Fundamental analysis helps you know if the stock is undervalued or overvalued

A method of security valuation which involves examining the company's financials and operations, especially sales, earnings, growth potential, assets, debt, management, products, and competition. Fundamental analysis takes into consideration only those variables that are directly related to the company itself, rather than the overall state of the market or technical analysis data.

Fundamental analysis is critical component in stock analysis. It is quite accessible, extremely valuable. The problem of fundamental analysis is however that it can very easily get quite complicated, but it doesn't have to be.

A fundamental analysis is all about getting an understanding of a company, the health of its business and its future prospects. It includes reading and analyzing annual reports and financial statements to get an understanding of the company's comparative advantages, competitors and its market environment.

The end goal of performing fundamental analysis is to produce a value that an investor can compare with the security's current price, with the aim of figuring out what sort of position to take with that security (underpriced = buy, overpriced = sell )

Fundamental analysis is built on the idea that the stock market may price a company wrong from time to time. Profits can be made by finding underpriced stocks and waiting for the market to adjust the valuation of the company. By analyzing the financial reports from companies, you will get an understanding of the value of different companies and understand the pricing in the stock market. After analyzing these factors, you have a better understanding of whether the price of the stock is undervalued or overvalued at the current market price. Fundamental analysis can also be performed on a sectors' basis and in the economy as a whole.

Example of this is that if the current market price of a stock is lower than the intrinsic price, the investor should purchase the stock because he expects the stock price to rise and move towards its true value. Alternatively, if the current market price is above the intrinsic price, the stock is considered overbought and the investor sells the stock because he knows that the stock price will fall and move closer to its intrinsic value. To determine the true price of the company's stock, the following factors need to be considered.

In the long run, the stock price should reflect its fundamental true value. However, in the short run, a stock might have great fundamentals but still be moving in wrong direction. This can be due to other factors, such as news releases and changes in future outlook, which also have effect on the price. Trends in the market and investors' emotions also effect the short-term fluctuation in stock prices resulting in the current market price deviating from its true value.

One question that is important to consider is: "What is the difference between a great business and a great investment?" - the answer is "price". If you pay too high price for even the best stock in the world, you will never make a good return on your investment. Therefore, a great investment does not likely have a high price. The point of this question is that the price you pay for a stock does matter enormously. It is the most important factor in your return. Accordingly, doing your fundamental analysis (thoroughly) is of a great importance when making your investments.

The key factors to look for fundamental analysis are earnings, profit margins, return on equity, price to earnings and price to book. When determining whether a company's stock is a good investment, fundamental analysis is a great toolbox to reach a conclusion. Fundamental analysis, like technical analysis, attempts to predict which stocks are valuable and which are not. According to its proponents, fundamental analysis offers a fuller picture of the possible movements of both the stock market and individual stocks because as many elements as possible are investigated. Technical analysis, on the other hand, only looks at past data of stock prices. Perhaps the greatest argument in favor of fundamental analysis can be made by observing the success of one of its most famous proponents: Warren Buffett.

The writer is senior vice president, Geojit BNP Paribas