Monday 13 November 2017

Technical Analysis v/s Fundamental Analysis

Dear Stocks enthusiasts,

My apologies for not being in touch for sometime. Joined a new job and was busy trying to get settled down!

Today I am going to tell you how I analyze companies for long term investing, using the bottom up  fundamental analysis approach. How I go about separating the wheat from the chaff!



First lets understand the TWO approaches that can be used for stock picking

1. Technical Analysis  (Short term view hence a trader)

  • Technical analysis is all about studying stocks price movements viewed using charting tools. It involves analyzing charts of the past movements of a stock’s price and its trading volume (total number of transactions, buy/sell) over the different time ranges - days, weeks and months mostly. 
  • The investor then tries to predict future price movement of the stock based on these past patterns. Once the investor finds a stock whose price is expected to move higher, she buys it and holds it until the chart patterns indicate that the price is expected to fall or become stable. 
  • The investor following technical analysis is concerned only with the past prices and trading volume data of the stock. 
  • The investor is indifferent to whether the stock is of a manufacturing, an agricultural or a financial services company or this company is making good sales and profits etc

2. Fundamental Analysis (Long term view hence an investor)

  • Fundamental analysis of a stock involves understanding the underlying business of a company. While conducting fundamental analysis, the investor tries to find out a company, which has a very good product, well-known customers, stable suppliers, honest & capable management etc. 
  • This is not an easy job as it takes a lot of patience and passion to do this. Even the best of fundamental investors can manage to find at the most 1-2 such companies in a quarter as he/she keeps screening the company through the various filter criteria's that he/she wants the company to meet before going ahead and investing the hard earned money
  • This is the reason most people find it better off delegating this job to an expert called as Fund Manager who runs a mutual fund scheme under a ABC or XYZ Asset Management company. This is what is called passive investing in equities. This isnt a bad approach at all, end of the day stick to whatever works for you!
  • Anyway, going back, once the (active) investor finds such a company, he/she can invest in its stock and expect to benefit from the future long term growth prospects of the business of the company
  • The premise here is that when the business of the company grows, the demand for the companies stock goes up since more people what a portion of the profits it makes (called as tax free dividends), since the number of outstanding shares of a company is mostly constant, investors are willing to pay higher price for the stock, the stock price then shoots up (as its a auctions marketplace), and then the existing investor who had bought the stock early anticipating all this, now gets benefits not only from the dividends earned but also the higher price of the stock eventually. This whole process may take from as early as 1 year to 5 years and sometime even a decade - hence "long term"
  • Fundamental investing is hence a great example of capital compounding - there by beating inflation and giving higher returns than bank FD's and other fixed investment instruments. Wih higher risk (stocks can go other way round and become half or 1/10th the value too!) comes higher rewards
In the next post I will explain the Top Down and Bottom Up approach to fundamental analysis.

Until then..Chao!