Fundamental Analysis 12.docx

Fundamental analysis What is Fundamental Analysis Fundamental analysis is a method of evaluating a security in an attempt to assess its intrinsic value, by examining related economic, financial, and other qualitative and quantitative factors. Fundamental analysts study anything that can affect the security's value, including macroeconomic factors (e.g. economy and industry conditions) and microeconomic factors (e.g. financial conditions and company management). The end goal of fundamental analysis is to produce a quantitative value that an investor can compare with a security's current price, thus indicating whether the security is undervalued or overvalued.

Understanding Fundamental Vs. Technical Analysis Fundamental analysis determines the health and performance of an underlying company by looking at key numbers and economic indicators. The purpose is to identify fundamentally strong companies or industries and fundamentally weak companies or industries. Investors go long (purchasing with the expectation that the stock will rise in value) on the companies that are strong, and short (selling shares that you believe will drop in value with the expectation of repurchasing when at a lower price) the companies that are weak. This method of security analysis is considered to be the opposite of technical analysis, which forecasts the direction of prices through the analysis of historical market data, such as price and volume.

The Basics of Fundamental Analysis Fundamental analysis uses real, public data in the evaluation a security's value. Although most analysts use fundamental analysis to value stocks, this method of valuation can be used for just about any type of security. For example, an investor can perform fundamental analysis on a bond's value by looking at economic factors, such as interest rates and the overall state of the economy. He can also look at information about the bond issuer, such as potential changes in credit ratings. For stocks and equity instruments, fundamental analysis uses revenues, earnings, future growth, return on equity, profit margins, and other data to determine a company's underlying value and potential for future growth. In terms of stocks, fundamental analysis focuses on the financial statements of the company being evaluated. One of the most famous and successful fundamental analysts is the so-called "Oracle of Omaha," Warren Buffett, who is well known for successfully employing fundamental analysis to pick securities.

An Example of Fundamental Analysis Even the market as a whole can be evaluated using fundamental analysis. For example, analysts looked at fundamental indicators of the S&P 500 from July 4 to July 8, 2016. During this time, the S&P rose to 2129.90 after the release of a positive jobs' report in the United States. In fact, the market just missed a new record high, coming in just under the May 2015 high of 2132.80. The economic surprise of an additional 287,000 jobs for the month of June specifically increased the value of the stock market on July 8, 2016.

Fundamentals Fundamentals consist of the basic qualitative and quantitative information that underlie a company or other organization's financial and economic position. Ratio Analysis A ratio analysis is a quantitative analysis of information contained in a company’s financial statements. Quantitative Analysis (QA) Quantitative analysis (QA) is a technique that seeks to understand behavior by using mathematical and statistical modeling, measurement, and research. Risk Analysis Risk analysis is the process of assessing the likelihood of an adverse event occurring within the corporate, government, or environmental sector. Qualitative Analysis Qualitative analysis is a securities analysis that uses subjective judgment based on non quantifiable information, such as management expertise, industry cycles, and labor relations. Financial Analysis Financial analysis is the process of assessing specific entities to determine their suitability for investment.

Meaning of Fundamental analysis Fundamental analysis is really a logical and systematic approach to estimating the future dividends and share price. It is based on the premise that share price is determined a number of fundamental factors relating to the economy, industry and company. Since the economic fundamentals, Industry fundamentals and company fundamentals have to be considered while analyzing a security for investment purpose. Fundamental analysis is , in other words, a detailed analysis of the fundamental factors the performance of the company. Each share is assumed that to have an economic worth based on its present and future earning capacity. This is called its intrinsic value or fundamental value. The purpose of fundamental analysis is to evaluate the present and future earning capacity of a share based on economy , Industry and company fundamentals and thereby assess the intrinsic value of the share. The investor can then compare the intrinsic value of the share with the prevailing market price to arrive at an investment decision. If the market price of the share is lower than its intrinsic value, the investor would decide to buy the share as its underpriced. The price of such share is expected to move up in future to match with its intrinsic value. On the contrary, when the market price of the share is higher than its intrinsic value, it is perceived to be overpriced. The market price of such a share . fundamental analysis thus provides an analytical framework for rational investment decision-making. This analytical framework is known as EIC framework, or economic-industry –company analysis. Fundamental analysis insists that no one should purchase or sell a share on the basis of tips and rumors. The fundamental approach calls upon the investor to make his buy or sell decision on the basis of a detailed analysis of the information about the company, the industry to which the company belongs, and the economy. This results in informed investing. For this, a fundamentalist makes use of the EIC framework of analysis.

Economy-Industry-Company analysis framework

The analysis of economy, Industry and company fundamentals constitute the main activity in the fundamental approach to security analysis. These can be viewed as different stages in the investment decision-making process and be depicted graphically with three concentric circles .

The logic of this three tier analysis is that the company performance depends not only on its own efforts, But also on the general industry and economy factors. A company belongs to an industry and the industry operates within the economy . As such, industry and economy factors affect the performance of the company . The multitude of factors affecting the performance of a company can be broadly classified as: 1. Economy-wide factors such as growth rate of the economy, inflation rate, foreign exchange rate, etc. which affect all companies. 2. Industry –wide factors such as demand-supply gap in the industry, the emergence of substitute products, changes in government policy relating to the industry ,etc. These factors affect only those companies belonging to a specific industry. 3. Company-specific factors such as the age its plant , the quality of management , brand image of its products, its labour-management relations, etc. These factors are likely to make a company’s performance quite different from that of its competitors in the same industry. Fundamental analysis thus involves three steps:   

Economy analysis Industry analysis Company analysis

Let us see what each of these analyses implies.

Economic Analysis :Economic analysis involves assessing or examining topics or issues from an economist’s perspective. Economic analysis is the study of economic systems. It may also be a study of a production process or an industry. The analysis aims to determine how effectively the economy or something within it is operating. For example, an economic analysis of a company focuses mainly on how much profit it is making. Economists say that economic analysis is a systematic approach to find out what the optimum use of scarce resources is. Economic analysis involves comparing at least two alternatives in achieving, for example, a certain goal under specific constraints and assumptions. Economic analyses factor in the opportunity costs that people or companies employ. They measure, in monetary terms, what the benefits of a project are to the economy or community.

The performance of a company depends on the performance of the economy. If the economy is booming, incomes rise, demand for goods increases, and hence the industries and companies in general tend to be prosperous . on the other hand, if the economy is in recession , the performance of companies will be generally bad. Investors are concerned with those variables in the economy which affect the performance of the company in which they intend to invest