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So let us understand this with the help of an example, If I ask you what is the price of Gold right now? You may say, Around 30000. Now if I ask you is this a fair value? Perhaps your answer will be, I DONT KNOW! But if I tell you that the cost of producing one gram of Gold is only Rs. 10000! Will you still buy it? Perhaps your answer will be Yes! The reason could be that GOLD is one of the safest forms of investment which could give good returns after certain tenure. This is a part of the perceived value.
Now coming back to the question what is a fair value? Suppose as discussed earlier the cost of production of GOLD is Rs. 10000, and it is trading at Rs. 30000, we might buy it as it has future potential to grow due to its ever shining demand by the Indians. This is how we determine whether we should buy gold at Rs. 30000 or not. Therefore a Fair Value is basically the price which should have been of the particular stock compared to the actual Current Market Price of the scrip depending on its future growth potential.
Let us understand it with an example. Suppose a growing company A is as its nascent stage, and has a huge future growth potential. Thus it will be more preferred than a company B whose demand of the products is not that high. Fundamental Analysis is basically the process of analyzing anything for its future value. It helps us to find the right price at which a particular item should be bought, held or sold.
Now let us know about the Fundamental Analysis Expert, which is the fundamental analyst. Fundamental Analyst is an expert who understands the business model as well as the sector of the company, then meet the company management, listen to their feedback on their company’s prospect, and then form an opinion on the future earning potential of the company. In simple terms, they try to find whether a company with its future growth prospects is trading at a cheap or an expensive valuation. Thus, Fundamental Analyst helps an investor to know about the business model, the sector and its future growth potential and the right price at which the stock should be bought.
So the fair value is one which is dependent on the strength of the financial statements and the future prospect detailed by the company management. A Fundamental Analyst helps us in determining the fair value of the company. Which helps us to decide whether a stock is undervalued or overvalued. If the Fair Value is higher than the CMP, then the stock is undervalued and we would like to buy it as it is available at a cheaper price compared to its earnings potential and vice a versa.
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