The document discusses fundamental analysis for investing, which involves analyzing financial metrics like earnings, cash flow, and debt to evaluate a company's performance and determine its intrinsic value. It covers the objectives, types, and tools of fundamental analysis such as evaluating financial ratios like the P/E ratio, dividend yield, and return on equity. The document also discusses the strengths of fundamental analysis in identifying long-term trends and undervalued companies, as well as its weaknesses including being time-consuming, subjective, and prone to analyst bias.

1. Venkata Reddy.B
Assistant professor,
Department of Management
Abhinav Hi-Tech college of Engineering.
Email-Id: venkatareddy2008@gmail.com
FUNDAMENTAL ANALYSIS
INTRODUCTION:
Fundamental analysis is the cornerstone of investing. In fact, some would say that you aren't really
investing if you aren't performing fundamental analysis. Because the subject is so broad, however, it's
tough to know where to start. There are an endless number of investment strategies that are very different
from each other, yet almost all use the fundamentals.
The goal of this article is to provide a foundation for understanding fundamental analysis. It's geared
primarily at new investors who don't know a balance sheet from an income statement. While “you may
not be a stock-picker extraordinaire" by the end of this article.
The biggest part of fundamental analysis involves delving into the financial statements. Also known as
quantitative analysis, this involves looking at revenue, expenses, assets, liabilities and all the other
financial aspects of a company. Fundamental analysts look at this information to gain insight on a
company's future performance.
OBJECTIVE OF FUNDAMENTAL ANALYSIS:
When the objective of the analysis is to determine what stock to buy and at what price, there are two basic
methodologies
1. Fundamental analysis maintains that markets may misprice a security in the short run but that
the "correct" price will eventually be reached. Profits can be made by purchasing the mispriced
security and then waiting for the market to recognize its "mistake" and reprise the security.
2. Technical analysis maintains that all information is reflected already in the stock price. Trends
'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional
responses to price movements lead to recognizable price chart patterns. Technical analysis does
not care what the 'value' of a stock is.
3. Investors can use any or all of these different but somewhat complementary methods for stock
picking. For example many fundamental investors use technical’s for deciding entry and exit
points. Many technical investors use fundamentals to limit their universe of possible stock to
'good' companies.

2. 4. The choice of stock analysis is determined by the investor's belief in the different paradigms for
"how the stock market works". See the discussions at efficient-market hypothesis, random walk
hypothesis, capital asset pricing model, Fed model Theory of Equity Valuation, market-based
valuation, and behavioral finance.
TYPES OF FUNDAMENTAL ANALYSIS:
Fundamental analysis includes:
1. Economic analysis
2. Industry analysis
3. Company analysis
On the basis of these three analyses the intrinsic value of the shares are determined. This is considered as
the true value of the share. If the intrinsic value is higher than the market price it is recommended to buy
the share. If it is equal to market price hold the share and if it is less than the market price sell the shares.
TOOLS OF FUNDAMENTAL ANALYSIS:
Fundamental analysis is a method used to determine the value of a stock by analyzing the financial data
that is 'fundamental' to the company. That means that fundamental analysis takes into consideration only
those variables that are directly related to the company itself, such as its earnings, its dividends, and its
sales. Fundamental analysis does not look at the overall state of the market nor does it include behavioral
variables in its methodology. It focuses exclusively on the company's business in order to determine
whether or not the stock should be bought or sold.
Earnings
It is often said that earnings are the "bottom line" when it comes to valuing a company's stock, and indeed
fundamental analysis places much emphasis upon a company's earnings. Simply put, earnings are how
much profit (or loss) a company has made after subtracting expenses. During a specific period of time, all
public companies are required to report their earnings on a quarterly basis through a 10-Q Report.
Earnings are important to investors because they give an indication of the company's expected dividends
and its potential for growth and capital appreciation. That does not necessarily mean, however, that low or
negative earnings always indicate a bad stock; for example, many young companies report negative
earnings as they attempt to grow quickly enough to capture a new market, at which point they'll be even
more profitable than they otherwise might have been.
Earnings Per Share:
Comparing total net earnings for various companies is usually not a good idea, since net earnings
numbers don't take into account how many shares of stock are outstanding (in other words, they don't take
into account how many owners you have to divide the earnings among). In order to make earnings
comparisons more useful across companies, fundamental analysts instead look at a company's earnings
per share (EPS). EPS is calculated by taking a company's net earnings and dividing by the number of
outstanding shares of stock the company has. For example, if a company reports $10 million in net

