The underlying theme in fundamental analysis is that the true value of the firm can be related to its financial characteristics -- its growth prospects, risk profile and cashflows. Any deviation from this true value is a sign that a stock is under or overvalued. It is a long term investment strategy, and the assumptions underlying it are:
(a) the relationship between value and the underlying financial factors can be measured.
(b) the relationship is stable over time.
(c) deviations from the relationship are corrected in a reasonable time period.
Valuation is the central focus in fundamental analysis. Some analysts use discounted cashflow models to value firms, while others use multiples such as the price earnings and price-book value ratios. Since investors using this approach hold a large number of 'undervalued' stocks in their portfolios, their hope is that, on average, these portfolios will do better than the market. From India