When it comes to investing in stocks, there are two main approaches that investors can use: fundamental analysis and technical analysis. Each approach has its own set of tools and methods for analyzing stocks, and investors may choose to use one or both methods depending on their investment style and goals.
Fundamental Analysis
Fundamental analysis is an approach to investing that involves analyzing a company’s financial statements, business model, industry trends, and other qualitative and quantitative factors to determine the intrinsic value of a company’s stock. The goal of fundamental analysis is to identify undervalued or overvalued stocks and make investment decisions based on this analysis.
The key components of fundamental analysis include:
1. Financial Statements: The financial statements of a company, including the balance sheet, income statement, and cash flow statement, are important sources of information for fundamental analysis. Investors use these statements to analyze a company’s profitability, liquidity, debt levels, and other financial metrics.
2. Business Model: Investors also look at a company’s business model and competitive position within its industry. Factors such as market share, product differentiation, and barriers to entry can all impact a company’s long-term growth potential.
3. Industry Trends: The overall trends within an industry can also impact a company’s future growth potential. For example, an investor may look at trends in consumer spending, regulatory changes, or technological advancements that could impact a company’s revenue growth and profitability.
4. Management: Finally, investors may also analyze a company’s management team and its track record of executing on its business plan. Factors such as management expertise, alignment with shareholder interests, and corporate governance can all impact a company’s long-term success.
Let’s take a look at a few examples of Indian stocks that investors may analyze using fundamental analysis:
1. Reliance Industries Limited (RELIANCE)
Reliance Industries is a conglomerate that operates in a variety of industries, including petrochemicals, refining, and telecommunications. In terms of financial statements, investors may look at metrics such as revenue growth, EBITDA margins, and debt levels. Investors may also look at the company’s competitive position within its industries, its plans for expansion and growth, and its track record of execution.
2. HDFC Bank Limited (HDFCBANK)
HDFC Bank is one of the largest private sector banks in India, with a focus on retail and corporate banking. Investors analyzing HDFC Bank may look at metrics such as net interest margins, loan growth, and asset quality. They may also analyze the bank’s position within the Indian banking industry, its plans for expanding its product offerings and customer base, and the strength of its management team.
Technical Analysis
Technical analysis is an approach to investing that focuses on analyzing the historical price and volume data of a stock to identify patterns and trends that can inform investment decisions. The goal of technical analysis is to identify trends in a stock’s price movements and use this information to make investment decisions.
The key components of technical analysis include:
1. Charts: The primary tool used in technical analysis is the price chart. Technical analysts use charts to identify patterns and trends in a stock’s price movements over time.
2. Technical Indicators: Technical analysts also use a variety of technical indicators to supplement their analysis. These indicators include moving averages, oscillators, and other metrics that can provide insights into a stock’s momentum, volatility, and other key metrics.
3. Volume: Finally, technical analysts also analyze a stock’s trading volume to identify trends in investor sentiment and market activity.
Let’s take a look at a few examples of Indian stocks that investors may analyze using technical analysis:
Example of Technical Analysis of Stocks
Let us consider the stock of Reliance Industries Limited (RIL), one of India’s largest conglomerates. Here, we will analyze the stock using technical analysis.
First, we will look at the chart of RIL’s stock price movement over the last year:
RIL stock price chart
As we can see, RIL’s stock price has been in an uptrend for most of the year, with the price making higher highs and higher lows. This is a bullish sign, indicating that the demand for the stock is increasing.
We will now look at some key technical indicators that can be used to analyze RIL’s stock.
Moving Averages
Moving averages are a commonly used technical indicator that helps to smooth out fluctuations in stock prices. They are calculated by taking the average price of a stock over a certain period of time. The most commonly used moving averages are the 50-day and 200-day moving averages.
Here is a chart of RIL’s stock price along with its 50-day and 200-day moving averages:
RIL stock price with moving averages
As we can see, the 50-day moving average (in Red) is above the 200-day moving average (in Green), indicating a bullish trend. Additionally, the stock price has been consistently trading above both moving averages, which is also a bullish sign.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) is a momentum indicator that measures the speed and change of price movements. It is scaled from 0 to 100 and is commonly used to identify overbought or oversold conditions in a stock.
