Thursday, December 14

A Good Company Needn't be a Good Investment

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You know the company is financially sound. It has been registering amazing performance over the years and sales and profits are expected to grow at 30% every year. Should you invest in such a company? The answer is that you need to analyze further before arriving at an investment decision. 

Financial experts say that if you are investing in individual stocks, it is essential that you have a methodology by which you come to a decision when to buy and sell stocks. It is important to have a methodology because a good company may not necessarily translate into a good investment and vice-versa. Here are some ways in which you can analyze the company 

Fundamental Analysis: 

Fundamental analysts believe that when you buy a share you are buying a part of the company’s business. Hence to get the price of the share, you actually need to know the worth of the business. This can be done by assessing the company’s financials and arriving at a value per share. This technique is known as fundamental analysis. 

The fundamental process involves analyzing a company’s management capabilities, competitive advantages, its competitors and the markets it functions in. You could look at key financial ratios such as operating margins, earnings per share and so on. After examining the key ratios of a business and analyzing the underlying fundamentals one can come at a conclusion about the financial health of a stock and put a value to it. 

If the share price is trading below the value arrived at by a fundamental analyst, investors should buy the stock, in anticipation of the share price rising to the true value in the future. Conversely, if the share price is higher than the estimated true value, investors should sell. 

So, fundamental analysis = finding out the value of the company.

Technical Analysis:

According to technical analysts share price behavior is repetitive in nature. It will help us to predict future price. It does not look at fundamentals or financial results at all. Technical analysts believe that all information, about a company, is factored into the share price. Based on historical share price data of a company, technical analysts identify share price levels that act as support or resistance. 

They try to identify support, resistance and breakout levels for stocks. Technical analysts also use various technical indicators and chart patterns to help them determine probable future share price movements. Technical analysis is extremely short term in nature and is used by intraday traders or those with short-term outlook. 

So, technical analysis = finding out the price of the company.

Quantitative Analysis:

It is a process of determining the value of a security by examining its numerical, measurable characteristics such as sales, earnings and profit margins. Both quant and technical analysts use back testing or historical analysis of data. 

Pure quantitative analysts look only at numbers with little or no attention to the underlying business. Although even fundamental analysis look at numbers from a balance sheet, their primary focus is always the underlying business, the environment in which the company is operating and so on. Quantitative analysts create mathematical algorithms which help them arrive at buy and sell decisions. 

So, quantitative analysis = creating methematical algorithms of the compnay.

Which should you use? 

There is no single answer. All these three methods of analysis have their advantages and disadvantages. While long-term investors could use fundamental analysis, day traders or short-term traders many a time use technical analysis to trade. High net worth individuals wanting an alternate flavor could allocate some money to quantitative techniques. Savvy investors also use a strategy known as techno-fundamental research to get the best of technical as well as fundamental research. 

Source: Economic Times

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