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Equity Fundamental analysis:
Investing in Equity Markets Back
Fundamental analysis:
Fundamental analysis involves studying the parity or difference between the current market price a company's stock and the company's own intrinsic present or future worth based on its assets and competitive strengths. There are three approaches to fundamental analysis:
 
  1. Anticipative valuation
  2. Absolute valuation
Anticipative valuation:
This approach is based on the assumption that the current price a company's stock reflects the true value of its issuing company and figuring out whether it would be worth more or less in future.
 
To do this one has to sift through accounting statements of a company to ascertain financial strengths and weaknesses, finding out competitiveness of the company on various parameters including technology, quality, marketing and funds, checking out trends in the industry the company operates in and then figuring where the company is headed depending on the past trends and present status. If one concludes that the value of the stock will go up in future, one buys and if it is going to go down, one sells.
 
To take an example, Hindalco is a company in the business of producing commodity aluminum as well as products extruded from that. Currently the company's stock is hovering around Rs 700. Given that Hindalco will make more money if the prices of aluminum were to rise, one would track the global aluminum prices on London Metal Exchange, LME, and also check with industry participants about demand-supply trends and possibility of prices hardening. If one believed that aluminum prices would go up and the market was not adding that to the stock's value right now, one would buy Hindalco stock.
 
Absolute valuation:
This approach gained its fame and notoriety in India thanks to Harshad Mehta. It is also known as the replacement value method. However, the method is applied by many to companies operating in capital intensive areas where the biggest barrier to entry is size of the capital. Such companies are largely commodity producers like Hindalco.
 
If one was to value Hindalco stock's fair price based on this method, one could arrive at a figure of about Rs 1000 compared with its current price of about Rs 700. For example, the 242,000 tonnes per annum smelting capacity of Hindalco could take about Rs 5000 crore to set up now, replicating its 620 MW power capacity could cost about Rs 2500 crore and its 74% stake in another aluminum company, Indal, would be worth about Rs 265 crore given than Indal stock has been trading at about Rs 70. So, based on absolute valuation or replacement value approach one would again buy Hindalco stock.
 

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