Fundamental analysis is the approach of viewing a publicly traded company as a business instead of just stock, in order to measure the financial health, growth and future prospects. Through fundamental analysis, value investors look for buying good, healthy businesses at cheap prices.
There are many ways fundamental analysis of a stock can be done, but I am going to share 5 step formula of fundamental analysis and how to pick stocks for long term portfolio:
Step 1: The financial performance
The first thing I look for in a company is its past financial performance. Analyzing past performance gives me a clear idea about company’s growth, earnings, profitability and how efficiently company is utilizing its capital. For this I look at 5 to 10 years of company’s data in the form of financial ratios. I use financial ratios because it makes it easier to compare a company’s performance with its peers. The financial ratios that I use are:
- Basic EPS: This is the basic earnings ratio which tells us about the company’s earnings on a per share basis. In other words, it is the ratio which tells us how much a company is earning against each share outstanding.
- Cash EPS: A conservative ratio compared to Basic EPS, which calculates how much cash a company is generating against each share of the company.
- Net profit margin: Gives you a idea about how much profit company is able to make on each sale made by the company. It is expressed in percentage terms. Higher percentage means company is able to charge high price from its customers, leaving fat profits in the pocket of the company.
- Debt/Equity: Gives an idea of how the company’s capital is financed. Companies with high debt usually are riskier investment because if a company suffers a loss, it still has to pay its debt, which can sometimes even lead to bankruptcy of a company. A company with low or zero debt is always preferable.
- ROCE: It is a financial ratio that measures how efficiently a company is utilizing its capital. For example i a company has employed Rs. 100 of capital and earns a return of Rs. 20, it means company’s ROCE is 20%. While Net profit margin shows the difference between the cost of making a product/service and revenue generated from the same, ROCE is calculated on total assets used by the company. Company with high ROCE are better investments as it shows company has good control over its financial resources and is able to run the business.
- Dividend per Share: It is the ratio that tells us how much dividend a company is paying against each share outstanding. Dividend is a part of company’s profit that company distributes to its shareholders. A company with consistent and growing dividend/share is a good investment as it keeps investors invested in the company.
Step 2: Reading Annual Reports
Reading annual report of the company for the past three years. This gives me an idea about what the company has been doing in its business, what goals and targets it had set for itself and if it has achieved them. A company that sets clear and time bound targets for this business shows how professional, and ambitious the management of the company is.
Step 3: Future plans
Every company has some future plans for its business. By looking at the company’s future plans, I get the direction in which the company is headed. Is the company going to start a new business, is it going to expand its current business? Is the company planning to go overseas? All such questions are answered by analyzing company’s future expansion and diversification plans.
After going through all the above mentioned steps I try to figure out how the company is going to look like in the future, what kind of revenues I can expect and what could be the profitability in the next 3 to 5 years. I don’t try to get the exact number but just a ballpark percentage growth I can expect in the future.
Step 4: Critical analysis
The fourth step I follow is to write down all the logical and rational reasons why I should invest in this stock. Doing so gives me ample positive and negative points about the company and areas where I should be cautious while investing. It is said that “If you cannot fill a page with logical reasons why you should invest in a stock, then you should not make that investment.“
Step 5: Waiting for the right price
Finally, I wait for the market correction to buy the stock at a low price. I do not put all the money at once, but buy on every dip in the price. Then there is a very long period of waiting, giving my investment time to grow. When I feel it is time to sell the stocks I start selling them in small quantities on every rally.
You may feel it’s a lot of work, but trust me it’s really worth all the effort.
Below is the list of 3 most accurate candlestick chart patterns which every trader should know about. They have been ranked based on the reliability and past success rate. I have tested these patterns on hundreds of charts in different time frames. Definitely they don’t work 100% of time, but these are more reliable and accurate than other price action chart patterns I have come across.
Head and Shoulders:
This is one of the most accurate candlestick chart patterns observed till date. It works like a charm in most of the charts be it any time frame. From our internal study, we found it to be 90% accurate, so if you follow head and shoulders religiously you can possibly make profit 9 out of 10 times. It is a reversal pattern, i.e. it indicates possible reversal in the ongoing trend.
This pattern is characterized by two nearly equal peaks, with a higher peak between them. The two equal peaks are called “Shoulders”, and the higher peak is “Head” . The line joining trough between two shoulders is called neckline. If the price breaks the neckline after rising to second shoulder, then it signals bearish reversal in ongoing uptrend. The opposite variant of this pattern is called “Inverted Head and Shoulder”. It indicates bullish reversal during ongoing downtrend.
Double Top and Double Bottom:
This pattern is also similar to Head and shoulders except for the fact that Head is missing. Double top is characterized by two nearly equal peaks next to each other. After making the second high if the price breaks the previous swing low between two peaks, then it signals a bearish reversal. Similarly Double bottom is characterized by two nearly equal troughs. Breakout from the previous swing high signals a bullish reversal.
There is another variant to this pattern known as Triple top and bottom. It has three peaks or troughs instead of two. It is definitely more accurate than the former but difficult to spot on a chart.
Bullish and Bearish Rectangle:
Rectangle is an easy identifiable chart pattern characterized by a visible trading range. The trading range should have multiple nearly equal highs and lows. The line joining highs is a horizontal resistance line, while the line joining lows is a horizontal support line. Breakout of resistance signals a bullish rectangle, while breakout of support signals a bearish rectangle.
Check out an E-book:
How to Make Money Trading with Candlestick Charts
Few tips before you start in stock market or do trading are as follows:
- Your own capital: Never take a loan or borrow money from a friend to trade in stock market. Many times I have seen that people borrowed money or took loan from someone on high interest rates and then lost capital and they caught in trouble.
