How to do fundamental analysis for Best Pick?

FII (Foreign Institutional Investor)
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Today, in this blog, we are going to talk about some fundamental analyzing which you should see before investing in any stock. See, whenever we go to any market, first of all we think that we should get a good value item at a cheap price, exactly the same happens in the share market. In the stock market also, we should invest in such stocks whose price is less than its intrinsic value.

There are many shares in the stock market whose price is very high but the intrinsic value of the stock is not that much, which can cause you loss.

Fundamental analysis is a crucial technique for investors to assess the intrinsic value of a stock before making investment decisions. By delving into a company’s financial statements and performance metrics, fundamental analysis allows investors to gauge the stock’s potential for growth and profitability. Through a careful examination of key ratios such as PE ratio, PB ratio, debt ratio, and current ratio, fundamental analysis provides valuable insights into the company’s financial health.

 Here I understand you price and intrinsic value:

Suppose you went to the vegetable market where very fresh coriander was available in one shop and its price was ₹ 10 and the same fresh coriander was available in another shop but its price was ₹ 30.  Now tell me which coriander will you buy, see we are getting fresh coriander in both the shops but there is a difference in price, one is more expensive and the other is less, so you will buy only ₹ 10 fresh coriander because it is available there at a cheaper price.  We are getting the value of fresh coriander. In the realm of fundamental analysis, the concept of intrinsic value takes center stage. This value represents the true worth of a stock based on its underlying fundamentals, such as earnings and assets. Investors who prioritize fundamental analysis aim to identify stocks with prices that are lower than their calculated intrinsic value, indicating a potential buying opportunity.

Thus

Stock price < intrinsic value of stock

Low stock price = high intrinsic value of stock

Example :

ITC stock’s intrinsic value is ₹254.29 while the current stock price is ₹454.6. So it means that here the intrinsic value is 44% less than the current stock price.

Ratio: There are many types of ratio in the stock market, the analysis of which helps us to invest in the right stocks.

PE Ratio:

The full form of PE Ratio is Profit to Earning .  We can find out two things from the PE ratio, 1st whether the demand for the stock taken by us is increasing or cheaper and 2nd how much profit the company is making. One of the fundamental analysis tools, the PE ratio, offers insights into market sentiment and the company’s earnings performance. A low PE ratio might signify an undervalued stock, suggesting that it could be a favorable investment choice. Similarly, the PB ratio, derived from comparing market value to book value, aids investors in distinguishing between overvalued and undervalued stocks.

PE ratio has a formula

PE Ratio = Current Price of the Stock / EPS

 Here the full form of EPS is Share on Earning i.e. how much profit the company makes from its one share.

 let’s take an example

 The EPS of ITC stock is ₹14.7 and the stock current price is ₹454.6. PE ratio = 454.6/14.7 = ₹30.9

 Ideally it is better to keep the PE ratio above 20.  Because you have to pay ₹ 31 to earn ₹ 1 from the stock.  One imp thing, Higher the eps, lower is the PE Ratio and you will have to pay the least amount to earn ₹1.  So invest in such stocks which have low PE ratio.

Also Read : 3 stocks of Nifty Smallcap 50: Giving high returns in the short term

PB Ratio:

To calculate the price to book value ratio:  the market price of a company’s total shares is divided by its book value.  If the PB ratio is above 1 then the company is overvalued and if the PB ratio is within 1 then the company is undervalued.  An ideal PB ratio should be around 3. So invest in such stocks whose PB ratio is low.

Debt Ratio:

Debt ratio is calculated by dividing debt with equity.  It is said that the lower the debt ratio, the better, but sometimes taking debt is much cheaper than giving equity. Because the companies which feel that they have the potential to move ahead of themselves, they do not give the equity of their company, they prefer to take debt instead.

 If the debt ratio is 10, it means that the debt has been taken 10 times more than the equity.  Therefore, generally speaking, one can invest in stocks with low debt ratio. The debt ratio, an essential component of fundamental analysis, reflects a company’s leverage and financial risk

 For example

 Itc’s total equity ₹695.4B and total debt 391.1M

 Debt to equity ratio = 391.1M/695.4B = 0.6% which is low.

