The finance theory does not believe that in an efficient capital market, the fundamental approach, or for that matter any other approach, can help anybody out-perform the market consistently. In fact, there is no conclusive evidence either in India or elsewhere, that fundamental analysis out-perform any randomly selected well diversified portfolio over a long investment horizon. This is because notwithstanding the short term-random changes in the share prices in the long run, prices of all securities ought to hover around or fundamental values.

In practice, however, it is observed that the market prices often deviate significantly from the fundamental. This is because many of the assumptions made in assessing the fundamental value of a share may not obtain reality. Further, for reasons of temporary imbalances in the demand and supply of securities, money, market moods, economic conditions, corporate performance, speculation, labour conditions, insider trading and a host of other reasons, the actual prices of securities may take long excursions from their fudamental.

The fundamental analysts, however, believe that any identifying and processing relevant information ‘correctly’ and quickly (as compared to the market as a whole), they can predict the share price movements faster than the market, and gain that short-lived edge over others which they can capitalize upon, and thus out-perform the market. However, there is no conclusive evidence, either in India or elsewhere, that fundamental analysis out-perform any randomly selected well diversified portfolio over a long investment horizon.

Also, it must be mentioned that the use of fundamental approach in estimating the returns from a security is at best an art, notwithstanding all its number crunching. To begin with, the approach has to be used in cofunction with one’s own knowledge, experience and assessment of the firm, the industry, as well as that of the economy as a whole. Even when the historic data is being used, the selection of periods, prices and averaging processes can introduce considerable differences in the computations.

Fundamental analysis is the examination of the underlying forces that affect the well being of the economy, industry groups, and companies. As with most analysis, the goal is to derive a forecast and profit from future price movements. At the company level, fundamental analysis may involve examination of financial data, management, business concept and competition. At the industry level, there might be an examination of supply and demand forces for the products offered. For the national economy, fundamental analysis might focus on economic data to assess the present and future growth of the economy. To forecast future stock prices, fundamental analysis combines economic, industry, and company analysis to derive a stock’s current fair value and forecast future value. If fair value is not equal to the current stock price, fundamental analysts believe that the stock is either over or under valued and the market price will ultimately gravitate towards fair value. Fundamentalists do not heed the advice of the random walkers and believe that markets are weak-form efficient. By believing that prices do not accurately reflect all available information, fundamental analysts look to capitalize on perceived price discrepancies.

Fundamental analysis submits that no one should purchase a share on a whim. Investment in shares is serious business and all aspects and factors, however minor, must be analyzed and considered. The billionaire Jean Paul Getty, until his death the richest man in the world, once said, “No one should buy without knowing as much as possible about the company that issues it”. Jim Slater was one of the most successful stock pickers of all time. He evolved a theory called the Zulu theory which submits that one must know all about the company and the industry and any other factor that may affect the company’s performance. His argument was that one could never lose if one has this information. If the company is likely to do badly, one can sell and then buy shares to cover this when the price falls, and vice versa. This is the philosophy of professional and successful investors – informed investing. And this is the foremost tenet of fundamental analysis. As Adam Smith says, “There is no substitute for information. The market is not a roulette wheel. Good research and good ideas are the one absolute necessity in the market place.”

There are three things that you need to know when it comes to the fundamentals of a company, which are:

1. Dividend Yield of the company
2. Price Earnings Ratio (PE ratio)
3. Earnings Per Share (EPS)

Fundamental Analysis tries to measure the intrinsic value of a stock by going through its financial, economic, quantitative and qualitative factors. It also considers the macroeconomic factors (both domestic and international) that could have an effect on the value of the stock . Some of the company or industry specific factors are Sales figure of the company (Quarterly, Yearly, etc.), Earnings of the Company, Assets and Liabilities of the Company, Management Efficiency of the Company, Company’s competitive position among its industry rivals. Fundamental Analyst s rely on the balance sheets of the company for arriving at its book value. This helps them to compare the actual value of the stock in the secondary market with that of the book value in order to evaluate whether the stock is overvalued or not. When the Market Value of a stock exceeds its Face or Intrinsic value then it signifies that the expectations of the investors are higher than the real value of the company. Hence, a correction in its price is evident. Fundamental Analysis studies the fundamental strength of the company which is effective in gauging the long run scenario of the stock price rather than the short run fluctuations.

Fundamental Analyst look at the following aspects for judging the fundamental strength of the company :-

1. Balance Sheet:Financial position of a company is reflected through its Balance Sheet where the detailed numerical of the assets and liabilities are recorded. It is always desirable for a company to have Assets and Liabilities reflects its sound financial condition.

2. Return on Assets:It measures the profitability of a company. This shows the company’s strength from the long term perspective and is a good indicator for the long term investors.

Return on Assets = (Net Income of the company for the last 1 year) / (Total Asset of the Company)

3.  Net Income: Revenue of a company comprises of income from the sales of its products, and other incomes. Cost of a company comprises operation costs, servicing of depreciation, interest payments, etc. Another business and economic jargon for Net Income is Bottom Line.

Net Income =(Total Revenue of the Company) – (Total Cost to the Company)

4. Revenue: Revenue of a company comprises its income from sales of its products, and other associated incomes. It indicates the demand scenario of the company’s products which are also an indicator of its growth.

5. Cash Flow: Liquidity Position of the company can be gauged by analyzing this tool. Hence, Fundamental Analysis is a part of the Stock Market Analysis which uses the fundamental aspects of the companies and the economy for predicting the future direction of the stock in particular and the economy in general.

Cash Flow of a Company (for a particular period of time) = (Cash Receipts of a Company) – (Cash Payments of the Company)