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Fundamental Analysis & the E-I-C Framework

In the stock market, prices change every second based on emotions and news. But a professional analyst looks deeper. They ask: "What is this company actually worth?" This method of finding a security's "true value" is called Fundamental Analysis.

1. Meaning of Fundamental Analysis

Fundamental Analysis is the study of everything from the overall economy and industry conditions to the financial health and management of an individual company.

The goal is to determine the Intrinsic Value (fair value) of a stock.

  • If Intrinsic Value > Market Price → The stock is Undervalued (BUY).
  • If Intrinsic Value < Market Price → The stock is Overvalued (SELL).

2. Objectives of Fundamental Analysis

Why do we spend hours reading balance sheets and economic reports?

  1. To Predict Future Price: By understanding a company's "earning power," we can guess where its stock price will go in the long term.
  2. To Minimize Risk: Avoiding companies with high debt, bad management, or shrinking industries.
  3. To Find Intrinsic Value: Determining the "true" price of a share regardless of market fluctuations.
  4. To identify Investment Opportunities: Spotting hidden gems that the general market hasn't noticed yet.

3. The E-I-C Framework: A Top-Down Approach

Professional analysts don't start by looking at a company's stock. They follow a "Top-Down" approach called the E-I-C Framework.

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Why this order?

  • If the Economy is in a deep recession, even the best company will struggle to grow.
  • If the Industry is dying (e.g., Typewriters in 1990), a well-managed company in that field is still a bad investment.
  • If both are good, we then pick the strongest Company in that space.

4. Fundamental vs. Technical Analysis

Students often get confused between these two. Here is the critical difference:

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Exam Pattern Questions and Answers

Question 1: "Define Fundamental Analysis and explain its core objectives." (6 Marks)

Answer: Fundamental Analysis is a method of evaluating a security in an attempt to measure its intrinsic value, by examining related economic, financial, and other qualitative and quantitative factors.

Core Objectives:

  1. Determining Fair Value: To calculate the 'intrinsic value' of a share based on its future earnings potential.
  2. Investment Decision: To compare the intrinsic value with the current market price. If the market price is lower, it provides a 'Buying' signal.
  3. Risk Assessment: To identify potential red flags in a company’s financial health or management quality before committing capital.
  4. Portfolio Building: To select fundamentally strong companies that can weather economic downturns.

Question 2: "Briefly explain the 'Top-Down' approach in Fundamental Analysis." (4 Marks)

Answer: The 'Top-Down' approach is popularly known as the E-I-C Framework. It involves analyzing the investment landscape in three levels:

  1. Economy Analysis: Assessing the macro-economic environment (GDP, Interest rates, Political stability).
  2. Industry Analysis: Evaluating the specific industry the company belongs to (Industry life cycle, competitive intensity).
  3. Company Analysis: Investigating the financial performance and qualitative aspects of the specific firm. By filtering from the top, an investor ensures they are investing in the right stock, within the right industry, at the right time for the economy.

Summary

  • Fundamental analysis is about "What" a company is worth.
  • The Intrinsic Value is the "holy grail" of fundamental analysis.
  • The E-I-C Framework filters investments from national level to company level.
  • It is the preferred method for Long-term Investors.

Quiz Time! 🎯

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