When you invest money in the stocks of a company, fundamental health of that company is always among the most important factors to consider. Fundamental analysis is a primary step towards a successful investing journey in stock market. In this article, we will discuss about fundamental analysis in general and the the role of Fundamental Analysis in Stock Market Investing.

What is Fundamental Analysis in Stock Market Investing?

Fundamental analysis is a type of financial analysis in which a company’s basic financial health is analyzed and evaluated. With fundamental analysis, an investor can look deeper into the financials of a company from its financial statements, business prospects, macro-economic indicators and overall economic positioning.

In stock market investments, this type of analysis is used mainly by the value investors. The Fundamental analysis differs from the technical analysis both in terms of their usage, approach, target audience and the purpose as explained in Fundamental Analysis versus Technical Analysis. When you are interested for a long-term investment in some high dividend yield stocks, fundamental analysis can provide you a great insight into the core business. With such analysis, you can make well calculated investing decisions.

How You can Perform Fundamental Analysis in Stock Market Investing Journey?

Typically, Fundamental Analysis in Stock Market investing is carried out based on following key points:

• Financial Statements are analyzed thoroughly. This includes Balance Sheet, Income Statement, Cash Flow statement analysis.
• As part of fundamental analysis, different important financial ratios are measured and analyzed.
• Fundamental analysis is carried with both horizontal and vertical methods. A historical data research and analysis is a key step in such analysis.
• Revenue and profit growth is examined using such analysis. You try to understand how business has been performing and how it is expected to grow in future based on available statistics.
• Such analysis can bring better meanings only when carried out in comparative terms. You need to have industry benchmarks, competitor results and overall market dynamics as your reference points.
• Micro and Macro economic factors also need a consideration. E.g. inflation and interest rate have a major impact on any businesses around. Similarly other market conditions, political and economic stability of the country also needs to be considered during such analysis. Additionally, microeconomic factors like consumer spending, demographic trends, and technological disruptions are also taken into account.

What to Look in the Financial Statements When Analyzing for Stock Market Investing?

Financial Statements contain the results announced by the listed companies. Such statements are issued on periodic basis by the companies. Following are the 3 main financial statements that are issued by the listed public companies:

• Statement of Financial Position (Balance Sheet)
• Profit or Loss Statement (Income Statement)
• Statement of Cash Flow

Analyzing the Balance Sheet of a Company: What to Look For

Below is the list of some of the major data items that you can extract from the statement of financial position (Balance Sheet) and draw meaningful conclusions:

• Analyze the assets, liabilities and equity of the company and examine how the company is growing its assets and dealing with its liabilities. Assets represent what the company owns, liabilities reflect what it owes, and shareholders’ equity represents the residual interest in the company’s assets after deducting liabilities.
• Further try to understand and analyze sub-sections. E.g. try to understand financial position of the company in short-term and long-term by evaluating current assets, current liabilities, long-term assets and long-term liabilities. This should give you a fair idea of a default risk of a company.
• Analyze how the company is dealing with its cash and inventory. You also need to look into the past periodic data to better understand how cash is being spent and what’s the trend.
• Using data from the balance sheet, you may calculate various important ratios including current ratio, quick ratio, debt to equity ratio, asset turnover ratio, return on equity ratio etc.

Analyzing the Income Statement of a Company: What to Look For in Profit or Loss Statement

Profit or Loss Statement (Income Statement) provides you an insight into a company’s revenue, profitability and expenses in much detail. Below are a few important points to consider when analyzing income statement for stock market investing purposes:

• Understand and analyze various sections and sub-sections to evaluate how company has performed for revenue growth, dealing with various expenses and reaching to a better bottom line (net profit).
• You need to assess the numbers from multiple periods. Analyze the trends of growth and profitability from the past. Try to understand how company is maintaining various ratios like Gross Profit Margin, Net Profit Margin etc.
• Analyze Earning Per Share (EPS) in comparative terms. You need to compare with previous periods as well as the competitor companies for a better industry wise conclusions.

Remember that analyzing an income statement is just one aspect of comprehensive fundamental analysis. It should be combined with the analysis of other financial statements, industry analysis, management assessment, and market factors to form a holistic understanding of a company’s financial health and investment potential.

Analyzing the Cash Flow Statement of a Company

By analyzing cash flow statement, you can better understand how a company is managing its cash flows. This includes both cash inflows and cash outflows. Consider following key points when analyzing cash flow statement:

• Understand and evaluate each component. Cash flows in investing, operating and financing activities need to be thoroughly considered.
• Focus on the cash flow from operating activities, as it provides insights into the cash generated or used by the company’s core operations.
• Cash flow in the investing activities can help you understand how the company is dealing with its investments. It should also give you a better understanding of company’s business directions.
• Examine the cash flows from financing activities to understand how the company finances its operations and capital structure. Positive cash flows from financing activities may indicate the company is raising capital through debt or equity issuances, while negative cash flows may indicate debt repayments or dividend payments. Analyze the trend in financing cash flows to assess the company’s capital structure and funding decisions.
• To better reach to any conclusions, consider different cash flow related ratios. This includes Cash Flow from Operations to Net Income ratio, Cash Flow to Debt Ratio, Cash Flow Adequacy Ratio etc.
• Analyze the cash flow statement for any potential red flags, such as consistently negative cash flows from operations, large negative cash flows from investing or financing activities, or sudden changes in cash flow patterns. These red flags may indicate underlying issues that require further investigation.
• Note that just like any other statement’s analysis, cash flow analysis should also be considered by taking industry as reference. Analyze the peers (competitors) before reaching to any conclusions.

Bottom Line: Fundamental Analysis in Stock Investing is a Key And It’s Role Should not be under-estimated

A company can perform well only if it is fundamentally sound. Your investment in a company can be fruitful only if the underlying company has a good financial health. Consider fundamental analysis as a pre-requisite for any investment decision in the stock market for value investing. Just keep in mind that analyzing one statement or evaluating against just a handful of ratios is not sufficient. All aspects of a business–internal or external must be considered to reach to a meaningful conclusion.