Do you own a company which has great fundamentals? Maybe the company has even come up with a completely revolutionary plan and many new products. Even the company’s quarterly results have been great. Everyday you hear news about how well the company is doing. But for some reason the stock price is not increasing. Even worse, it is possible that the stock price might be decreasing! But why is it happening?
Even when everything about the company is great in terms of the fundamentals why does the stock price not increase? The answer is simple – stocks do not move based on fundamentals. Stock price moves in the exact same manner as the price of anything else in our world – demand and supply (on which technical analysis is based). Want to know what is Fundamental & Technical Analysis, visit – Tools to analyze the Stock Market!
Right after the opening bell of a new trading day both buyers and sellers have the opportunity to either buy or sell any stock. While it might appear that buying or selling is an isolated process, that is not the case. In order to buy a stock you will need willing sellers and in order to sell a stock you will need willing buyers. You cannot just sell a stock when there is no buyer and vice versa. Stocks do not just vanish!
Let’s suppose that a stock is trading at Rs. 100. If somebody needs to buy this stock then there needs to be a seller of this stock available in the stock market. Suppose that the seller who is asking the lowest bid price is selling the stock for Rs. 101. So in order to buy this stock the buyer needs to pay Rs. 101 per stock. The stock goes from the seller to the buyer for a price of Rs. 101. This process changes the price of every single stock available to Rs. 101 even though only a handful of stocks have changed hands! Suppose there is another buyer who is willing to buy a large quantity of this stock. In such a case, this person will have to buy the stock from multiple sellers who might be selling them for different prices. This person buys a lot of stocks and suddenly the price jumps from Rs. 101 to Rs. 104. Now there is a trader who had bought this stock for a short term gain. As soon as he notices the price of Rs. 104, he tries to book profits. But unfortunately there is no buyer at Rs. 104. So he reduces the selling price to Rs. 103 and voila there is a buyer available looking to buy this stock for Rs. 103. The trader sells the stock to the buyer and the price of the stock is now set to Rs. 103.
Did you notice what happened here? The stock price went up from Rs. 100 to Rs. 104 and then reduced to Rs. 103 because multiple transactions took place. For every single transaction, a buyer AND a seller were involved. This is exactly how the stock price fluctuates. Generally the price transition is much smoother because instead of a few people (as described in this example), there are lakhs of people buying and selling the stock every second! But the reason for stock movement remains the same – supply and demand. If there are people willing to buy a stock for a higher price then the price of the stock will go up. And if there are people willing to sell a stock at a lower price then the price of the stock will go down. Notice how this has absolutely nothing to do with the fundamentals of the company. If everyone decides to sell a share for any reason then regardless of the fundamentals of the company, the price of the stock will fall relentlessly!
Now you must be wondering – Is fundamental analysis useless? Since stocks don’t really care about the fundamentals of the company and the price movements happen only due to demand and supply, then what is the use of fundamental analysis! The answer is NO, fundamental analysis is not useless. Even though the day to day movement of the stock is purely based on technical analysis, the stock price more or less aligns based on the fundamentals and the performance of the company.
Even though price fluctuations happen everyday, a company like TCS which has made more and more revenue and profits over the years has grown in terms of stock price. This is regardless of the ups and downs in the stock price which happens every single second of every trading day. On the other hand, the revenue and profits have been continuously reducing for a company like Suzlon which has turned the company into a penny stock! So it is very important to understand that the stock prices, over a long term, will always align as per the fundamentals of the company.
Fundamental analysis is all about trying to find companies which are available at a cheap valuations. If there is a company which produces Rs. 1 lakh every year as profits and you can buy this company for a price of Rs. 3 lakhs, then you have been offered an amazing deal! This means that the company is available at a P/E ratio of 3 which is extremely attractive! Because if you buy this company today then you would make your money back in 3 years and every single year after that is just free money.
Fundamental analysts try to find companies which are valuable, produce good profits and are available at a lower price. Investing in a company which has a great future will always result in big capital gains! Because fundamental analysts know that – even though stock prices fluctuate every second based on demand and supply, the price over the long term aligns as per the company fundamentals!
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DISCLAIMER : I am not a financial advisor. I am not for or against any stocks mentioned in this post. Please consult your financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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