3. earnings for the previous year and has 5 million shares of stock outstanding, then that company has an
EPS of $2 per share. EPS can be calculated for the previous year ("trailing EPS"), for the current year
("current EPS"), or for the coming year ("forward EPS").
P/E Ratio
EPS is a great way to compare earnings across companies, but it doesn't tell you anything about how the
market values the stock. That's why fundamental analysts use the price-to-earnings ratio, more commonly
known as the P/E ratio, to figure out how much the market is willing to pay for a company's earnings.
You can calculate a stock's P/E ratio by taking its price per share and dividing by its EPS. For instance, if
a stock is priced at $50 per share and it has an EPS of $5 per share, then it has a P/E ratio of 10. (Or
equivalently, you could calculate the P/E ratio by dividing the company's total market cap by the
company's total earnings; this would result in the same number.) P/E can be calculated for the previous
year ("trailing P/E"), for the current year ("current P/E"), or for the coming year ("forward P/E"). The
higher the P/E, the more the market is willing to pay for each dollar of annual earnings.
Dividend Yield
The dividend yield measures what percentage return a company pays out to its shareholders in the form
of dividends. It is calculated by taking the amount of dividends paid per share over the course of a year
and dividing by the stock's price. For Example, if a stock pays out $2 in dividends over the course of a
year and trades at $40, then it has a dividend yield of 5%. Mature, well-established companies tend to
have higher dividend yields, while young, growth-oriented companies tend to have lower ones, and
most small growing companies don't have a dividend yield at all because they don't pay out dividends.
Dividend Payout Ratio
The dividend payout ratio shows what percentage of a company's earnings it is paying out to investors in
the form of dividends. It is calculated by taking the company's annual dividends per share and dividing by
its annual earnings per share (EPS). So, if a company pays out $1 per share annually in dividends and it
has an EPS of $2 for the year, then that company has a dividend payout ratio of 50%; in other words, the
company paid out 50% of its earnings in dividends. Companies that distribute dividends typically use
about 25% to 50% of their earnings for dividend payments. The higher the payout ratio, the less
confidence the company has that it would've been able to find better uses for the money it earned. This is
not necessarily either good or bad; companies that are still growing will tend to have lower dividend
payout ratios than very large companies, because they are more likely to have other productive uses for
the earnings.
Book Value
The book value of a company is the company's net worth, as measured by its total assets minus its total
liabilities. This is how much the company would have left over in assets if it went out of business
immediately. Since companies are usually expected to grow and generate more profits in the future, most
companies end up being worth far more in the marketplace than their book value would suggest. For this
reason, book value is of more interest to value investors than growth investors. In order to compare book

4. values across companies, you should use book value per share, which is simply the company's last
quarterly book value divided by the number of shares of stock it has outstanding.
Price / Book
A company's price-to-book ratio (P/B ratio) is determined by taking the company's per share stock price
and dividing by the company's book value per share. For instance, if a company currently trades at $100
and has a book value per share of $5, then that company has a P/B ratio of 20. The higher the ratio, the
higher the premium the market is willing to pay for the company above its hard assets. Price-to-book ratio
is of more interest to value investors than growth investors.
Price / Sales Ratio
As with earnings and book value, you can find out how much the market is valuing a company by
comparing the company's price to its annual sales. This measure is known as the price-to-sales ratio (P/S
or PSR). You can calculate the P/S by taking the stock's current price and dividing by the company's total
sales per share for the past year (or equivalently, by dividing the entire company's market cap by its total
sales). That means that a company whose stock trades at $1 per share and which had $2 per share in sales
last year will have a P/S of 0.5. Low P/S ratios (below one) are usually thought to be the better investment
since their sales are priced cheaply. However, P/S, like P/E ratios and P/B ratios, are numbers that are
subject to much interpretation and debate. Sales obviously don't reveal the whole picture: a company
could be selling dollar bills for 90 cents each, and have huge sales but be terribly unprofitable. Because of
the limitations, P/S ratios are usually used only for unprofitable companies, since such companies don't
have a P/E ratio.
Return on Equity (ROE)
Return on equity (ROE) shows you how much profit a company generates in comparison to its book
value. The ratio is calculated by taking a company's after-tax income (after preferred stock dividends but
before common stock dividends) and dividing by its book value (which is equal to its assets minus its
liabilities). It is used as a general indication of the company's efficiency; in other words, how much profit
it is able to generate given the resources provided by its stockholders. Investors usually look for
companies with ROEs that are high and growing
STRENGTHS AND WEAKNESS OF FUNDAMENTAL ANALYSIS
Strengths of Fundamental Analysis:
Long-term Trends
Fundamental analysis is good for long-term investments based on long-term trends, very long-term. The
ability to identify and predict long-term economic, demographic, technological or consumer trends can
benefit patient investors who pick the right industry groups or companies.

