Valuation of Stocks using Fundamental Analysis - Dr Shashank M Hiremath

Dear Investors,

 

          Valuation of Stocks using Fundamental Analysis!!

 

          While technical analysis is a widely used method for valuating stocks and predicting the future, fundamental analysis also becomes very important and critical many a times. It is not very easy to make money in the stock market by just doing technical analysis, reading charts, graphs etc all the time. Many researchers have proved that fundamental analysis is EQUALLY IMPORTANT. Here in this write-up, I would like to discuss more about the fundamental analysis of stocks before investing.

 

          Fundamental analysis is a stock valuation technique that uses financial and economic analysis to predict the movement of stock prices. The fundamental information to be analyzed should include a company's financial reports, non-financial reports such as growth estimates of demand for products and services, competition analysis, economic factors, government policies etc. A fundamental analyst perceives that the market price of a stock tends to move in the direction of its real value or INTRINSIC VALUE. If the intrinsic value of a stock is higher than the current market price, the investor would start buying the stock because he knows that the stock price would rise further and move towards its intrinsic or real value. If the intrinsic value of a stock is lower than the current market price, the investor would start selling the stock because he knows that the stock price is going to fall further and come closer to its intrinsic value.

 

          All this looks very simple to express but finding out the intrinsic value of a company requires a lot of skill. Once you master this, you will be able to compare intrinsic price with the market price of several companies and decide whether you want to buy or sell the stocks. A fundamental analyst begins finding out the intrinsic value by examining the present and future overall health of the economy. After analyzing the overall economy, you have to analyze the companies of your choice. You should analyze factors which give the companies a COMPETITIVE ADVANTAGE in its basket such as experiences of executives, performance history, growth ability, low cost leadership, brand value etc, indentifying as much as possible about companies and their products. Unfortunately, in the emerging countries like India, a large number of investors buy underperforming stocks on the basis of news, stock tips, hearsay, suggestions given by the experts on social media etc. After investing all their money into such stocks they start doing the fundamental and technical analysis. Less than 2% of the population in INDIA participates in the stock market. On the contrary, USA has around 50% of their total population in the stock market. Lack of financial education in schools, low risk appetite for investing, lack of patience to hang on to profitable stocks while betting on loosing stocks, financial scams in the past and so many other factors add up to ZERO OR MINIMUM EXPOSURE to stock markets in India.

 

          Do companies carry core competencies or fundamental strengths that lay them ahead of all the other competitors? What advantage do they have over their competitors? Do they have a strong market presence and market share? How are they marketing and finding out new customers and combating for a greater market share? After you know about the companies & know what they do, knowing how they connect to the market and their customers is important. You would then be in a better situation to decide whether the stock prices of several companies are going to move up or down. After understanding the essentials of fundamental analysis, let us examine some other details. While we invest in shares or stocks, we immediately want the prices to rise and expect BIG PROFITS! Not only do we want our stock prices to rise, we also want it to rise as fast as possible. Hence, the challenge for good investors would be to identify which of the stock prices are going to rise steadily? Some stocks are low-priced and some stocks are high-priced. How do we finally select a profitable stock which sits in our portfolio is a million dollar question. Everybody craves for owning such stocks.

 

          Some stocks are worth Rs.20,000 and some are worth Rs.2 only. In such a situation the prices of stocks are not significant. The price levels do not make any stock a good thing to buy. What is more important is how much the price of such stocks is likely to increase by time. Let me try to explain with an example: If you invest Rs.20,000 in a stock worth Rs.20,000 each, you will have 1 stock in the portfolio, and if the price goes up to Rs.25,000 you will make Rs.5,000 profit i.e. 25% return on the investment. On the other hand, if you invest Rs.20,000 in shares worth Rs.20 each, you will have 1000 stocks, and if the price goes up from Rs.20 to Rs.30 you will make Rs.10,000 as profit i.e. 50% return on the investment. If you comprehend this example, you can observe that the price of the stock is not vital. A thing which is crucial is the percentage rise in the stock prices. PERCENTAGE!! is more important than just increase or decrease in the value of stocks. Several investors fail to understand this logic.

 

          From the above example, it is clear that Rs.20,000 worth stock becomes Rs.25,000, it is a 25% rise. This 25% rise gives us Rs.5,000 profits. On the other hand when we invest the same Rs.20,000 in a stock worth Rs.20 and its price go up to Rs.30, it is a 50% rise as the stock price has considerably increased. This 50% rise gives you Rs.10,000 profit. This is just an example to make you understand the importance of PERCENTAGES in stock market. This phenomenon will gradually lead to the POWER OF COMPOUNDING. The point I am trying to tell you here is simple, while picking up any good stock, in which you are interested, the stock prices would rise by a large percentage initially and stop growing further. SMART INVESTORS will start selling whatever they would have bought at the lowest prices, and I need not mention what happens next. This cycle repeats all the time due to human GREED and FEAR. 

 

          What SENSE do we make from the above? STOP chasing only the low-priced stocks as mentioned above, it may appear like a brilliant idea to buy large quantities of cheap stocks worth Rs.20 15, 7 etc with a FALSE HOPE that the prices may rise one day by 30% or 40% or 60% or more. This sounds good, but it could damage your capital sooner or later. Many investors average loosing stocks until their capital dries up. Such cheap stocks are very volatile and usually OPERATOR DRIVEN, one should avoid buying them looking at low prices. However, the point you should note here is to buy stocks which would generate high CAGR / high percentage returns as the time passes, irrespective of whether the stock price is low or high. It would be wise if investors compare the stocks within the respective sectors and select only the winning horses for long-term investments. Investors should do fundamental analysis by using the appropriate tools and ratios for comparing all sorts of companies before investing. Finally, the technical analysis should be carried out for becoming a successful investor. Both the fundamental and technical analysis should be convergent in order to make your stock market investment a comfortable journey.

 

Happy Investing!! 😎🙏

 

Dr. Shashank M Hiremath,

Associate Professor, Sindhi Institute of Management,

Kempapura, Hebbal, Bengaluru-24

Ph: 9845239036, Email: shashankmh2000@gmail.com

YouTube Channel: https://www.youtube.com/channel/UC7Ydp53iTxiGnO-1rSAz-qA