Fundamental Analysis of a Company – Importance, Advantages & Example

Not understanding a company’s fundamentals is like investing in stocks without a compass. While the stocks may change prices as people buy and sell them, a company’s real value is found in the fundamental data-earnings, assets, growth potential, and strength of its management.

Fundamental analysis fills in the gaps and helps investors decide if a stock is temporarily undervalued, overvalued, or fairly priced. It is a necessary step when investing for the long term.

This blog will cover what is fundamental analysis of a company, why it’s important, the advantages, and how to do it, using an example in the real world.

 

What Is Fundamental Analysis?

Fundamental analysis is a system of determining a company’s intrinsic value. To do this, an analyst will evaluate the company’s financial statements and other data like business models, competitors, and real economic indicators.

It seeks to understand the real worth of a business. By analyzing a company’s financials, including revenue, earnings, debts, and profit margins, an investor can rationally justify a buy or sell decision.

In simple words, the fundamental analysis of stocks helps you find the answer to "Should I invest in this stock at its price?"

 

Main Parts of Fundamental Analysis of a Company

 In most cases, fundamental analysis has two major parts

 

1. Qualitative Analysis

This consists of the evaluation of non-financial components which include:-

• The business model and the quality of the products.

• The efficiency of the management and the hierarchy.

• The brand's power and standing in the marketplace.

• The degree of industry competition.

• The overall economic setting.

2. Quantitative Analysis

This consists of the evaluation of financial data, which includes:-

• Growth in sales.

• Net profit and earnings per share.

• The ratio of debt to equity.

• Return on Equity and Return on Capital Employed.

• Cash flow from business.

• P/E ratio.

The two aspects above combined will provide an all-around analysis of the financial position of a company

 

Importance of Fundamental Analysis

 

The value of fundamental analysis, and especially its importance to investors lies in its ability to distinguish between speculation and informed decision making

 

1. Help in Recognising Undervalued and Overvalued Stocks

By assessing the market price in relation to the intrinsic value of the company, undervalued potentials that are likely to yield great returns in the future are likely to be discovered.

 

2. Supports Long-Term Investment Decisions

Fundamental analysis is preferable to technical analysis since it concentrates on short-term trends. Since fundamental analysis concentrates on long-term investments, it is more appropriate for people who are keen to gradually build wealth.

 

3. Reduces Investment Risk

Understanding fundamental data helps you rationalise why a company’s worth will remain regardless of short-term volatility.

 

4. Evaluates Financial Strength

Fundamental analysis strives to determine whether a company has revenues, low debt, profits, and cash flow stability in order to assess sustained growth.

 

5. Helps Compare Peers

 Fundamental analysis focuses on assessing various companies based on the industry. Using multiples like the P/E, ROE, and EBITDA margin ratios will help identify the most valuable stocks in a sector.

 

 

Advantages of Fundamental Analysis

 Fundamental analysis is more than good stock selection. It helps structure investments in a logical, fact-based, and rational manner.

 

1. Determines True Value

It helps you determine a stock’s intrinsic value, providing a benchmark to guide your buy and sell decisions.

 

2. Builds Long-Term Confidence

Fundamental investors will remain confident in a market correction with their investments since they understand the long-term value.

 

3. Informs Sector-Wise Investing

By analysing the pillars of different industries, investors are able to determine which sectors are likely to expand. Investors might focus on sectors such as renewable energy, banking or technology as those are expected to grow.

 

4. Predicts Future Performance

Evaluating industry performance and the fundamentals of the industry helps in predicting potential profitability and future expansion.

 

5. Aids in Portfolio Diversification

Analysing fundamentals helps investors achieve target allocation by selecting different weighted fundamental risks and company risks.

 

How to Do the Fundamental Analysis of a Company

For the fundamental analysis of a company to be successful, there are a few ordered steps to follow:

 

Step 1: Understand the Business

Research the company’s business model and how it executes it. Learn about its products, clientele, its market share, and how it monetises its activities.

 

Step 2: Analyse Financial Statements

Look at the three main reports:-

Income Statement – specifies revenue and profitability.

Balance Sheet – summarises resources and obligations.

Cash Flow Statement – assesses the money transactions within a period.

 

Step 3: Study Key Ratios

Earnings Per Share (EPS): Measures profit share.

P/E Ratio: Assesses stock and its earnings, useful in price determination.

ROE and ROCE: Measures efficiency in capital use and profit.

The debt-to-equity ratio indicates potential danger.

Profit Margins: Determine how effectively a business controls its expenses.

 

Step Four: Evaluate Your Peers

Examine how the business is performing compared to its competitors in the same sector.

 

Step Five: Check Growth Prospects

Analyse industry reviews, growth commentary, and management plans to assess future potential.

 

Fundamental Analysis-Most Simplified ie. Infosys Ltd.

Let's consider Infosys Ltd., one of the biggest IT companies in India.

 

Metric	FY25	FY24	FY23
Revenue	₹1,65,000 Cr	₹1,55,000 Cr	₹1,45,000 Cr
Net Profit	₹28,000 Cr	₹26,000 Cr	₹24,000 Cr
EPS	₹67	₹63	₹58
ROE	32%	31%	29%
Debt/Equity	0.10	0.12	0.11

Interpretation:

The company demonstrates consistent and growing profitability and a strong return on equity.

The company has a strong and profitable business position to support a growing, low-risk, and low-debt financing strategy.

The valuations of the company are considered to be of strong investability based on the positive fundamentals.

 

Limitations of the Fundamentals Analysis

While the fundamentals of the business are still strong, there are opportunities in the market at relatively low investments:

• They are generally time-intensive to research.

• The prices of the stock will generally reflect temporary market conditions, which are heightened during negative events.

• Growth valuations and ratios, in which future growth expectations are embedded, are often inaccurate.

• Regardless of the limitations, there are still strong, positive fundamentals to invest in.
   

 

Conclusion

It is highly emotional when an investor is trading and using a strong, positive window of fundamentals to guide trading decisions can significantly reduce emotional trading. Understanding company fundamental data is necessary to assess revenue, profit, ratios, and quality of management and determine whether or not a business is a value builder over time.

Understanding value investing fundamentals is key to not speculating. This informs steady wealth accumulation as opposed to ‘guessing’ where money will go. Mastering fundamental analysis of stocks will be the first step to financial freedom if you take investing in the stock market seriously.

DISCLAIMER: This blog is NOT any buy or sell recommendation. No investment or trading advice is given. The content is purely for educational and information purposes only. Always consult your eligible financial advisor for investment-related decisions.