Basics of Fundamental Analysis

We received too much emails related to Fundamental Analysis, Today I want to show Basics of Fundamental Analysis, before discussion on it we must know about Fundamental Analysis.
What is definition of Fundamental Analysis:
Fundamental analysis is a stock valuation method that uses financial and economic analysis to predict the movement of stock prices.
Read Top 10 Treading Rules first.

Here is best book available for Fundamental Analysis

  1. A Back-to-the-Basics Investment Guide to Selecting Quality Stocks, Revised Edition (Hardcover)
  2. The Basics of Fundamental Analysis

The fundamental information that is analyzed can include a company’s financial reports, and non-financial information such as estimates of the growth of demand for products sold by the company, industry comparisons, and economy-wide changes, changes in government policies etc..
Fundamental Analysis is a method of security valuation which involves examining the company’s financial and operations, especially sales, earnings, growth potential, assets, debt, management, products, and competition. Fundamental analysis takes into consideration only those variables that are directly related to the company itself, rather than the overall state of the market or technical analysis data

Here is some more detail so you can understand fundamental analysis more clearly.
When investing in the stocks, Evey one want the price of his/her stock to rise. Not only do we want our stock price to rise, we want it to rise FAST!It is human nature because we want money fast and as early as possible, this is one of the bad habit because this habit redirect us to wrong path, So the challenge is to figure out: which stock prices are going to rise fast?

Some stocks are cheap and some are costly. Some are worth Rs.1000 and some are even worth Rs 1.Some stock are highly treader and some are called penny stock.
Please remember that price of the stock is not important. The price of the stock does not make a stock good to buy. What is important is how much the price of the stock is likely to rise.

Best Example
If you invest Rs.1000 in one stock of Rs.500 and the price goes up to Rs.1100 you will make Rs.100. However, if you invest Rs.1000 in a Rs 1 stock, you will have 1000 stocks. If the price of the stock goes up from 50paise to Rs.2, then the Rs.2000 you invested is now Rs.2000. You made a profit of Rs.1000.
If you understand this, you can see that the price of the stock is not important. What is important is the rise in the stock’s price. More specifically the “percentage” rise in the stock price is important.
If the Rs.1000 stock becomes worth Rs.1100 then that is a 10% rise. This 10% rise only makes us Rs.100. On the other hand when we invest the same Rs.1000 in the Rs 1 stock and the stock price goes up to Rs.2, it is a 100% rise as the stock price has doubled. This 100% rise makes us Rs.2000.

The point is that when picking a company, we are interested in a company whose stock price will rise by a large percentage.

Please note: Rs 1 or Rs 2 These really small stocks are very volatile and unless you know what you are doing, do NOT get into them.Read what is Penny stock.

However, the point to be noted is that we are interested in stocks that will have the highest % rise in the stock price. Now the question is, how do you compare stocks.

How do you compare two companies that are in different fields and different industries? How do you know which one is fundamentally strong and which one is week?

If you try to compare two companies in different industries and different customers it is like comparing apples and elephants. There is no way to compare them!

So fundamental analysts use different tools and ratios to compare all sorts of companies no matter what business they are in or what they do!
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  1. Mika says

    Below is just a little information on this topic from my small unique book “The small stock trader”:

    The most significant non-company-specific factor affecting stock price is the market sentiment, while the most significant company-specific factor is the earning power of the company. Perhaps it would be safe to say that technical analysis is more related to psychology/emotions, while fundamental analysis is more related to reason – that is why it is said that fundamental analysis tells you what to trade and technical analysis tells you when to trade. Thus, many stock traders use technical analysis as a timing tool for their entry and exit points. Technical analysis is more suitable for short-term trading and works best with large caps, for stock prices of large caps are more correlated with the general market, while small caps are more affected by company-specific news and speculation…:

    Fundamental analysis

    Perhaps small stock traders should not waste a lot of time on fundamental analysis; avoid overanalyzing the financial position, market position, and management of the focus companies. It is difficult to make wise trading decisions based only on fundamental analysis (company-specific news accounts for only about 25 percent of stock price fluctuations). There are only a few important figures and ratios to look at, such as:
    • EPS/Revenue
    • Cash/EBIT(TA)
    • Margins
    • Debt
    • Management
    • Products
    • Shareholders
    perhaps also:
    • ROE
    • P/E
    • Dividend yield

    Furthermore, single ratios and figures do not tell much, so it is wise to use a few ratios and figures in combination. You should look at their trends and also compare them with the company’s main competitors and the industry average. Preferably, you want to see trend improvements in these above-mentioned figures and ratios, or at least some stability when the times are tough.

    Technical analysis

    Despite all the exotic names found in technical analysis, simply put, it is the study of supply and demand for the stock, in order to predict and follow the trend. Many stock traders claim stock price just represents the current supply and demand for that stock and moves to the greater side of the forces of supply and demand.

    If you focus on a few simple small caps, perhaps you should just use the basic principles of technical analysis, such as:

    • Price and volume
    • Support and resistance
    • Trends and moving averages

    I have no doubt that there are different ways to make money in the stock market. Some may succeed purely on the basis of technical analysis, some purely due to fundamental analysis, and others from a combination of these two like most of the great stock traders have done (Jesse Livermore, Bernard Baruch, Gerald Loeb, Nicolas Darvas, William O’Neil, and Steven Cohen). It is just a matter of finding out what best fits your personality.
    I hope the above little information from my small unique book was a little helpful!

    Mika (author of “The small stock trader”)

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