Stock markets are highly volatile in short term but tend to stabilize over long term. That’s why most equity research firms which focus on long term wealth creation use fundamental analysis to select stocks.
There is very popular joke about stock markets which says a lot about technical analysis.
“What is the best way to end up with a million in stock markets? Well start with 2 million and use technical analysis to invest”
While both methodologies have their own advantages and disadvantages, equity research firms prefer fundamental analysis to evaluate a stock’s future potential in long term. On the other hand, technical analysis is all about predicting the future price direction of a stock in short term.
Equity research firms focusing on long term wealth creation use fundamental analysis as it is a logical and practical approach to investing by looking at the financial soundness of a company and its business prospects. On the contrary, technical analysis, focusses on the psychological aspects of the market by analyzing past market movements to predict future movement.
Key Components Of Fundamental Analysis Used By Equity Research Firms In India
Equity research firms in India use price-to-earnings ratio to determine the market value of a stock compared to the company’s earnings. It shows what the market is willing to pay today for a stock based on its past or future earnings.
The price-to-book ratio or P/B ratio can help equity research firms in India to measure whether a stock is over or undervalued by comparing the net assets of a company to the price of all the outstanding shares.
Free cash flow
Free cash flow refers to the cash produced by a company through its operations, after deducting the cost of expenditures. It helps equity research firms in India to determine how efficient a company is at generating cash and is an important measure in determining whether a company has sufficient cash to reward shareholders through dividends and share buybacks.
Debt level of the company
Checking the debt ratio is one of the most important factors considered by equity research firms in India while doing fundamental analysis of stocks. It is a well-known fact that a company cannot perform well if it has a huge debt ratio.
Future growth prospects
The company’s future growth prospect and sustainability is also a very important factor to consider.
Why Equity Research Firms In India Prefer Fundamental Analysis Over Technical Analysis?
Before the advent of high-speed computing, fundamental analysis was the most used method for analyzing stocks before investing. With variety of technology and algorithms available now, technical analysis has become easy. However technical analysis is all about having a short term investing view which has lot of risks. And short term investing can never create sustainable wealth. That’s why fundamental analysis is one of the most preferred methods used by equity research firms in India while selecting stocks.