Fundamental analysis is a stock valuation methodology that uses financial and economic analysis to picture the movement of stock prices.
The fundamental data that is used to analyse include a company’s financial reports and non-financial information such as estimates of its growth, demand for products sold by the company, industry comparisons, economy-wide changes, changes in government policies etc.
Understanding the Intrinsic Value
The outcome of fundamental analysis is a value (or a range of values) of the stock which is called as ‘intrinsic value’, often called ‘price target’ by fundamental analysts’ in the daily news. To a fundamental investor, the market price of a stock tends to revert towards its intrinsic value.
If the intrinsic value of a stock is above the current market price, the investor would purchase the stock because he believes that the stock price would rise and move towards its intrinsic value.
If the intrinsic value of a stock is below the market price, the investor would sell the stock because he believes that the stock price is going to fall and come closer to its intrinsic value.
Intrinsic value > Current Price : Buy
Intrinsic value < Current Price : Sell
Steps in finding the Intrinsic Value
To find the intrinsic value of a company, the fundamental analyst initially takes a top-down view of the economic environment; the current and future overall health of the economy as a whole.
After the analysis of the macro-economy, the next step is to analyse the industry environment which the firm is operating in. One should analyse all the factors that give the firm a competitive advantage in its sector, such as, management experience, history of performance, growth potential, low cost of production, brand name etc. This step of the analysis entails finding out as much as possible about the industry and the inter-relationships of the companies operating in the industry. The final step is to study the company and its products.
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