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Fundamental analysis

What is Fundamental Analysis?

  • Fundamental Analysis (FA) is a holistic approach to study a business. When an investor wishes to invest in a company for the long term (say 3 – 5 years), it becomes truly essential to understand the business from various perspectives.
  • It is critical for an investor to separate the daily short term noise in the stock prices and to concentrate on the underlying business performance. Over the long term, the stock prices of a fundamentally strong company tend to appreciate, thereby creating wealth for its investors.
  • Ex: Infosys Limited, TCS Limited, Eicher Motors, Bosch India, Nestle India etc. these companies have delivered on an average over 20% compounded annual growth return (CAGR) year on year for over 10years.
  • To give you a perspective, at a 20% CAGR the investor would double his money in roughly about 3.5 years.
  • Higher the CAGR faster is the wealth creation process.
  • Companies such as Bosch India Limited have delivered close to 30% CAGR. Therefore, you can imagine the magnitude and the speed at which wealth created if one would invest in fundamentally strong companies.

  • Ex: of wealth destructors like Reliance power.

  • So you can separate the investment-grade companies which create wealth from the companies that destroy wealth.
  • Investment-grade companies have a few common attributes that set them apart. Likewise, all wealth destructors have a few common traits which are visible to an astute investor.

A common misconception about fundamental analyst:

  • A common misconception is that only chartered accountants and professionals from commerce background can be good fundamental analysts, this is not true.
  • To become a fundamental analyst, you will need simple skills.
  • Understanding the basic financial statements.
  • Understand businesses concerning the industry in which it operates.
  • Basic arithmetic operations such as addition, subtraction, division, and multiplication.

What is Technical Analysis?

  • Technical Analysis is a research technique to identify trading opportunities in the market based on the actions of market participants. The activity of market participants can be forecast using a stock chart. Over time patterns are formed within these charts, and each pattern conveys a specific message. The job of a technical analyst is to identify these patterns and develop a point of view.
  • Like any research technique, technical research stands on a bunch of assumptions. As a technical analyst, you need to trade the markets, keeping these assumptions in perspective.
  • Also, at this point, it makes sense to throw some light on a matter concerning FA and TA. Often people get into the argument that contending a particular research technique is a better approach to the market. However, in reality, there is no such thing as the best research approach. Every research method has its merits and demerits. It would be futile to spend time comparing TA and FA to discover which is a better approach.
  • Both techniques are different and not comparable. A prudent trader would spend time educating himself on both the skill so that he can identify great trading or investing opportunities.

Technical Analysis vs Fundamental Analysis:

  • Technical Analysis (TA) helps you garner quick short term returns. It helps, you time the market for a better entry and exit.
  • However, TA is not a useful approach to create wealth.
  • Wealth is created only by making intelligent long term investments.
  • However, both TA and FA must coexist in our market strategy.
  • To give you a perspective, Look at the below chart of Eicher Motors:

  • Let us say a market participant identifies Eicher motors as a fundamentally strong stock to invest and therefore invests his money in stock in the year 2006.
  • You can see the stock made a relatively negligible move between 2006 and 2010.
  • The real move in Eicher Motors started only from 2010.
  • It also means FA based investment in Eicher Motors did not give the investor any meaningful return between 2006 and 2010.
  • The market participant would have been better off taking short term trades during this time. Technical Analysis helps the investor in taking short term trading bets.
  • Hence both TA & FA should coexist as a part of your market strategy.

 Tools to Analyze FA:

  • Annual report of the company, All the information that needed for FA is available in the annual report.
  • Industry-related data, You will need industry data to see how the company under consideration is performing concerning the industry.
  • Access to the news, Daily News helps you stay updated on the latest developments happening both in the industry and the company you are interested within.
  • MS Excel – It can be beneficial in fundamental calculations.

What is an Annual Report?

  • The annual report (AR) is a yearly publication by the company.
  • Published by the end of the Financial Year, and all the data made available in the annual report is dated to 31st March.

What to look for in an Annual Report?

  • The annual report has many sections that contain useful information about the company.
  • So you need to know how to read an annual report. Running through every page of an AR is not practical.
  • So you have to understand what information is required and what information we can ignore.

 Conclusion:

  • The fundamental analysis used to make long term investments.
  • Investments in a company with, good fundamentals create wealth.
  • Using Fundamental Analysis one can separate an investment-grade company from a junk company.
  • All investment-grade companies exhibit a few common traits. Likewise, all junk companies exhibit common traits.
  • Fundamental analysis helps the analysts identify these traits.
  • To become a fundamental analyst, one does not require any exceptional skill. Common sense, basic mathematics, and a bit of business sense is all that is required.
  • Tools for FA are generally simple most of these tools are available for free.
  • Technical Analysis is a popular method to develop a point of view on markets. Furthermore, TA also helps in identifying entry and exit points.
  • Technical Analysis visualizes the actions of the market participants in the form of stock charts.
  • Patterns formed within the charts and these patterns help a trader identify trading opportunities.
  • TA works best when we keep a few core assumptions in perspective.
  • TA is best to figure out short terms trades.
  • Both Technical analysis and fundamental analysis should coexist as a part of your market strategy.

 

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