Stock markets are highly volatile in the short term but tend to stabilize over the long term. That’s why most equity research firms that focus on long-term wealth creation use fundamental analysis to select stocks.
There is a very popular joke about stock markets, which says plenty 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. While technical analysis is all about predicting the future price direction of stock in the short term.
Equity research firms focusing on long-term wealth creation use fundamental analysis as it is a logical and practical approach to look at the financial soundness of a company and its business prospects. On the other hand, technical analysis focuses on the psychological aspects of the market by analyzing the past market movements to predict future movements.
Key Components Of Fundamental Analysis Used By Equity Research Firms In India
Equity research firms in India use the 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.
The debt level of the company
Checking the debt ratio is one of the most important factors most equity research firms in India consider while analyzing the fundamentals of stocks. It is a well-known fact that a company cannot perform well if it has a high debt ratio.
Future growth prospects
The company’s future growth prospects and sustainability are vital factors to consider. Whether the company can grow, scale up, or create solutions instead of just products will have an impact on the company’s future.
Why do 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 to analyze stocks before investing. With a 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 a lot of risks. Short-term investing can never help investors create sustainable wealth. That’s why fundamental analysis is one of the most preferred methods equity research firms in India use while selecting stocks.