We follow two methods for analysing a stock in order to find out a potential investment opportunity;
- fundamental, and
Market participants are always debating which is better.
Fundamental analysis focuses on a company’s fundamental information about the strength, quality, soundness of the company and its products. The technical analysis is used to know how a stock is performing in the marketplace.
Fundamental analysts believe that a company’s profitability is one of the most important factors that have a big impact on the stock price.
This means these investors bet for those stocks which show consistent earning growth, have increased sales, strong operating and net profit margin and have a high return on equity.
Here are certain important financial ratios used by fundamental analysts for finding potential investment opportunity;
- Earnings per share: Calculated by dividing net earnings by the number of shares outstanding
- Return on equity (ROE): Measures return on equity capital of a company
- Growth in annual earnings and sales: Calculated by comparing quarterly and annual financial statements of a company.
On the other hand, technical analysis is the study of market movement mainly by using the price charts and volume movement. This will help you analyse the supply and demand of a stock.
Technical analysts observe price and volume per day or per week to interpret supply and demand correctly. They try to know whether the stock is going up or down in price on greater or less than normal volume.
Volume signals whether big institutions are buying or selling the stock.
The main objective of trading is to make big money when you are right and to get out early when you appear to be wrong.
To make big money, one should always go for winning stocks. Sales and earnings growth are among the most important characteristics of winning stocks. In order to find growth in earnings and sales, you have to compare quarterly and annual results of a company to its previous quarter or year.
Technical analysis assumes that all the information worth knowing about a stock or company is already reflected in a stock price. They base their decision by studying the pattern in which stock prices move up and down.
Technical analysts are only bothered to recognize candlestick price patterns in stock price charts so that the best time to get in and out can be known. These analysts are not concerned about what the company does and how much profit it makes.
Following things are generally used by technical analysis:
- Stock price movement over a period of time
- Stock volumes in comparison to price movements
- Trading pattern to find out when to get in and out by deciding support level, target price
- Stocks average price over a period of time – Moving averages.
- Technical Indicators such as support, resistance, trend lines, MACD, RSI, etc..
If you want to invest in a stock after knowing how the underlying business is doing financially, then fundamental analysis is best for you. If you have done a thorough analysis, then you can easily identify potential threats to the business from a troubling economy or industry specific threat.
Basically, fundamental analysts try to find out the intrinsic value of a stock. Then, by comparing it with the actual price, they will come to know whether a stock is overvalued or undervalued. Overvalued stock means its market price exceeds the intrinsic value.
Fundamental analysis also looks at economic and financial factors that influence a business.
Here are three important points to understand the difference between fundamental and technical analysis:
- Fundamental analysis starts with the income statements, balance sheet, statement of cash flows, and financial tools to analyse a company’s financial statements, while technical analysis starts with charts of share price and volume.
- Technical analysts believe that a company’s financial statements have no relevance for analysis of a stock since price already includes relevant financial and economical information. Fundamental analysts believe in the intrinsic value of a stock. If the market price is below the intrinsic value, then they buy the stock.
- Technical analysts invest for a short duration, whereas fundamental analysts invest for a long-term.
Both the techniques are good and a combination of both are used by traders and investors across the world. For instance, an investor after finding a stock to buy, may take help of technical analysis to know the best entry and exit point to take a position. Similarly, a trader may find a breakout in charts before earnings are published but take a position if fundamental analysis suggests that the earnings will beat the market.