5. Value Spotting
Sound fundamental analysis will help identify companies that represent a good value. Some of the most
legendary investors think long-term and value. Graham and Dodd, Warren Buffett and John Neff are seen
as the champions of value investing. Fundamental analysis can help uncover companies with valuable
assets, a strong balance sheet, stable earnings, and staying power.
Business Acumen
One of the most obvious, but less tangible, rewards of fundamental analysis is the development of a
thorough understanding of the business. After such painstaking research and analysis, an investor will be
familiar with the key revenue and profit drivers behind a company. Earnings expectations can be potent
drivers of equity prices. Even some technicians will agree to that. A good understanding can help
investors avoid companies that are prone to shortfalls and identify those that continue to deliver. In
addition to understanding the business, fundamental analysis allows investors to develop an
understanding of the key value drivers and companies within an industry. A stock's price is heavily
influenced by its industry group. By studying these groups, investors can better position themselves to
identify opportunities that are high-risk (tech), low-risk (utilities), growth oriented (computer), value
driven (oil), non-cyclical (consumer staples), cyclical (transportation) or income-oriented (high yield).
Knowing Who's Who
Stocks move as a group. By understanding a company's business, investors can better position themselves
to categorize stocks within their relevant industry group. Business can change rapidly and with it the
revenue mix of a company. This happened too many of the pure Internet retailers, which were not really
Internet companies, but plain retailers. Knowing a company's business and being able to place it in a
group can make huge difference inrelative valuations.
Weaknesses of Fundamental Analysis
Time Constraints
Fundamental analysis may offer excellent insights, but it can be extraordinarily time-consuming. Time-
consuming models often produce valuations that are contradictory to the current price prevailing on Wall
Street. When this happens, the analyst basically claims that the whole street has got it wrong. This is not
to say that there are not misunderstood companies out there, but it is quite brash to imply that the market
price, and hence Wall Street, is wrong.
Industry/Company Specific
Valuation techniques vary depending on the industry group and specifics of each company. For this
reason, a different technique and model is required for different industries and different companies. This
can get quite time-consuming, which can limit the amount of research that can be performed. A
subscription-based model may work great for an Internet Service Provider (ISP), but is not likely to be the
best model to value an oil company.

6. Subjectivity
Fair value is based on assumptions. Any changes to growth or multiplier assumptions can greatly alter the
ultimate valuation. Fundamental analysts are generally aware of this and use sensitivity analysis to
present a base-case valuation, a best-case valuation and a worst-case valuation. However, even on a
worst-case valuation, most models are almost always bullish, the only question is how much so.
Analyst Bias
The majority of the information that goes into the analysis comes from the company itself. Companies
employ investor relations managers specifically to handle the analyst community and release information.
As Mark Twain said, "there are lies, damn lies, and statistics." When it comes to massaging the data or
spinning the announcement, CFOs and investor relations managers are professionals. Only buy-side
analysts tend to venture past the company statistics. Buy-side analysts work for mutual funds and money
managers.
CONCLUSION:
Whenever you’re thinking of investing in a company it is vital that you understand what it does, its
market and the industry in which it operates. You should never blindly invest in a company. One of the
most important areas for any investor to look at when researching a company is the financial statements.
It is essential to understand the purpose of each part of these statements and how to interpret them.
Reference:
http://www.investopedia.com/university/fundamentalanalysis/fundanalysis.