CA Shefali Mundra
Are you new to the exciting world of trading and investing? Are you confused or anxious about selecting the right stocks? Well, it's an undeniable fact that money holds a peculiar place in everyone's life, and financial losses can bring life to a standstill. Investing your hard-earned money requires a thorough understanding of the industry and in-depth stock analysis.
Fundamental analysis is the most rewarding mechanism for analyzing the multitude of companies in Indian stock markets. Fundamental analysis measures the stock's intrinsic value by evaluating relevant economic, financial, and other quantitative & qualitative factors. Comparing a stock's intrinsic value with the current price, helps to determine whether the stock is currently undervalued or overvalued. For instance, REC Limited is currently quoted at a price of ₹108.15, while the stock's book value is ₹192.85, which shows that you can buy this stock in expectation of a price increase in the future.
Now, let's have a quick insight into how fundamental analysis is helpful for stock selection.
Analysis of Business Fundamentals
An in-depth understanding of the company is the foremost step toward analyzing a stock. Interestingly, there are over 7,400 companies listed on the Indian stock exchanges, and selecting the right stocks can be cumbersome. You need to identify and choose companies operating in your circle of competence. If you have decided on the company to invest in, you need to analyze the financial statements (Balance sheet, income statement, cash flow statement) to assess the company's financial position and business performance accurately. Financial statements provide a snapshot of the company's financial health, highlighting revenue, expenses, profitability, the status of assets & liabilities, and cash flows. Financial statement analysis is a key metric used to evaluate the future earning potential of any company.
Take a view of Promoter Shareholding
It is pertinent to note that promoters play a vital role in the overall growth and success of the company. Therefore, investors need to take a bird's eye view of promoters' shareholding before investing. Additionally, the trend of increase and decrease in the percentage of promoter holding is also significant. For instance, XYZ Limited has a promoter stake of 26%, which is lower than other companies operating in a similar space. However, the stake was 19% in the last quarter and 15% in the quarter before that. This increasing trend indicates growing promoter belief and interest in the company's growth and could be a good buy. Alternatively, the decreasing trend of promoter stakes can be a negative indication and may not be a good buy for investment. A consistent reduction in promoter shareholding could indicate a lack of confidence in the company's future.
Hence, promoter stakes are important numbers to assess a company's performance but should never be considered in isolation. The analysis should also consider financials, competitive position, management position, and other analysis before buying stocks.
Analyze the Earnings Trend
Earnings are a significant indicator of the financial stability and growth of the company. EPS is calculated to identify the state of profitability of a company.
EPS = Net Profit / Total number of outstanding shares of the company.
The higher the EPS, the higher the profitability of the company and vice-versa. Investors can choose stocks by comparing EPS with the stock price and gain insight into the company's future growth prospects.
Additionally, EPS is used in calculating the P/E ratio (Price-to-Earnings ratio), relating a company’s share price to its earnings per share. It helps in identifying whether the stock is overvalued or undervalued.
Stock Performance is Linked with Profitability
Profitability is of immense importance and a critical aspect of a company's existence. Before investing in a stock, an in-depth understanding of current and future profits is essential. The company's net profit is calculated after deducting all the manufacturing and operational expenses. Profitability ratios help in assessing business productivity through multiple channels.
For instance, EBITDA margin = (Earnings before interest, tax, depreciation, and amortization) /Total Revenue.
This ratio helps determine a company's profitability from operations.
Analyze the Company's Competitors
Today, in the 21st century, you have multiple investment options to consider. There is large-scale competition between the market players, and being proactive is imminent to make the right investment choice. For example, there is stiff competition between the telecom giants, Reliance and Airtel, wherein Reliance Jio is known as a disruptor of the Indian telecom industry, with a market share of 35%, and Airtel is standing strong with a market share of 31.5%. Even though Airtel has a low market share compared to Reliance Jio, it has successfully outperformed JIO on the wireless business front, with increased revenue and customers in Q42022. An effective financial analysis is essential before investing in stocks.
The company you plan to invest in should be ahead of its competitors. It should demonstrate strong credibility, better prospects, a good market share, and an ability to mitigate risks and maximize profits.
Prefer Dividend Paying Stocks for the Long-term
A dividend is a payment distributed by listed companies to their shareholders from their company's earnings. Dividends are calculated as a percentage of the face value of the share. For example, if the company with the face value of the share of Rs.10 declares a dividend of 20%, the dividend amount received by the investor would be Rs.2 per share. Dividend paying companies possess a substantial amount of cash and demonstrate strong potential for growth and development.
You should check the dividends in respect of the market price of the share.
Dividend yield = Annual Dividend / Current Stock Price.
Investors should choose higher dividend yielding stocks for capital appreciation.
The aspiration to attain future financial objectives is fulfilled by trading and investing in stock markets perpetually. The overall purpose of fundamental analysis is to identify companies with the potential to grow manifold in the future and provide investors with an opportunity for long-term investment.
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