Fundamental Approach: The basic talents of fundamental approach are as follows:
- There is an intrinsic value for each stock and this value can be determined by a penetration analysis of the fundamental factor to the company, industry and economy.
- At any given point of time due to temporary market disequilibrium the current market price of a stock can be at variance with its intrinsic value. Therefore, superior returns can be earned by buying undervalued securities and selling overvalued securities. This approach focuses on certain basic factors relating to the company, the industry and the economy and seeks to determine the optimum price of a security.
In practice the fundamental analysis determines the intrinsic value of a security by discounting the prospective dividend stream using the rate of return required by the investors as discount rate. As the prospective dividend stream depends upon the economic and industrial environment, relative importance of the company within the industry, the company’s financial strength, quality of its assets, management etc. the fundamental analysis relationships between the economic, industry and company indicators. These relationships can be used for forecasting earnings and dividends.