How to pick stocks based on their fundamentals?

fundamental analysis of stocks

It is very rightly said by our experts that a building will stand solid if its foundation is strong. The same goes with stock investing. When you are investing in stocks, you need to scan its fundamentals that work as a foundation for a company. At times, the market reacts negatively due to some consequences but you can still bet on those companies that are falling with a negative trend but have good fundamentals.  

If a company is constantly posting strong results but its shares are falling due to the market's bearish reaction. You need not worry as this fall will stay temporary. All thanks to strong fundamentals. 

In this article, we will be analyzing how to pick stocks based on their fundamentals? For succeeding in fundamental analysis you need to evaluate different parameters that would help you for making a wise decision. 

Some of the crucial spots that one needs to study include: Industry prospects, Business model of the company, Financial statement, Financial ratios, Management of the company, and the company's future prospect. All these parameters need to study in a serial order briefed below.

Fundamental analysis of stocks 

Given below are the ideal steps that one should keep in mind while doing a fundamental analysis of stocks

1. Industry Prospects 

This is the initial and the foremost step that one needs to follow before jumping into a company's actual analysis. If you are looking for infusing your money into a pharmaceutical company then you should examine the broader sector in which various pharma companies exist. 

You need to identify both risks and opportunities that are aligned within the industry considering future anticipations. If the external environment has set up some favorable policies for pharma companies when you need to give more weightage to your investment in this sector and vice versa. 

And for getting up-to-date knowledge about your favorite sector then you need to make yourself aware of the daily updates and held your next moves in a smart manner. 

2. Business model of the company 

This is the next crucial step after reading about industry prospects. A business model simply outlines the operations of a company and how the operations are performed by the different business verticles within the business portfolio. You can bet big on a company only after having clarity over different business verticles within a company you wanted to invest in. 

Example: Maruti Suzuki is a well know automobile brand but as an investor in Maruti Suzuki, you must be aware of its other subsidiaries. Such as Maruti Suzuki driving school, Maruti Suzuki pre-owned cars, Maruti Suzuki smart finance, and Maruti Suzuki's car insurance verticle.  Along with this, it is good to track the market share of the company and its varied businesses. 

3. Financial statements 

Financial statements help in accessing the financial performance of a company. And it makes it easy for an investor to evaluate the financial strength of a business based on the numbers. The financial statements include the income statement, balance sheet, and cash flow statement.

An income statement helps in generating clarity on profit/loss made by a company. It simply depicts revenue and expenditure incurred by a company in a particular period of time. 

The balance sheet showcases the assets and liabilities that give us a glimpse of borrowings that the company owns and the amount invested in different resources. On the other hand, the cash flow statement reveals the sources of cash flow and build a comparison between cash flows at different period of time. 

4. Financial ratios  

Reading financial statements might be boring and financial ratios on the other hand are extracted from financial statements only. So, reading these ratios is quite an effortless task but you need to develop some understanding of the constituents of these ratios. 

Some of the key financial ratios are working capital ratio, quick ratio, debt to equity ratio, current ratio, price to earnings ratio, etc. 

5. Management of the company 

A company's management is the ultimate driver of the company. And the financials alone cannot justify the company's performance as eventually, sustainability comes with a great group of people on board.  Good management will be able to sail the company even during the tough times and assist in generating continuous returns for their investors.

Example: Hindustan Unilever Ltd., HDFC Ltd., and Infosys Ltd. continued to be among the best-governed companies because of their effective management and quality decision-making. 

6. The company's future prospect 

A business is more sustainable and valuable if it considers the long-term prospects. Adding innovations to their products or services is the best way to enhance market share and compete well with the competition in the market. As customers are very conscious, even a subtle product enhancement by your competitor can shift their interest. 

It is ideal to invest in companies that are futuristic and derive valuable changes to products or services with the passage of time. Example: With the adoption of more green energy by most automobile makers, a particular automobile company is viable if it also adopts environment-friendly sources. Else it will deteriorate its market share. 

Take away

In this article, we interpret varied points that one needs to consider before picking stocks. Some of the crucial spots that one needs to keep in mind while doing a fundamental analysis of stocks.  

Industry prospects, Business model of the company, Financial statement, Financial ratios, Management of the company, and the company's future prospect. 

The aim of this reading was to abridge crucial parameters that one needs to consider. Although, this does not mean that analyzing all these factors will award you mastery in studying fundamentals. But, the reality is that fundamentals have no end you may deep down into infinite factors for evaluating.