How to do Fundamental Analysis on Stocks?
A Beginner’s guide on how to do fundamental analysis on stocks (Updated): Fundamental analysis of a stock is used to determine the financial and business health of a company. It is always recommended to perform a proper fundamental analysis of the stock before investing if you are planning for long term investment.
If you’re involved in the market, you might also have about the term ‘Technical Analysis’. Well, technical analysis is a good approach to find the entry and exit time stock for intraday trading or short term. You can make good profits using different technical indicators efficiently. However, if you want to find a multi-bagger stock to invest, which can give you good returns year after year, then the fundamental analysis is the actual tool that you have to utilize.
This is because to get multiple times returns (say 5x or 10x), you need to remain invested in a stock for the long term. While the technical indicators will show you exit signs in the short term whenever there’s a downtrend or small setbacks, however, you have to remain invested in that stock if the company is fundamentally strong. In such cases, you have to be confident that the stock will grow and give good returns in the future and avoid short-term underperformance. Short-term market fluctuations, unavoidable factors, or mishappenings won’t affect the fundamentals of the strong company in the long term.
In this post, we are going to discuss how to do fundamental analysis on stocks. Here, we will elaborate on a few guidelines that if you follow with discipline, you can easily be able to select fundamentally strong companies.
How to do fundamental analysis on stocks?
Here are the six essential steps that you need to perform to analyze the fundamentals of a company in Indian stock market. They are really simple, yet effective to find fundamentally healthy companies. Here it goes:
Step 1: Use the financial ratios for initial screening
There are over 5,500 stocks listed in the Indian stock exchange. If you start reading the financials of all these companies (i.e. balance sheet, profit-loss statement, etc.), then it might take years. The annual reports of most companies are around 200-300 pages long. And it’s not worth your time to read each and every company’s report.
A better approach is first to shortlist a few good companies based on a few criteria. And then to study these screened companies one-by-one to pick the one that suits you the best.
For the initial screening of the stocks, you can use various financial ratios like Price to Earnings (PE) ratio, Price to Book Value (PBV) ratio, ROE, CAGR, Current ratio, Dividend yield, etc. If you want to know more about best financial ratios for screening, here’s an article on 8 Financial Ratio Analysis that Every Stock Investor Should Know. In short, you need to use different financial ratios for initial screening.
Next, for performing the stock screening using financial ratios, you can use different financial websites like Screener, Investing.com, Tickertape, etc. Let me give you an example of how to screen stocks using Investing.com.
How to do a screening of stocks using Investing.com?
Step 1: Go to Investing.com
Step 2: From the top menu, select Tools -> Stock Screener
Step 3: Add Criteria (financial ratios) to screen stocks
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For example, if you want to filter companies with PE ratio between (5, 18) and dividend yield % between (1, 3), you can select the following criteria. Investing.com Screener will shortlist the stocks according to the criteria mentioned and give you the list of companies.
Further, you can also add a number of financial ratios in your criteria like CAGR, ROE, etc.
Besides, you can also use other financial websites to screen stocks as mentioned earlier. Here’s a demo on how to shortlist companies using Screener.in website:
Step 2: Understand the company
Once you’ve screened the companies based on the above criteria, the next step is to investigate them. It is important that you understand the company in which you are investing. Because if you don’t, you won’t be able to decide whether the company is performing good or bad, whether the company is making the right decisions towards its future goal or not; whether their competitors are doing good or bad compared to them and most importantly whether you should hold or sell the stock.
Therefore, it is essential that you understand the company. Questions like what are its products/services, who are leading the company (founders/promoters), management efficiency, competitors, etc should be known to you.
A simple way to understand the company is to visit its website. Go to the company’s website and check it’s ‘ABOUT’, ‘PRODUCTS’, ‘PROMOTERS/BOARD OF DIRECTORS’ page, etc. Read the mission and vision statement of that company. Further, if you can find the annual report of the company, download and read it. This report will give the in-depth knowledge of the company.
Further, if you are able to understand the products, services & vision of the company and find it attractive, then move further to next step. Else, ignore that company.
Also read: How to select a stock in Indian market for consistent returns?
Step 3: Study the financial reports of the company
Once you have understood the company and found it appealing, next you need to check the financials of the company like Balance sheet, Profit loss statements, and cash flow statements.
As a thumb rule, Revenue/Sales, net profit, and margin increasing for the last five years can be considered a healthy sign for the company. After that, you also need to check the other financials like Operating cost, expenses, assets, liabilities, etc.
Now, where can you find the financials of a company that you’re interested to invest? One of the best websites to check the financial statements of a company that I most frequently use is SCREENER. Here are the steps to check the financial reports of a company on Screener website:
Step 1: Go to screener.in
Step 2: Enter the company’s name in the search box. The company’s details will open like charts, analysis, peers, quarters, profit and loss, balance sheet, etc.
Step 3: Study the company’s financial reports for the last 10 years.
It is required that you study the financials of the company carefully in order to select a good stock for long term investment. If you do not know how to read the financials of a company, you can check out this financial statement and ratio analysis course for beginners.
