Fundamental Analysis

1. What fundamental analysis is

Fundamental analysis asks whether a business is worth its price. It looks at the company's sales, profits, debts, cash, management and industry. The goal is to estimate what the business is worth and compare that with the share price. The gap between the two is the margin of safety that value investors look for.

2. Where to find the information

• Annual report: the full picture, including management discussion, risks and audited financial statements.
• Quarterly results: the latest profit, sales and sometimes cash flow. Filed on the exchange websites (NSE and BSE).
• Investor presentations and earnings calls: management's explanation of the numbers.
• Shareholding pattern: promoter, institutional and public holdings, filed every quarter.
• Corporate announcements: dividends, bonus issues, board decisions and material events.

3. The three financial statements

A company's story is told in three statements that must be read together.

• Profit and loss statement: revenue, expenses and profit over a period. Shows whether the business earns money.
• Balance sheet: assets, liabilities and equity at one date. Shows what the company owns and owes.
• Cash flow statement: cash from operations, investing and financing. Shows whether profits become real cash.

A company can show a profit and still run out of cash. Always check whether operating cash flow is close to net profit over several years.

4. Core ratios with formulas and an example

• EPS (earnings per share) = net profit ÷ number of shares. Example: ₹300 crore profit ÷ 10 crore shares = ₹30 EPS.
• P/E ratio = share price ÷ EPS. Example: ₹450 ÷ ₹30 = 15 times earnings.
• ROE (return on equity) = net profit ÷ shareholders' equity. Example: ₹500 crore ÷ ₹2,500 crore = 20%.
• Debt-to-equity = total debt ÷ shareholders' equity. Example: ₹1,000 crore ÷ ₹2,500 crore = 0.4.
• Dividend yield = dividend per share ÷ share price. Example: ₹10 ÷ ₹450 ≈ 2.2%.
• Operating margin = operating profit ÷ revenue. Shows how much each rupee of sales keeps after running costs.

5. Growth: is the company getting bigger and better?

A good business grows its sales and profits over time, and does so without needing ever more debt. Look at 5 to 10 years of data, not one quarter. Check whether revenue growth comes with stable or improving margins, and whether the return on capital stays high as the company expands.

6. Quality: the business behind the numbers

Ratios cannot tell you everything. Quality questions include: Does the company have a durable advantage, such as a brand, cost position, network or regulatory licence? Is management honest and competent, with a record of allocating capital well? Are related-party transactions or accounting changes a concern? Is the business easy to understand?

7. Valuation: how much is it worth?

Valuation estimates what the business is worth per share, using methods such as comparing P/E with peers, comparing price-to-book, or estimating future cash flows discounted to today. No method gives a single correct answer. Use two or three approaches to get a range, and buy only when the price is comfortably below your estimate.

• Relative valuation: compare P/E, price-to-book and EV/EBITDA with similar companies.
• Absolute valuation (discounted cash flow): estimate future cash flows and discount them. Very sensitive to assumptions.
• A cheap-looking stock can be a value trap if earnings are falling. A high-priced stock can still be good if growth is strong and durable.

8. A worked example

Company X: price ₹450, EPS ₹30 (P/E 15), ROE 20%, debt-to-equity 0.4, sales growing 15% a year for five years, operating margin steady at 18%. Peers trade at an average P/E of 20. Company X looks reasonable on these figures: strong returns, low debt and a P/E below peers. Before deciding, check the annual report for one-off profits, the quality of cash flow and the risks listed by management. The example is illustrative, not a recommendation.

9. Red flags to check every time

• Profits rising while operating cash flow falls for several years.
• Receivables growing much faster than sales.
• Frequent changes in auditors or accounting policies.
• Promoter shares being pledged in large amounts.
• Heavy reliance on one customer, one product or one government contract.
• Management that changes its targets or explanations often.

10. Building your own process

Write a one-page checklist: business model, growth, margins, returns, debt, cash flow, management, valuation, and risks. Fill it in from the annual report before you read any opinion. Review your holdings when results come out, not every day. Your job is to understand the business well enough to explain why you own it, and to know what would make you sell.