Monday, 27 February 2012

Pick The Right Stock: Fundamental Analysis

Sura Nualpradid
There are two ways of analyzing a stock, the technical ways and the fundamental ways.  Technical analysis is more of Traders way. Traders focus on technical parameters like support, resistance, etc for   stock picking. Fundamental analysis is more of Investors way of stock picking. One can say Fundamental analysis or Value investing go hand in hand.
Before we dive deep into details of fundamental analysis, let’s try to understand fundamental analysis from laymen perspective. An example should help in easy understanding.   Example: Tata NANO” The One Lakh Rupee Car”, everybody knew company was going to increase the price very soon.  This means that one lakh is good price, anything lesser than this is better.
If in case under some scheme or festival offer, you are able to grab NANO at  may be 25K lesser than one Lakh or in other words if you are able to buy NANO at  75k, then one can say you brought it at best offer. You were able to get it at undervalued price. Good Deal….  
Let us deep dive and see fundamental analysis in detail: Financial Gurus say Stock picking that is not based on fundamental analysis is Gambling. It cannot be considered as investing.
Let us look into the parameters that help in doing this Fundamental analysis:
·   Reputation of the company/Management: Reputation of the company is very important parameter when you are looking to invest you rmoney into a company.Long term investors invest money only in established companies with good reputation. A Bad Managed company can wipe out all your investment.
·    Company Size: Investors hunt for bigger companies.  Turnover of  5000 + crores is safe bet.
·    Competition or Competitors:  It is very important to be Market Leader. Investors are reluctant to invest money in company or sectors where there is huge competition. If competition is more than chances of profitability reduces.
·    Out Standing Debt or Cash Rich Company: Most companies have some debt. One should filter out companies that have big debt on their balance sheet.  Cash Rich or low debt companies have more potential to reward the investor.
·    Sales Figure: Increasing sales figure shows the sign of growth.
·    Investor Friendly:  Companies that pay rich dividends are termed as investor friendly. In addition to this one should watch out how informed investors are when Management is going for acquisition or planning to sell one of its divisions. An investor friendly company will always take their investors into confidence before going for a big change.
·    Customer Base : It is meaningless to invest in company that can produce but cannot sell. Companies with weak customer Base should be ignored. One should watch out for companies that have only Government organizations as customer base. With change in Government or policies such companies will be have severe impact on profitability
Some Thumb Rules: 
·    P/E Ratio:  Very important Parameter. Example should help in better understanding. Suppose Company “A” and Company “B” are two reputed car manufacturing companies of almost same size. If P/E ratio of “B” is lower than “A” then “B” then one can infer that “B” is undervalued. There are more chances of stock price of “B” appreciating relative to “B”. You should compare P/E in same sector. P/E of Manufacturing Company cannot be compared to P/E of IT Company.
·    EPS: Earning Per Share is very good indicators that can give you measure of companies health over a period of time. Example if data for last 15 years show that EPS has been consistently growing, it shows the company has been growing year on year.
·    Debt to Equity Ratio: Company with debt/ equity ratio <1 is termed to be good. Usually manufacturing company has this debt/equity ratio up to 2.  So a manufacturing company with debt/equity ratio < 1 is really good picking.
·    ROA: Return on Asset gives an indication on how well the Management is using its asset to generate earnings. Example if “A” company net income is 1 lakh and its total assets is 10 lakh and  “B” Company  net income is 1 lakh and its total asset is 5 lakh. Now both company have same net income but the asset used are different. Company “B” uses  lesser assets  hence ”B”  ROA is better than “A”
·    ROI:  In simple terms if the ROI is not positive one should avoid investing in it. In other words, if x amount invested in Company “A” would give you 100 rs gains where as if the same amount invested in Company “B” would give you 50 rs gains. One should invest in “A” and ignore “B” assuming the investment period is same and both companies are reputed and belong to same sector.   
·    Dividend Yield:  A company that has been giving consistent dividend is a better bet. This will give you a fair idea on your earnings. Dividend Yield of 5 to 6% is good.
To summarize, all the above parameters help you in evaluating the company’s financial health. The Mantra for investors is to buy stocks of financially healthy company at undervalued price. 

Are there any other evaluation parameters that could be added to the above list?


Gautam Pasupuleti said...

Good post on stock analysis. We are a firm believer in fundamental analysis and value investing methodologies. We have just launched our service for individual investors at Do check it out - would love to hear what you think.

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