Fundamental analysis is the study of a company’s financial strength, based on historical data; sector and industry position; management; dividend history; capitalization; and potential for future growth. It is a stock valuation method that uses financial and economic analysis to predict the movement of stock prices. The analysis attempts to find the intrinsic value of a security that helps investors to make decisions. The fundamental information that is analyzed can include a company's financial reports, and non-financial information such as estimates of the growth of demand for products sold by the company, industry comparisons, and economy-wide changes, changes in government policies etc. The various steps involved in the fundamental analysis are:
1. Macroeconomic analysis, which involves considering the overall health of the economy and its future. 2. Industry analysis, which involves the analysis of the industry in which the company is operating. 3. Situational analysis of the company, studying their business model, management, products and services, its current position, its future, etc. 4. Financial analysis of the company, which involves analyzing the financial statements like balance sheets, income statements, cash flows and ratios. 5. Valuation, which attempts to find the intrinsic value of the securities of the company. The approach to fundamental analysis is often referred to as E-I-C Approach. The E-I-C denotes the three parts of the fundamental analysis. The three distinctive parts of fundamental analysis are: 1. Economic Analysis
2. Industry Analysis and
3. Company Analysis
Economic analysis is the analysis of forces operating the overall economy a country. It is a process whereby strengths and weaknesses of an economy are analyzed and is important in order to understand exact condition of an economy. The various factors considered are: The Economic Cycle
Countries go through the business or economic cycle and the stage of the cycle at which a country is in has a direct impact both on industry and individual companies. It affects investment decisions, employment, demand and the profitability of companies. It is very important to determine the stage of the cycle into which the economy is passing through. The four stages of economic cycle are depression, recovery, boom and recession.
Investors should attempt to determine the stage of the economic cycle the country is in. They should invest at the end of a depression when the economy begins to recover, and at the end of a recession. Investors should disinvest either just before or during the boom, or at the worst, just after the boom. Investment and disinvestments made at these times will earn the investor the greatest benefits.
The Political Equation
A stable political environment is necessary for steady, balanced growth. If a country is ruled by a stable government which takes decisions for the long-term development of the country, industry and companies will prosper. Foreign Exchange Reserves
A country needs foreign exchange reserves to meet its commitments, pay for its imports and service foreign debts. If the reserves are not managed properly it may pose foreign exchange risks. Foreign Debt and the Balance of Trade
Foreign debt, especially if it is very large, can be a tremendous burden on an economy. India pays around $ 5 billion a year in principal repayments and interest payments. Inflation
Inflation has an enormous effect in the economy. Within the country it erodes purchasing power. As a consequence, demand falls. If the rate of inflation in the country from which a company imports is high then the cost of production in that country will automatically go up. Interest Rates
A low interest rate stimulates...