As the name suggests, fundamental analysis involves study of basic information of a company based on its business and financial performance. The process is a combination of qualitative as well as quantitative information. For instance, qualitative factors include brand value, while quantitative data includes balance sheet information, and how the company is positioned compared to its peers. The analysis is useful to understand factors that could influence the price of a stock in the future such as external events and influences, as well as financial changes, and industry trends. With fundamental analysis investors can arrive at a value of the share price of the company to invest or sell their holdings.

What is fundamental analysis?

The value of a business is not all about its financial data; it also has factors beyond data such as quality of management, corporate governance, sustainability initiatives, brand value and other similar factors. There is a lot of subjectivity with qualitative factors. For instance, for several years ITC Ltd fought the perception of being a cigarette manufacturer, which impacted its share price among investors who were against the impact on one&rsquo;s health with cigarette smoking. With its diversification into several other areas, the perception has changed and worked well for both investors and the company in its valuation.

Some other qualitative aspects include nature of business, nature of assets and liabilities, workplace policies, social responsibility initiatives, shareholder initiatives etc.&nbsp;It also includes quality of earnings and the company&rsquo;s positioning as a good corporate citizen.

Qualitative analysis 

This is the aspect of fundamental analysis which includes financial performance of a company through data and financial statements. The available data is useful to compare the performance of the company at different times and against its peers and other similar businesses. The available data is useful to quantitatively analyse the performance of the company to make investment decisions.

Primarily data from income statement, cash-flow statement, balance sheet, financial ratios based on stock price movement, earnings projections, sales data etc.

Quantitative analysis 

The concept of EPS is useful to understand several other financial ratios of importance. EPS is the net profit that a company has made in a given time period divided by the total outstanding shares of the company. Generally, EPS can be calculated on an Annual basis or Quarterly basis. As an investor, if the EPS is growing over the years, it&rsquo;s a good sign. The 3-year EPS of Reliance Industries share on April 15 was Rs 4.18.

Earnings Per Share (EPS)

A company&rsquo;s price-to-earnings ratio, or P/E (PE) ratio, is the measure of its stock price relative to its earnings. It is the ration of the current price of a company&rsquo;s share in relation to its earnings per share (EPS); P/E Ratio = (Current Market Price of a Share/Earnings per Share). The PE ratio can help you gauge the future direction of the stock and whether the price is, relatively speaking, high or low compared to the past or compared to other companies in the same sector.﻿ Typically analysts and investors consider earnings from different periods for the calculation of this ratio; however, the most commonly used variable is the earnings of a company from the last 12 months or one year. It is also referred to as price multiple of earnings multiple. For instance, the PE of Reliance Industries Limited as on April 15, 2021 was 31.11.

Price to Earnings ratio (P/E)

The book value of a company is defined as its net asset value and is calculated by adding up total assets and subtracting all liabilities. The Price/Book Value ratio (P/BV) is calculated by dividing the price of a share of stock by the book value per share. The P/BV indicates the relationship between the total value of the company&rsquo;s outstanding shares and the book value of its equity, which is simply the market capitalisation compared to the value of assets the company possesses. The value indicated the amount that shareholders would theoretically receive per share of stock held if the company went out of business and all the assets were liquidated. For instance, the PE of Reliance Industries Limited as on April 15, 2021 was 2.09.

 Price to book ratio (P/B)

This ratio measures the relationship between the amount of capital that has been borrowed (debt) and the amount of capital contributed by shareholders (equity). It&rsquo;s the indication of how much a company is leveraged, hence a low figure is an indicator of good business, however, like other financial indicators; this too should not be seen in isolation. For instance, if the company&#39;s returns are higher than its interest cost, the debt will enhance value. The DE ratio of Reliance Industries was 0.74 for the financial year-end March 2020.&nbsp;

Debt to Equity ratio (DE)

Every investor looks for return on their investment; the ROE, measures the return that shareholders get from the business and overall earnings. It helps to compare the profitability of companies in the same industry. ROE is calculated by dividing the net income by shareholder equity. In other words, ROE tells you how good a company is at rewarding its shareholders for their investment. The 3 year average ROE of Reliance Industries is 11.36.

Return on Equity (ROE)

The current ratio is a key financial ratio for evaluating a company&rsquo;s liquidity that is the ability to pay its short-term liabilities in a short-time. It is arrived by dividing the current assets by current liabilities. If the ratio is over 1, the firm has more short-term assets than short-term debts, but you should not factor in this ratio in isolation.

Current Ratio

Earnings before interest, taxes, depreciation and amortization (EBITDA) are a useful metric for understanding a business&#39;s ability to generate cash flow for its owners and for judging a company&#39;s operating performance. It indicates a company&#39;s financial health and can be used as an investment yardstick.

Fundamental Analysis

What is fundamental analysis?