Step 4: Check the debt and Red Flags
The total debt in a company is one of the biggest factors to check before investing in a stock. A company cannot perform well and reward its shareholders if it has a huge debt. They have to repay the debt and also pay interest on the borrowed money before anything else. In short, avoid companies with huge debts.
As a thumb rule, always invest in companies with a debt/equity ratio of less than one. You can use this ratio in the initial screening of stocks or else check it while reading the financials of a company.
In addition, also other red flags in the company can be continuously declining profit/ margin, low liquidity, and pledging of shares.
Step 5. Find the company’s competitors
It’s always good to study the peers of a company before investing. Determine what this company is doing that its competitors aren’t.
Further, you should be able to answer the question that why you are investing in this company and not any of its competitors. The answer should be convincing one like Unique selling point (USP), Competitive advantage, Low-cost products, Brand Value, future prospects (upcoming projects, new plant), etc.
You can find the list of the competitors of the company on the Screener website itself. Just enter the stock name in the search box and navigate down. You will find a peer comparison there. Else, you can do a google search to find the competitors of the company. Study the competitors in detail before investing.
Step 6: Analyze future prospects
Most good investments are based on the future aspects/potential of the company and hardly on their current situation. Investors are interested in how much returns they can get from their investments in futures. Therefore, always invest in a company with strong long future prospects. Select only those companies to invest whose product or services will still be used twenty years from now.
Moreover, there is no point in investing in a CD or pen-drive making company with no long term (say 10 years from now) prospects. With cloud drives evolving so fast, these products will become obsolete with time.
If you are planning to invest for the long term, then the long life of the company’s product is a must criterion to check. Further, check future prospects, expansion possibility, potential sources of revenue in the future, etc.
Summary
Fundamental analysis is an old and proven method to find strong companies for long term investment. In this post, we discussed how to do the fundamental analysis of stocks.
The six steps to perform fundamental analysis on stocks explained in this article are: 1) Use the financial ratios for initial screening, 2)Understand the company, 3) Study the financial reports of the company, 4) Check the debt and red signs, 5) Find the company’s competitors 6) Analyse the future prospects.
Besides, here is an animated video on how to do fundamental analysis on stocks to help you summarize the concepts.
Also read: How To Invest Rs 10,000 In India for High Returns?
That’s all for today. I hope this post on ‘How to do fundamental analysis on stocks’ is useful to the readers. Further, If you find this post helpful and want me to write more contents on any similar topic, please comment below. Besides, if you’ve any doubts/queries, you can also ask in the comment section. I’ll be happy to help. Take care and Happy Investing.
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Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
Hii..i would really appreciate your effort for writing this article.It has really helped me in stocks selection criteria..could you please also list the various screeners and ratio with the their suitable range to be used .
Hi Mahek. Thanks for your comment. Please check out this image about the various financial ratios that should be considered before investing.
Excellent article. Your writing style is so clear that a newbie can easily understand all the basics of stocks. Thanks a lot
You are welcome Ameen.
Very helpful. Very lucid way of presentation. Thanks ???
You are welcome Rajendra!
I am a newbie, Your article is very good and easy to understand. I am looking for a blog with an example, say you pick a stock and explain the high-level parameters you use for analysing. That helps. Thanks.
You are welcome Gangadhar. I have written a similar post here which you may find useful: https://www.tradebrains.in/best-stocks-for-long-term-investment-in-india/
Good explanation in a lucid manner. Appreciate your effort. I read many other articles in this website after reading this. All of them are easy to understand and very informative. Thank you!
You are welcome Kiran.
sir,you are giving awesome message to us.i have one doubt about how to predicting in future stocks?it were not that much of easy.just give me the hints sir.
thanking you.
Good article, Keep it up..
Hi Kritesh,
I am also reading a lot about fundamental analysis. Can you please let me know which course did you completely followed to become “NSE Certified Equity Fundamental Analyst”.
Thanks
Puneet
Hi Abhishek,
The above article was very helpful and the information you put on this website is also very useful. Thanks a lot for your efforts.
For technical analysis and stock discovery/screening, you could also look at a tool my startup has developed – SaralStocks (www.saralstocks.com)
Good
Good Article… I am a newbie to investing and stock marketing. This article is helping me to start analyzing the company’s financial things.
I am also in stock market since 2016. Entire content written in a very simple language so that it can be understood by all types of market participants. Enjoyed reading it. Cheers
wait….you are in stock market since 2016 and knowing about fundamental analysis now…i.e your lol
Good one, simple and informative. Thanks for sharing the valuable information.
VERY Useful And Informative Thanks, Keep Helping People
It is really informative for the new entrants and existing investors. It helps a lot to know where to Start and how to win the game of investing.Thanks a lot.
That’s a wonderful article. It has given me some idea on how to do a fundamental analysis of stocks. Thanks a lot!
Amazing information. Would really like to know what professional degree you have opted to become a equity analyst.
Still I have a doubt on stock selection for intraday can you share an article link by which I can understand
Thank in Advance