”

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