The best investors know which stocks will perform better than others. It's no magic, but Fundamental Analysis. Here’s how it works:
What is Fundamental Analysis
Fundamental analysis is akin to reviewing a company's health report. Instead of chasing stock tips, you look at the company’s actual performance—earnings, assets, debts, growth—and decide whether this business is worth investing.
Fundamental analysis is a way to figure out how much a company is worth by looking at its financial statements (like balance sheets, statements, and cash flow statements), key financial ratios, and qualitative factors like how well management is doing and how competitive the company is.
Every company tells its story through three reports: balance sheets, income statements, and cash flow statements.
Balance Sheet:
A Balance sheet is like a financial selfie of a company taken on a certain date. It shows the organisation’s Assets, Liabilities and Shareholders’ Equity on that specific date, that is 31.03 for Indian companies. It gives the investors an insight into the financial position of the company and is a solid document for them to evaluate book value, liquidity, solvency, etc.
Income Statement:
The income statement tells the story of money coming in and going out—revenues, expenses, and profits—showing how well the business is really performing.” It is a financial report that summarizes a company's financial performance over a specific accounting period. It includes a company's revenue, expenses, and net income. It is very important for figuring out if a company is making money, keeping an eye on its costs, and making comparisons between time periods and with other companies in the same industry. The document lets managers, investors, and other people who have an interest in the company look at how well it runs, what trends are happening, and how long it will last.
Cash Flow Statement:
And the cash flow statement? That’s all about tracking the actual cash. A cash flow statement is a financial statement that reports the cash inflows and outflows of an organisation during a specific period, categorising how cash is generated and used from operating, investing, and financing activities. Unlike the income statement, which can reflect non-cash transactions, the cash flow statement focuses strictly on real cash movement, helping stakeholders assess whether a company can meet its obligations, fund growth, and regulate business operations.
Important Financial Ratios For Evaluating Company Performance
P/E Ratio:
Price vs. Earnings. Tells you if the stock is cheap or overpriced. The price-to-earnings (P/E) ratio shows how much investors are willing to pay for each unit of earnings. It does this by comparing the current share price of a business to its earnings per share (EPS). The P/E ratio is best used to compare businesses in the same field or to see how much a company has changed in value over time. A P/E ratio between 10 and 20 is generally considered 'fairly valued,' while optimal benchmarks vary by industry and market conditions. Technology businesses typically demonstrate high P/E ratios due to growth expectations, while utility organisations often show low P/E ratios. The benchmark must be continuously assessed against historical averages for the stock or industry and current market trends.
ROE (Return on Equity):
How well the company uses investor money to make profits. Return on Equity (ROE) is a financial ratio that measures a company's ability to generate net income (profit) from its shareholders' equity. It indicates how effectively management is using the equity invested by shareholders to produce profits, also providing insight into management's effectiveness in creating shareholder value. Generally, ROE above 25% is considered really strong and reliant considering a company’s worth.
Debt-to-Equity:
Is the company over-borrowed? The Debt to Equity (D/E) ratio is a financial metric that measures a company's financial leverage by comparing its total liabilities (debt) to its shareholders' equity. It indicates how much debt a company uses to finance its assets relative to the money invested by its owners. A higher D/E ratio means the company is more reliant on debt financing, which could imply higher financial risk but also potential growth through leverage. Acceptable ratio is 1:2.
EPS (Earnings per Share):
Profit per share, the basic building block of stock value. Earnings Per Share (EPS) is a financial metric that indicates how much profit a company generates for each outstanding share of its common stock. It reflects the company's profitability on a per-share basis and is commonly used by investors to assess financial performance.
There’s no universal “good number” because EPS depends on company size and industry.
Think of financial ratios as X-rays for a business. They reveal hidden strengths and weaknesses that is whether the company is making good profits, managing cash well, or carrying too much risk. For investors, that’s the fastest way to cut through the noise and see the real picture.
Ratios tell part of the story, but quarterly earnings reveal the plot twist. That’s where the truth about a company shows up.
When you look into the quarterly earnings you can know the real truth.
- Steady revenue growth shows that there is strong market positioning, reliability and healthy business growth. It also increases the confidence of investors to a large extent, leading them to be more satisfied with their investment decisions. Companies with ongoing revenue growth can better survive challenges and also strategically invest in innovation, expansion, and human resources.
- Expanding profit margins is often a sign of very efficient operations and the ability to scale without directly increasing costs. Higher margins show management is controlling expenses and generating more profit from sales, increasing overall financial health.
- Earnings outperformance generally leads to prompt share price growth and enhanced market confidence. Companies that continually meet expectations have outstanding leadership and powerful fundamentals, frequently resulting in greater valuations and continued investor interest.
Last but definitely not least, this is something you can’t afford to ignore…that is the Intangibles of the Company
- Does the company have a moat?
A moat is its defense system. For example, Apple has brand power, making customers buy iPhones even at premium prices. Pharma companies with patents can block competitors. And a leader like HUL has dominance that makes it very hard for rivals to catch up. A strong moat simply makes it easier for the company to protect the profits for years. {Can give visuals of moat companies like HDFC Bank, IRCTC, Pidilite Industries. etc}
- Is the industry growing?
A perfect example for this would be Kodak. It was a pioneer in photographic films and cameras for a long time. It failed to adapt with the digital age and hence lost its market control. So even if the company is really good, it can still fail if the industry is shrinking or people are resorting to something more advanced.
- Do you trust the management team?
In the end, the company will not stand with just huge profits or Networth, it greatly depends on the quality and ethical standards of the management and leadership. Accountability, Integrity, trust and transparency should be a major part of their corporate culture, or dishonest management can destroy even a profitable business.
Now, let’s look at the warning red lights—the signs of danger before it actually hits.
When a business's profits keep going down, it's a clear sign that it's losing strength or has bigger problems. Another risk is growing debt that doesn't keep up with growth. Borrowing is fine for growth, but taking out more loans while sales stay the same is a time bomb waiting to go off. It can also be risky to depend too much on a single customer or product. If that one source fails, the whole business could fail. Lastly, be cautious of promises that cannot be fulfilled. Management is probably up to no good if they are continually claiming "guaranteed high returns" yet have failed to deliver. With today's uncertain global economy, including rising inflation, fluctuating interest rates, and volatile political situations, dangers can be even bigger than these warning indicators at the corporate level. Ignoring these warning signs doesn’t just dent returns; it can wipe out an investor’s wealth in one go.
Here’s the real lesson:
When you purchase stocks, don't just do it without any research. Think about it like you're buying a business. When you know a company's basics, such its earnings, growth, and competitive advantage, you're not taking a chance; you're investing with confidence. That is how wise investors make money: by owning firms that can last. They don't just chase hype; they chase facts and performance.