When you buy a banana from the market, you pay a price that you think is right.
If a fruit seller asks you to pay Rs 50 for a banana is that right? In the same
way, if a banana is available for 50 paise is that right? You know that one dozen
of bananas should cost Rs 40-50. So, per banana cost is about Rs 4. So, if the banana
is available at a steep discount or steep premium, there must be valid reasons why
the asking price is such. When you go to buy a stock, for example Infosys, you know
the current market price is Rs 780 per share. This price is only the market price
i.e. some seller must be asking for this rate to sell the Infosys stock.
Your job as a long term investor is to
buy the stock at a far lower price than the intrinsic value. So, if the
true value of Infosys stock is Rs 900, buying it for Rs 780 is logical. On the other
hand, if the true value of Infosys stock is Rs 700, buying it at Rs 780 is not a
good deal for you.
Fundamental analysis and various stock
fundamental reports tell the investor what is the true value or fair value.
Hence, you know whether you are entering a good deal for the buyer or the seller.
If the current market price is lower than the fair value, also called intrinsic
value, then the company/stock is said to be undervalued. If the current market price
is higher than the fair value, then the company/stock is said to be overvalued.
In a nutshell, this is the importance of fundamental analysis of a stock.