The advent of Fin-Tech has made buying stocks as easy as ordering something on Amazon or Flipkart. Search a stock, add quantity, set price and click Buy. Congrats, welcome to the world of equity investing! As easy as it may sound, avoiding bad investment decisions is never that easy. Technology has made investing or rather, trading easy. But the hidden devil lies in feeding the impulsive nature of investors to deploy money without adequate research. Perhaps the cliched disclaimer “Investments are subject to market risks” need to be displayed right below the Buy button on trading platforms. But even the disclaimer on mutual funds advertisements which mention this quick running statement, doesn’t ask you to do some basic research before investing, instead asks you to read scheme related documents which are basically sales pitch documents. Despite all that, do we really know the risk of bad investment? Firms selling investment products’ intent is to make the process of investment easy, an admirable intent, but as investors do we have due-diligence? The risk of identifying good stocks to invest in, is mitigated by mutual funds, but for direct equity investing, you are on your own. Which is why, you cannot skip the step between searching a stock and clicking the “Buy” button. That step is fundamental analysis.
In an earlier article on the art of stock picking, you would have been (re)-introduced on the 2 schools are stock analysis, Fundamental & Technical. Do give it a read, if you have missed it.
To summarise, fundamental analysis helps you identify a wish-list of stocks based on the prospect of the company, while technical analysis helps in timing your entry and exit from the identified stock.
Fundamental analysis helps you form a perspective about the company you wish to invest in, for the long term. When you are buying shares of a company, you are buying a part of their business itself. Hence it becomes highly important to know what you are buying into. So before you click on the buy button on a stock, you should be knowing about the business, industry, competitors, profitability, margins, financials, future plans and prospects, risks, valuation, shareholding and some more. The list may seem daunting, but when you get down to it, it is not so difficult. These are filter criteria which you need to apply to filter out average and below average companies and move the remaining companies which satisfy the criteria into your wish-list.
Fundamental analysis is broadly divided into 2 categories, qualitative and quantitative. The best part is, you do not need to hold a degree in finance to understand the quantitative analysis of the company. They are just financial ratios which give the company’s profitability in terms of numbers. The Quarterly and Annual results announced by the companies will lay bare the actual functioning of the company. You would just need comparison skills to evaluate the numbers provided by the company with the industry average or with the competitor’s numbers. For the company’s own performance, a Quarter on Quarter (QoQ) or Year on Year (YoY) comparison would be provided by the company by default in its report, for us to understand the growth that the company is witnessing. So you do not have to be an expert in finance and calculate how these numbers were arrived at. Rather, these will be done by auditors by the rules defined by SEBI. The regulatory framework would take care of the correctness of the data. As for investors, the only thing you should be knowing is, what the financial ratios or numbers mean and how that affects the company’s prospects, positively or negatively. So quantitative analysis is the easiest part of fundamental analysis, as opposed to the general misconception that it is complex.
On the contrary, the qualitative analysis is the more tricky part. Qualitative aspects of the company are the ones which talk about the management, their vision, their credibility, their governance, sector prospects, competition, macroeconomic impacts on their business, shareholding and so on. As you could see, these are highly subjective topics which are difficult to analyse. Though the company’s annual report gives some insights into their operation model, their goals and expected risks, these items cannot be audited by an independent panel like how financial matters are audited. So you need to believe what the management says or you need to do a press reporter’s work. But there are ways to ascertain the management commentary with comparative study with their competitors and what the industry veterans say. Qualitative analysis is solely based on information gathering. By following news flow about the company and by checking if the management commentary remains consistent and not contradictory, you could evaluate the qualitative aspects. Some Fin-Tech service providers help you get consolidated qualitative information about the companies, where you can get highlights of management commentary, news, shareholding pattern, reviews etc. In absence of these, Google is your best friend. Once we feel comfortable with the company’s direction and market activities, quantitative analysis will drive the majority of the decision making. Bad investment decisions are made when we fail to look at these parameters. These are readily available and mostly free, the decision making is solely under our control.
This series is intended at providing some basic insights on how to read the most important quantitative and qualitative parameters of fundamental analysis, what it means and how it can be used to prevent poor quality stocks from entering a portfolio. The series is expected to be a long one, as lots of topics need to be covered. But it is sure to make your investment journey interesting by helping you avoid bad decision making. In the next article of the series, we would be covering what not to do while investing. You can subscribe or register on the website to get notification over email for subsequent posts in the series. Until next time, stay safe!
👍👍