What is Fundamental Analysis All About?

I have been involved in identifying, investing and monitoring equity opportunities for 7 years now. Over the years I have read numerous Investor Presentations, Analyst reports and even tried my hands on making complex financial models to understand a company’s valuation. So I am sharing my opinion on what ultimately we should look for, with a breakdown of one of the best performing defence stocks.

In the world of equity investments, having a sense of a company’s true worth is crucial, whether it is a profit making startup or a mature company, held privately or listed on an exchange. 

The challenge is:

• It is forward looking &
• It is completely based on one’s expectations with the industry and the said company

Hence, valuation is a very subjective concept. For me a company’s valuation is a product of its Intrinsic Value which is its tentative future cash flows, this is derived from one’s understanding of the sector and the company, and its Transactional Value which is what value someone will pay for it in a transaction, this is derived from the confidence one has on a company’s future earnings.

Hence, Fundamental analysis plays an important role in one’s decision of investing in equity. It goes beyond surface-level metrics. It’s about diving deep into the financial health and business model of a company to make predictions with a high level of certainty. Simple ratios alone won’t cut it.

Hence it becomes utmost important to understand one’s circle of competence. I would like to quote Warren Buffett, “Everybody’s got a different circle of competence. The important thing is not how big the circle is. The important thing is staying inside the circle.”

Breaking down returns of Hindustan Aeronautics Limited (NSE: HAL). The company saw a 79% jump in its FY23 EPS (Transactional Value) to ₹76.05 from its FY21 EPS of ₹48.44. The stock price mirrored its eps performance and jumped from ₹517 in April 2021 to ₹1365 in April 2023. The magic of intrinsic value happened post April 2023. The stock went ahead to give another 48% jump in its EPS to ₹113.57 in FY24 compared to FY23’s EPS of ₹76.05. But the stock moved more than that, it jumped 246% in one year to ₹4729. This was due to an increase in its PE (Intrinsic Value) of 15 in FY23 to 40 in FY24. Market became confident on its future orders and earning potential. Please find below a snapshot of screener’s PE chart for your perusal.

So, in fundamental analysis one should check how their equity investments will perform with regards to its Transactional and Intrinsic Value. Are you going to analyse your equity positions on these two parameters?

You can always delegate this activity to your equity advisor and get their help in analysing and monitoring the performance of your company.