InvestorQ : If I am doing a fundamental analysis of a stock, what are the key questions that I need to be asking to get a clear view?
Aashna Tripathi made post

If I am doing a fundamental analysis of a stock, what are the key questions that I need to be asking to get a clear view?

Arya Nanda answered.
2 years ago

As the name suggests, fundamental analysis is all about looking at the strengths and the weaknesses of the business model of the company and also the financial strengths as depicted in the balance sheet and the income statements and cash flows. Fundamental analysis is all about arriving at the valuation of the company based on quantitative and qualitative factors. In a nutshell, fundamental analysis is an attempt to evaluate the company on five very key factors as under.

Growth: Most analysts consider growth the most important pillar of fundamental analysis. Among the various factors that impact valuations, growth is the most prominent. Typically, high growth sectors and companies get premium valuations in the market. By growth we are referring to growth in revenues, which forms the basis for the other financial variables to improve.

Profitability: We learnt in the dotcom boom and bust that eyeballs only matter up to a point. Beyond that you need to make real money. The company has to be operationally profitable and also generate net profits so that it can reward its shareholders. That is when shares of the company become attractive.

Solvency and liquidity: These are two very important factors which judge the sustainability of any company. By liquidity, the company should be able to churn its working capital assets and payables in a way that it does not fall perpetually short of cash. By solvency we imply the level of the debt. Stock markets are not comfortable with a very high level of debt or a very low interest coverage ratio.

Competitive positioning: Every company can survive in the long run if it has a sustainable competitive advantage. In technical parlance it is often referred to as a Moat. A moat could mean a variety of things. It could be a brand, it could be a distribution network that is hard to replicate, it could be product loyalty etc. Unless companies are able to meaningfully differentiate, their advantage cannot be sustained.

Corporate Governance: This is a fairly new introduction into analyst lexicon and it means two things. Firstly, it shows how transparent promoters and business managers are in sharing the truth about the company with the shareholders. Secondly, it also means that the business managers of the company and the promoters are acting in a manner that is alignment with the interest of minority shareholders of the company. Typically, companies with high standards of corporate governance tend to get premium valuations. As Mr. Narayana Murthy said, “When in doubt, disclose”.