- Sufficient Capital: I have seen many people who make loss just because they don’t have sufficient capital to survive in market like many people trade 5 lots for Intraday in 1 lac capital. I don’t recommend this because sometimes you may get profit but it’s purely a gambling to trade like this. Always put sufficient capital to trade as per NSE margin guidelines and also maintain MTM so that you don’t have to book losses.
- Following a Stop loss: New comers don’t follow stop loss and they just keep on holding a losing stock and it ruin your whole capital. Don’t do that. Always cut the loosing position before it wipes out everything.
- Hold Profit with a trailing Stop loss: Many times I have seen that people book 2 rs profit and hold in 20 rs loss. You should always hold profitable stocks with trailing stop loss to maximize your gains and minimize your losses whenever you are in loss. In this way you can gain good profit from market.
- Be cautious on other’s advice: Many people buy or sell anything because a friend, an adviser or anyone suggested. It may give sometimes profit but it’s riskier too because you can’t earn consistently by just following TV advisers or any friend. So always do your own research before trading or investing. Because learning by you is a key to earning.
- Be cautious when everyone is buying or selling: we have seen many times that if everyone is saying that this stock will reach 200–250 level, it doesn’t happen and that stock gives opposite movement. You should follow warren Buffet’s golden lines that be fearful when others are greedy and be greedy when others are fearful.
- Over Trading: Many people trades too much in a day and they hold too many stocks at a time which is a indication of a disaster. Some are too curious to trade that they put trade at 9:15 AM only and that trade gives losses too many times. One should always wait for perfect opportunity to earn in market because less trading saves profit while frequent trading takes away saved profits.
- Following an advisory company: This is the most common problem nowadays and I was a victim too before I joined tradepsychology.com There are thousands of unregistered and registered advisory companies and tips providers in India. Follow only reputed advisers or follow anyone after doing proper research about them because it’s your hard earned money after all. You will get so many Facebook tips providers and WhatsApp tips providers but don’t believe them until you know everything about them. Because it’s very easy to make fool people through Social media by posting wrong information.
- Learn Basic technical: Always try to learn basics of stock movement so that at least you can get idea about stock’s support and resistances. Always Buy on support and sell on resistances with stop loss.
- Don’t Average: Many people buy a stock for an example at 190 and then average at 188 and may be again at 185 and then they have to cut all positions at 180 because of insufficient margin. Don’t average in market because adding loosing positions is always riskier. Better just give up and find other opportunity.
- Risk Appetite: Always follow risk percentage of your capital. Suppose if you have 1 lac capital, don’t take more than 10% of risk in single stock because if you lose 10%, it can be covered but if you lose more, than it create a problem. So always follow risk management formula to minimize your risks.
- Don’t be emotional in trading: Many people follow any particular stock or index like it’s their favorite and their friend. Don’t love any stock or index. Just follow basics and trade. Sometimes loving a stock gives us big losses.
- Stop Trading: Stop trading whenever you are losing frequently because it happens sometimes that you’re all decisions and thoughts are against of market which are giving you losses. So whenever this kind of situations are happening, just stop trading and take a break.
- It’s not primary source of Income: Many people think that this is their primary sources of income and they leave their work or job. I just advise them that never leave your primary source of income because stock market earnings are external source of income and keep it as extra income only. Never make it as a main source because it may harm you and your family. Don’t be emotional and sentimental in stock market because market doesn’t understand anyone’s emotions or problems. Don’t expect that market gives you money for any operation, any loan payment or any other sympathy earning. Just be practical and trade.
These are tips for trading and basic rules which will help beginner to start his trading journey without much hurdles.
Reading as a Hobby:
I read books primarily because I find it relaxing and a way to get away from reality. I started reading at a very young age and I believe I wasn’t really looking for any advantages or benefits then.
Anyways, over the course, some of the advantages of reading that I can perceive are as follows:
- Improves your vocabulary – You can develop fluency in speaking English with rich vocabulary
- Develops your imagination – A perfect example would be Harry Potter or the Lord of the Rings
- Stress buster – As a trader you need to come out of game, one such method is by reading book
Improving vocabulary and knowledge are the big advantages. Most of the knowledge you get seems to be “useless, superficial and irrelevant”, but over the years you will be surprised at how often these little bits of knowledge become helpful.
Do successful people read lots of books?
Most successful people do read books a lot. However I believe that nowadays, people don’t just read books. This is because we now have variety of sources of getting information from internet.
Some people are amazed with how fast people can read or the time they can take to read books. But you have to understand that they use certain techniques to read efficiently. Everyone has their own objective of why they want to read. There are people who just simply like to read. But you need to read right knowledgeable blogs & books which can really boost your carrier.
I’ve been surrounded by successful people, have many very successful close friends, and enjoy a great deal of success through entrepreneurial pursuits.
In my experience with friends and business associates I’ve found they either enjoy reading or they don’t. This will typically determine whether or not they read books.
Almost all successful people I know will read information specific to their field e.g. Wall Street Journal, business journals, trade magazines, and blogs/websites.
The most successful people I know are voracious readers. They read, and write, constantly. The subjects are diverse and are often unrelated to their area of professional specialties.
Following are 4 Must Read Books Every Financial Planner :
Think and Grow Rich by
The Intelligent Investor by
The Power of your Subconscious by
Either you’re an experienced trader or just the beginner, reading books will help you to have the better understanding of the world, give you mental strength and make you smart, especially if those books are about trading.