Achieving investment goals in the stock market requires understanding the basics of investment. Irrespective of one’s level of experience and knowledge of the market, one cannot at any point trade successfully without any form of analysis.
There are 156 listed equities on the floor of the Nigerian Exchange, and the honest fact is that no investor, either institutional or retail investor could be said to have invested in all these equities. Investors all over the world only take their time to find out which of these equities is bound to yield good returns. This is where any form of Analysis comes to play. Technical Analysis is a good approach to find the entry and exit time for intraday trading or short term. You can make good profits using different technical indicators efficiently. However, if you want to find a multi-bagger stock to invest, which can give you good returns year after year, then the fundamental analysis is the actual tool that you have to utilize.
While the technical indicators will show you exit signs in the short term whenever there’s a downtrend or small setbacks, however, you have to remain invested in that stock if the company is fundamentally strong. In such cases, you have to be confident that the stock will grow and give good returns in the future and avoid short-term under-performance. Short-term market fluctuations or unavoidable factors won’t affect the fundamentals of the strong company in the long term.
We have often been advised to take position in fundamentally sound stocks but the big task I guess is how to identify these fundamentally sound stocks among numerous stocks listed on the floor of the Nigerian Exchange, and that is why we deem it fit to delve into this subject.
Fundamental analysis is used to measure the intrinsic value of an equity by examining related economic and financial factors including the balance sheet, strategic initiatives, micro economic indicators, and consumer behavior associated with that firm.
Fundamental analysts study anything that can affect the stocks’ value, from macroeconomic factors such as the state of the economy and industry conditions to micro economic factors like the effectiveness of the company’s management.
So, how does one identify fundamentally sound stocks?
These are few things one must have in mind when you think of stock fundamentals:
QUALITY OF THE MANAGEMENT
When evaluating an equity investment, understanding the quality and skill of a company’s management is key to estimating future success and profitability.
Technically speaking, the management of a publicly traded company is in charge of creating value for shareholders and it is normal for management to possess that supreme qualities to run the company in the interest of the owners. Of course, it is unrealistic to believe that management only thinks about the shareholders. Managers are human too and are like anybody else, looking for personal gain. Problems arise when the interests of the managers conflicts sharply from the interests of the shareholders.
Looking at the stock price alone, can give false signals. In fact, several great companies all over the world have soaring stock prices despite corrupt and inept management operating behind the scenes. There is no magic formula for evaluating management, but there are factors to which one should pay attention.
While it’s hard for retail investors to meet and truly evaluate managers, you can look at the corporate website and check the resumes of the top guys and the board members.
Insider buying and Stock Buybacks is also a good factor to consider. If insiders are buying shares in their own companies, it’s usually because they know something that normal investors do not. Insiders buying stock regularly show investors that managers are willing to put their money where their mouths are. The key here is to pay attention to how long the management holds shares. Flipping shares to make a quick buck is one thing; investing for the long term is another.
Checking the track record of the top management, especially the CEO is very vital too. There are businesses one should can enter into just knowing who is behind such business through his or her track records.
CORPORATE GOVERNANCE
Corporate governance describes the policies in place within an organization denoting the relationships and responsibilities between management, directors and stakeholders.
The role of Corporate Governance in the effective running of a quoted company cannot be overemphasized.
Organisations with good Corporate Governance will have the following in place as their priority:
- Sound Board structure
- Rights and equitable treatment of shareholders
- Interests of other stakeholders
- Integrity and ethical behavior
- Transparency
- Timely disclosure of material information
QUALITY OF EARNINGS
Another thing to look at is the company’s earnings. Is the company’s earnings growing or stagnated over a long time? What is the quality of earnings they are bringing?
To see where companies are likely headed, look for earnings momentum. That is the slowing or acceleration of earnings growth from one period to the next.
It is said that when a small boy fail an examination, he will come home and say he has lost is report card. But he if came first, before he gets home, he would have already announced that this is my report card. It also depends on hour early these companies release their result.
PRICE MOVEMENT
Check the behaviour pattern of the prices of companies you intend to invest in. When the market is bad, all stocks will be affected, but the moment the market becomes good, some stocks are leaders that will herald the rally in the market.
PRODUCT
You need to pay attention to the products of the firm you intend to invest in.
For instance in the cement industry, Dangote Cement, BUA Cement and Lafarge will continue to enjoy patronage as there are numerous infrastructural projects in the country.
The Banking Sector play a key role in any economy. There is virtually no transaction that will not eventually pass through the bank. Year on year, banks continue to increase their market share as they introduce mouthwatering product offerings to their customers. The unbanked population in Nigeria is gradually reducing as most banks have introduced Agency Banking, which means villages are not left out. Banking stocks happen to always emerge among the top traded stocks in terms of volume, deals and value. They are very liquid stocks.
Another example is the Palm Oil business. There is no substitute for palm oil; Okomu and Presco will continue to enjoy that. So if you need palm oil, you either buy from Okomu or Presco.
INDUSTRY THE FIRM BELONGS TO
The industry a firm belongs is critical to its growth. A predominant situation in an industry could adversely affect a company in that industry and vice versa.
Recall that in year 2020, Oil companies faced a lot of challenges because their product was hampered by world’s crude price. Their earnings were affected that period because Global crude price came down below $40 per barrel. Fast forward to year 2021, things have looked up in the oil sector as Global crude oil is currently $72.68 per barrel.
In conclusion, fundamentals changes. It doesn’t mean that when you are fundamentally strong today, you are going to be fundamentally strong forever. There is no bad stock forever and there is no good stock forever.
When we say fundamentally sound stocks, it does not mean that the one you are taking position in, you are expecting for it to be fundamentally sound forever. You keep reviewing fundamentals from period to period.