fundamental analysis Tools and Skills for smart Investing

What is fundamental analysis?

Fundamental Analysis is a comprehensive way to examine a firm. If an investor is looking to put money into a business for the long haul say 3 – 5 years, it is vitally important to gain insight into the company from different views. It’s essential to separate the daily stock price movements and pay attention to how the company performs overall. Usually, stocks of companies with strong fundamentals appreciate over time, thus generating wealth for their investors.

There are many companies in the Indian market that have given investors returns of over 20% CAGR yearly for at least a decade. TCS, Nestle, and Infosys, among others, are some examples. With a 20% CAGR rate, your money can double in roughly 3.5 years. But an even higher CAGR – such as 30% by Bosch India Ltd. – further accelerates this wealth-building process.

Do remember these are just 3 examples of the many that you may find in Indian markets. Here are long-term charts for 3 companies that can get you thinking about long-term wealth creation.

There are many companies that also deplete wealth. These are just three examples.

The trick has always been to separate the investment-grade companies that create wealth from the companies that destroy wealth. Investment-grade companies all share a few common characteristics that set them apart from the rest. A wealth destroyer shares a few common traits that are evident to an astute investor as well.

By identifying these attributes of wealth-creating companies, Fundamental Analysis gives you the conviction to invest long-term.

– Can I be a fundamental analyst?

There is a widespread misconception that individuals who are skilled in fundamental analysis must exclusively possess a chartered accountant designation or come from a commerce background. This is not true at all. An analyst adds two and two and ensures they add up to four. You will need a few basic skills to become a fundamental analyst.

1. A basic understanding of financial statements
2. Know the industry in which a business operates
3. Multiplication, division, and addition of basic arithmetic operations

The objective here is to ensure that you acquire the first two skills.

– I’m happy being a Technical Analyst, so why bother about Fundamental Analysis?

With Technical Analysis (TA), you can get quick short-term returns. It helps you find the right time to enter and exit the market. However, TA is not an effective way to generate wealth. Wealth can only be created by making intelligent long-term investments. For a better understanding of your market strategy, here is Eicher Motors’ chart:

A market participant might take a FA approach and choose Eicher Motors as a stock to invest in 2006. Unfortunately, however, the stock saw only a modest rise until 2010. This means investors’ returns were insignificant if they stuck with it. To make more money, shorter-term trades should have been taken instead, which is where TA plays an integral role. Having both approaches as part of one’s strategy is key – this particular methodology is known as the Core Satellite Strategy.

Let’s say a market participant has a corpus of Rs.1,000,000/-. The capital can be divided into two unequal portions, for example, 70 – 30. The 70% of the capital, Rs.700,000/-, can be invested for the long term. This portion, known as the core portfolio, is expected to grow at an annual rate of at least 8% to 10%.

The remaining 30% of the capital, which is Rs.300,000/-, can be allocated to the satellite portfolio. It is anticipated that this portfolio will generate a minimum absolute return of 6% to 8% per year. The satellite portfolio aims to capture additional returns beyond the core portfolio, utilising more active investment strategies.

By diversifying the capital into the core and satellite portfolios, the market participant seeks to achieve a balanced approach, with the core providing stability and steady growth, while the satellite offers the potential for higher returns.

 – Tools of FA

 For fundamental analysis, you will need the following tools, most of which are free.

1. You can download the annual report from the company’s website for free and find all the information you need for FA.
2. You will need industry data to see how the company under consideration is performing in relation to the industry. Basic data is available for free on the website of the industry’s association.
3. You can stay on top of the latest developments in the industry and the company you are interested in with the help of a good business newspaper or services such as Google Alert.
4. Although it is not free, MS Excel can be extremely helpful when performing fundamental calculations

By using just these four tools, one can create a fundamental analysis that is on par with institutional research. It is unnecessary to rely on additional tools for conducting effective fundamental research. Interestingly, even at the institutional level, the aim is to maintain simplicity and logic in the research process.