Equity Investments are subject to market risk, please invest with caution”, you must have read / heard this or similar disclaimer many a times. All of us want to understand equity markets. All of us want to multiply our money in very short period of time. You must have read so many success stories where people made huge profits via equity investments, but what you might not have read is the failure stories. Equity market is full of opportunities yet one has to be extremely careful and analytical. First we must discuss fundamental analysis.
All those who want to make investments in equity or shares understanding “Stock Picking” is of utmost importance. There are two main methods of “Picking a stock”
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- Fundamental Analysis and
- Technical Analysis.
The fundamental analysis focuses on “Value Investing” whereas technical analysis focuses on “Timing”. There is a common belief, which is more or less true also – “No one can time the market”. That means it is next to possible to buy a share when it’s at the lowest price and to sell the share when it is at the highest price. Hence one has to buy and sell the share based on investment objectives and for a target gain. Hence, we limit our discussion in this article to Fundamental Analysis only.
Fundamental analysis, as the name suggests, is the analysis of Basics of a Company, Industry and Economy. It is also called EIC analysis i.e. Economy, Industry and Company Analysis.
Any investor who wants to invest his money in stock market, i.e. shares must first be confident about the opportunities offered by the Economy. The first step in equity investment is to understand the direction the economy is headed to or the cycle or the stage in which the economy is. Say for example at present Indian Economy is around US$ 2.5 Trillion in size and expected to double to US$ 5 Trillion by year 2025. Similarly per capita income of the Indians is expected to cross Rs. 1,00,000 per annum in 2017. This growth rate of GDP of 7-8% per annum offers a huge growth opportunity for the equity markets. There might be some seasonal hiccups but there is no stopping for Indian Economy to become the 3rd largest economy globally. This broad analysis of the economy helps the investors to make investment decisions. Since the economy is all set to grow, one can decide to make fresh investments in the equity market or can continue to hold his investments with a little bit of reshuffle.
Every stage of an economic cycle offers different kind of opportunity and threat for investors. People those who have made a fortune in the stock market, have been able to understand these better than others.
Also read: What is Fundamental valuation of Stocks?
Other economic, social and political environmental factors are also need to be understood with respect to what they hold for future. Say for example political stability in the nation, changes in demographic patterns, growth rate of population, change in customs, fashion and life style of people, change in technology, status of basic infrastructure facilities etc. All these ‘external environmental’ factors are beyond the control of the investors. An investor has to adjust his/her portfolio of investments according to these factors. All this forms the part of fundamental analysis.
Once you have seen the direction of the economy, next is to analyze different “Industries” or “Sectors”. The companies are clubbed into homogenous groups commonly referred to as “Industry” or “Sector” i.e. Infrastructure Sector, Automobile Industry, Glass Industry, Banking and Financial Services Sector, Pharma Industry, Healthcare sector etc.
It is not necessary that all the sectors perform in same manner at a given point in time. Certain sectors or industries will outperform other sectors, whereas some sectors will remain laggard for certain period.
In a country every ruling party has focus on certain industries based on its poll promises or election manifesto. Also political party’s priorities may change from time to time, depending upon internal and global factors. Hence it is important for the investors to analyze the industries which – 1. Will grow in next 2-5 years at very high rate or might experience accelerated growth; 2. Will grow at a normal rate or may tend to decline or slow down over a period of 3-5 years and 3. Will slow down substantially or might experience serious losses in near future.
This industry analysis will help the investor to decide the sectors where to put fresh money, where to hold the investment and where to exit, i.e. ‘adjust the portfolio’.
Say for example the present Central Government in the country has a mandate of “Housing for all by 2022”. It is expected that between 2018 to 2024 approximate 60 million affordable houses worth US$ 1.3 trillion will be constructed. How does this affect various industries? Cement, steel, construction and construction equipment companies, housing development companies will see a high direct growth. A new opportunity comes in the form of “Pre-fabricated” low cost houses. The companies developing such low cost housing might see “Super Normal Growth” in next three to five years. Industries like tyres, lubricants, facility management will see indirect growth due to implementation of above.
Once industries or sectors are identified for fresh investment, hold or exit, one needs to analyze the individual companies forming that industry. Each company may not be having same strengths or weaknesses. Every company in a particular industry has its unique characteristics due to various quantitative and qualitative parameters. These organization specific characteristics will decide the investment decision in that particular company.
For example the growing Indian middle class and it’s growing per capita income offers a huge opportunity for automobile companies. But every automobile company is not able to encash this opportunity. On one hand companies like Maruti Suzuki India Limited and Mahindra & Mahindra are doing extremely well, on the other hand MNC giants like General Motors and Ford are struggling in the same Indian market.
The internal factors relating to a company decide the future of one’s investment. Quality of Management, Technological Factors, Capital Structure, Cost of Capital, Profit Potential of the offerings of the company, Market Share, Installed Capacity and Capacity Utilization, Human Resources, Distribution Network, Growth of Revenue, market share, gross profit and net profit etc are some of the parameters one needs to analyze for making an investment decision. The published statements of the companies i.e. Annual Reports help in understanding and comparing the Vitals. Simple statistical tools like Ratio Analysis are employed to analyze and compare the financial information. Though past performance may not be guarantee for the future performance, but it gives a fair idea about the company. It helps make you an Informed Decision about your investments.
Fundamental Analysis helps one avoid ‘playing the blind’ or ‘shooting in the dark’. As the ace investor Mr. Warren Buffet says “Buy a business, don’t rent stocks”. This one line is enough to understand the importance of Fundamental Analysis.
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