Here is a chart of RIL’s stock price along with its RSI:
RIL stock price with RSI
As we can see, the RSI has been consistently above 50, indicating a bullish trend. Additionally, the RSI has not reached overbought levels of 70 or higher, which is also a bullish sign.
Example of Fundamental Analysis of Stocks
Now, let us consider the stock of HDFC Bank, one of India’s largest private sector banks. Here, we will analyze the stock using fundamental analysis.
First, we will look at HDFC Bank’s financial statements to understand its financial performance:
Net Interest Income (NII)
NII is a key metric for banks, representing the difference between interest earned and interest expended. HDFC Bank’s NII for the fiscal year 2020-21 was 18,070 crores, indicating a healthy interest income.
Net Profit
Net profit is a key metric that measures a company’s profitability. HDFC Bank’s net profit for the fiscal year 2020-21 was 7,730 crores, indicating a healthy profitability.
Gross Non-Performing Assets (GNPAs)
GNPAs are a key metric for banks, representing the percentage of loans that are not being repaid by borrowers. HDFC Bank’s GNPAs for the fiscal year 2020-21 was 1.47%, which is below the industry average and indicates a healthy loan portfolio.
Return on Equity (ROE)
ROE measures the return generated by a company on the equity invested by its shareholders. ROE is calculated as the net income of the company divided by its shareholders’ equity. It is expressed as a percentage. A higher ROE is generally considered better as it indicates that the company is using the funds provided by shareholders more efficiently.
ROE = Net Income / Shareholders’ Equity
Let’s take the example of HDFC Bank, one of the largest private sector banks in India. As of March 2021, HDFC Bank had a net income of INR 31,116 crore and shareholders’ equity of INR 1,20,628 crore. Therefore, the ROE of HDFC Bank for FY2021 can be calculated as follows:
ROE = (31,116 / 1,20,628) x 100
ROE = 25.81%
This indicates that HDFC Bank generated a return of 25.81% on the equity invested by its shareholders.
Price-to-Earnings (P/E) Ratio
The P/E ratio is a widely used valuation ratio in the stock market. It measures the price of a stock relative to its earnings per share (EPS). The P/E ratio is calculated by dividing the current market price of a stock by its EPS.
P/E Ratio = Current Market Price / EPS
For example, if the current market price of a stock is INR 500 and its EPS is INR 20, then its P/E ratio would be 25x.
A high P/E ratio indicates that investors are willing to pay a premium for the stock, which could be due to high growth prospects or strong financial performance. On the other hand, a low P/E ratio could indicate undervaluation of the stock or weak financial performance.
Let’s take the example of Infosys, one of the largest IT services companies in India. As of March 2021, Infosys had a market price of INR 1,427 and EPS of INR 72.91. Therefore, the P/E ratio of Infosys can be calculated as follows:
P/E Ratio = 1,427 / 72.91
P/E Ratio = 19.56x
This indicates that the market is willing to pay a premium of 19.56 times the earnings of Infosys.
Technical Analysis of Stocks
Technical analysis involves analyzing stock price and volume data to identify trends and patterns that can help predict future price movements. Technical analysts use various charts and technical indicators to study the historical price and volume data of a stock.
Some of the commonly used technical indicators include moving averages, relative strength index (RSI), and Bollinger Bands. Moving averages are used to identify the overall trend of a stock, while RSI and Bollinger Bands help identify overbought or oversold conditions.
Let’s take the example of Tata Consultancy Services (TCS), one of the largest IT services companies in India. The following chart shows the stock price movement of TCS from January 2021 to May 2021.
TCS stock price chart
As we can see from the chart, TCS has been in an uptrend since January 2021. The stock price has been consistently making higher highs and higher lows, indicating a bullish trend. Moreover, the stock has been trading above its 50-day and 200-day moving averages, which is a positive signal.
The RSI indicator for TCS has been hovering in the overbought zone for most of the period, indicating that the stock is overbought and may see a correction in the near term.
Conclusion
Fundamental and technical analysis are two different approaches to analyze stocks. While fundamental analysis focuses on the financial and economic factors