Current Ratio :

 In this, the current total assets are divided by the current total liabilities.  The higher the current ratio, the more the stock can be worth investing in.

 Current Ratio = Current Total Assets / Current Total Liabilities

Example

 ITC stock has FY2023 current ratio of 2.89%

 An ideal current ratio should be 2:1, this ITC ratio is around 3:1. Incorporating fundamental analysis involves a meticulous examination of a company’s balance sheet, which unveils crucial information about sales, profits, assets, liabilities, and cash flow.

Balance Sheet:

 Before investing in any stock it is necessary to see its balance sheet.  In the balance sheet, you basically have to analyze sales, profit, assets, liabilities and cash flow etc.

You have to see whether the company’s sales are increasing every year or not, whether the profit is increasing every year or not.  How many Assets have been created and how much more or less are the liabilities and how much cash is available with the company to use etc. Furthermore, understanding the industry within which a company operates is integral to fundamental analysis.

Example

ITC has sold a total of ₹ 72,917.34cr in the year 2023, while the total sale of 2022 has been ₹ 62,504.44cr, so there has been an increase in the sale.  ITC has earned a net profit of ₹ 19724cr in the year 2023, while last year’s net profit has been ₹ 15,701, which means the profit has also increased.

ITC’s total assets have increased by 11.16% in the year 2023 while in 2022 there was an increase of 4.66%. ITC’s total assets have increased by 13.21% in the year 2023 while there was an increase of 10% in the year 2022. There has been an increase in assets but there has also been an increase in liabilities which is a negative point.

But if the total assets of the current year are more than the total liabilities of the current year, then it is also a positive point.  ITC has a Net Cash Flow of ₹139.23cr which is an Average Cash Flow. The more cash flow the better.

fundamental analysis in Identification of the Industry:

Before investing in any stock, it is important to know in which sector that stock company works, in which you can find out whether there are chances of growth in the future of the company or not. As a textile company, you all know that the trends in clothes keep changing and the business of clothes will continue to grow in the future as well.  

If you have seen that there is only growth in the textile company, then you can invest in such a company.  Similarly, tech also has a good future, so you can invest in that too. Therefore, those who are thinking of investing in stocks, they will be able to invest in 90% right stocks if not 100% right by analyzing these fundamentals. By combining insights from fundamental analysis with industry knowledge, investors can make well-informed decisions about which stocks to include in their portfolios.

frequently asked questions (FAQs)

What is intrinsic value, and why is it important in stock investing?

Intrinsic value refers to the true worth of a stock based on its underlying fundamentals, such as earnings, assets, and cash flow. It’s important because investing in stocks with prices below their intrinsic value can potentially lead to better returns and reduced risk.

What is the PE ratio, and how does it help in stock analysis?

The Price-to-Earnings (PE) ratio is a valuation metric that compares the stock’s current market price to its earnings per share (EPS). It helps investors understand the stock’s relative valuation and whether it is overvalued or undervalued. A lower PE ratio might indicate a potentially undervalued stock.

What is the PB ratio, and how is it used to assess stocks?

The Price-to-Book (PB) ratio compares a company’s market value to its book value (net asset value). It can help investors gauge whether a stock is overpriced or underpriced based on the company’s assets. A PB ratio below 1 could suggest an undervalued stock.

How is the debt ratio relevant in stock analysis?

The debt ratio (debt-to-equity ratio) compares a company’s total debt to its equity. A lower debt ratio is generally preferred, indicating lower financial risk. However, some companies may choose debt over equity for strategic reasons. It’s crucial to consider the context and industry norms.

What is the significance of the current ratio in stock evaluation?

The current ratio measures a company’s ability to cover short-term liabilities with its short-term assets. A higher current ratio indicates better liquidity and financial health. It’s used to assess whether a company can meet its immediate obligations.

How does analyzing a company’s balance sheet help in stock investing?

Analyzing a balance sheet provides insights into a company’s financial health, including its assets, liabilities, and equity. It helps investors understand the company’s ability to generate profits, manage debt, and maintain a positive cash flow.

Why is it important to identify the industry a company operates in before investing?

Identifying the industry helps investors assess a company’s growth potential. Industries with favorable long-term trends and prospects are more likely to provide sustained growth. Understanding the industry dynamics can guide investment decisions.

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