Fundamental Analysis

When it comes to make a long term call, I think 9 out of 10 analysts will be right or may be 10 out of 10, and even an experienced investor who reads well, will be able to make a right call but when it comes to making a short term call it becomes an arduous job for the most learnt researchers. There are so many factors which contribute to the movement of prices that it becomes very difficult to predict their trend. However an insight of all major events, news flows, financial information and basics of the company gives us a view whether the price of the stock is justified or not, is it worth owning the stock at the given price or the stock is already overvalued. It works well if you make a prediction for the long term, but the short term movements are always governed by macroeconomic factors, general trends and Government announcements which are not predictable, therefore it is easy to make a long term call by using fundamental analysis. And that is why most of the mutual funds take long term calls considering them to be safe. For example you find a stock which is going very cheap and fundamentals suggest buying the stock but suddenly some negative factor triggers in US and there is a sell off in Global markets and our markets are also not spared and that stock also could not swim against the stream and is hammered down and a good stock gives you a negative return in the short term in spite of being a value buying. But if you have bought if with a long term view and the company is fundamentally sound the stock will rebound when the crisis is over and will give you a good return in the long term. The whole discussion was to bring home the fact that if you are novice to this market make your first call a long term call, there are more chances of making money. After some experience you can become a swing trader or a day trader but first be an investor.

Economy analysis

The first step towards picking stocks is to analyze macro economic factors. After having a look at the macro economic factors you will have a feel about the overall future outlook of the markets. The GDP numbers, inflation, exchange rates, interest rates, Foreign Direct Investments, industrial growth and a forecast given by the Government on expected GDP and industrial growth numbers are to be tracked. A strong GDP growth and industrial numbers indicate a strong economic growth and a growing Foreign Direct Investments shows the potential of companies operating in India. An increase in inflation might trigger the urgency to raise interest rates and increasing interest rates will slow down credit growth and demand in the country and thereby resulting in lower profits by the companies and falling interest rates have an opposite effect and will have a direct impact on the Automobile and real estate companies, lower interest rates will increase profits of these companies. An appreciating currency will attract more foreign investments and carry trades giving boost to the markets. A combined effect of all the above factors gives us an indication of a strong or weak future outlook. When every thing is going well and the economy is growing there are more chances of stock markets going up and fundamentally strong stocks will rally with the markets.

Industry analysis

It is necessary to have a look at the industry as whole to which your pick belongs. If the industry or the sector as a whole is in a downtrend then there will be a downward pressure on your pick being in that reeling industry. For example Sugar Industry has been in a downtrend for last one year and the valuations are looking very cheap still the stocks have underperformed if compared with the broad indices, most of the sugar stocks have given negative returns whereas the markets have grown sharply in the last one year, the economy has also been booming. Similarly metal stocks, Tea stocks, Oil stocks, Textile stocks and other sector stocks follow sectoral movements which depends on various factors like international commodity prices, currency prices, crude prices and overall demand and supply situation in that sector. Therefore the whole industry should be analyzed before picking your favorite stock.

Company analysis

The last step is to analyze the company you are going to invest in. For this purpose you will need financial statements of the company for past few years and the recent news flows about the company. This information can be taken from any brokerage house website and such information is also available at the websites of stock exchanges. The first thing to watch is the consistency in growth of profits and turnover, the turnover and profits should be growing consistently from quarter to quarter and from year to year, this would ensure that the company you are going to invest in will have growth prospects which should be reflected in its stock price.

EPS and PE ratio

After having a look at the profitability and its consistency, you have to check whether the current market price of the stock is justified or not. Two basic ratios are used to find a correlation between the market price of the stock and the profitability of the company. EPS or earnings per share are the profit per share of the company. It can be calculated by dividing the total profits of the company by total number of outstanding shares. For example a company makes a Net profit of Rs. 10, 00, 00,000/- and the total number of shares are 53, 00,000 then the EPS of the company is Rs. 18.86. The PE ratio or the price to earnings ratio is found out by dividing the Market price of the share by the EPS arrived at above. In the above example if the stock price is Rs. 260 then the PE ratio is 13.78. Every industry has different PE ratios and it also varies from stock to stock, the more reputed and large sized companies enjoy larger PE ratios as compared to small companies. These ratios should be compared to the peer group companies, for example two companies are in the same sector and the size is also not very different then the stock with the lower PE ratio is cheaper than the other and has less chances of correcting in a falling market.

In my previous article in this series we had learnt to prepare ourselves mentally to get into the markets and learnt some basic exercise before actually jumping into the markets. In this article we shall try to cover practical aspects of investing like opening of various accounts and understanding basic concepts of trading.