Primary Decision-Making Factor: Weigh Fundamentals Before Investing
Understanding revenue drivers – whether from core operations, new markets, or emerging product lines – helps assess growth sustainability. Cost efficiency, managing expenses effectively, optimizing resources, and maintaining a competitive edge are crucial for profitability. Technology enhances investing but does not replace the need to understand business models, financial health, and market dynamics
Reassessing portfolio holdings to ensure investments are in fundamentally strong companies with solid revenue drivers and efficient cost management is essential. Monitoring debt levels is crucial, as companies with excessive leverage may face higher financial risks during uncertain times. Free cash flow (FCF) remains a critical indicator of a company’s financial health and long-term value creation. AI and algo-trading should be used as support tools rather than decision-makers
As the quarter-end earnings season unfolds, a noticeable trend is emerging – many companies are failing to meet their set earnings targets for the third consecutive quarter. This pattern is reflected in various market indicators, raising concerns among investors and analysts alike. While multiple factors are at play, one clear message stands out: the market is signalling a shift back to fundamentals.
For years, stock markets have been driven by price trends, momentum investing, and benchmarks. However, in today’s volatile environment, fundamentals are regaining significance.
The current market slowdown is not just a coincidence. Several factors have contributed to this trend. Foreign institutional investors (FIIs) are withdrawing investments and seeking better returns elsewhere, possibly driven by higher payoffs in other global markets or economic uncertainties. At the same time, domestic institutional investors (DIIs) are rebalancing their portfolios, spreading investments across large-cap, mid-cap, and small-cap stocks, anticipating a market rebound. However, their optimism is met with global pressures and rising volatility. Additionally, increased uncertainty due to geopolitical tensions, inflation concerns, interest rate fluctuations, and slowdown fears influence market sentiment. With these uncertainties looming, relying solely on price trends and speculation is no longer sufficient. Investors and market participants must revisit fundamental analysis to make informed decisions.
Operational fundamentals determine a company’s ability to sustain and grow its business. A strong order book reflects future revenue potential, and companies with a robust pipeline of confirmed orders are more likely to maintain steady cash flows. Understanding revenue drivers – whether from core operations, new markets, or emerging product lines – helps assess growth sustainability. Cost efficiency, managing expenses effectively, optimizing resources, and maintaining a competitive edge are crucial for profitability. Metrics such as EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and EBIT (Earnings Before Interest and Taxes) indicate how well a company manages its operating expenses and business risks – strong operational performance positions companies to withstand market downturns and sustain profitability over the long term.
While operational efficiency is essential, financial health determines how well a company can manage external pressures and shareholder expectations. Leverage and debt management play a key role; excessive debt increases financial risk and may make it difficult for companies to meet interest payments, impacting profitability and investor confidence.
When a company borrows heavily, a portion of its profits is sacrificed to cover interest expenses, reducing the overall returns available to shareholders. Investors closely monitor key financial indicators such as Return on Assets (ROA) and Return on Equity (ROE) to gauge how efficiently a company uses its assets and equity to generate profits. Ultimately, strong financial fundamentals lead to higher free cash flows, which are essential for creating value and determining a company’s enterprise value.
Market cycles often influence investor behaviour. During bull runs, fundamentals are usually overlooked when stock markets hit new highs. Companies rush to launch Initial Public Offerings (IPOs) to capitalise on favourable market conditions, attracting speculative investors. The small-cap IPO frenzy sees investors rushing into stocks without thoroughly analysing business models. Social media influencers and financial bloggers assure high returns, encouraging retail investors to stay invested despite warning signs. However, when markets begin to slow down – as seen in the last three quarters – investors start reconsidering their strategies, leading to market corrections and reinforcing the importance of returning to fundamentals.
In the age of AI and big data, traditional fundamental analysis remains indispensable. Advanced AI models process large volumes of financial data, identifying trends that might not be immediately visible to human analysts, but AI-driven insights are most valuable when combined with fundamental reasoning. While algorithmic trading (algo-trading) relies on patterns, momentum, and arbitrage opportunities, long-term investing still requires understanding a company’s core fundamentals. AI cannot predict fundamental weaknesses affecting a company’s future earnings. Fundamental analysis remains the backbone of long-term investment decisions. Technology enhances investing but does not replace the need to understand business models, financial health, and market dynamics.
Given the market’s current conditions, investors should adopt a balanced approach that integrates fundamentals with technological advancements. Reassessing portfolio holdings to ensure investments are in fundamentally strong companies with solid revenue drivers and efficient cost management is essential. Monitoring debt levels is crucial, as companies with excessive leverage may face higher financial risks during uncertain times. Free cash flow (FCF) remains a critical indicator of a company’s financial health and long-term value creation. AI and algo-trading should be used as support tools rather than decision-makers, with fundamental analysis remaining the primary decision-making factor. Preparing for market volatility and being cautious about speculative trends ensures investments are backed by sound business models.
Despite rapid advancements in AI, algo-trading, and big data, fundamentals remain the foundation of strong investment strategies. The recent market trends highlight that companies struggling to meet targets for three consecutive quarters cannot rely on speculation alone. Investors must return to analysing business strength, financial stability, and long-term value creation. The market always moves in cycles—during booms, fundamentals may be ignored, but when challenges arise, fundamentals always regain significance. Smart investors recognize this pattern and focus on long-term value rather than short-term hype. The question is not whether we should go back to fundamentals – it’s whether we ever should have ignored them in the first place.
(Writer is an Associate Professor at Institute of Public Enterprise, Hyderabad)