2.fundamental analysis

8/3/2019 2.Fundamental Analysis

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Security analysis is the first step undertaken in theprocess of investment decisions.

The task involves determining prospective benefitsfrom investment in a security, the conditions subject

to which they may be received, and the likelihood ofsuch conditions. The task involves arriving at what ought to be the

price . Security valuation is the end objective of security

analysis in this sense. Its objective is to identify under priced and overpriced

securities.


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Active Approach

- Fundamental Analysis

-

Technical Analysis

Passive approach

- Buy and Hold Approach- Index Fund Approach


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Introduction


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To determine a proper price for a firmsstock, the security analyst mustforecast the dividend and earnings thatcan be expected from the firm.

This is the heart of fundamentalanalysis - that is, the analysis of thedeterminants of value such as earning

prospects.

Fundamental Analysis is based on thepremise that a security has an intrinsicvalue at any given time.


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TOP-DOWN V. BOTTOM UPTOP-DOWN APPROACH

attempts to forecast in the following order

1. economic activity

2. industry performance

3. firms performance

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TOP-DOWN V. BOTTOM UPBOTTOM-UP APPROACH:

attempts to estimate prospects in the following

order:

1. The firm

2. The Industry3. The economy

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1. To analyze overall economy andsecurities markets.

2. Analyze the industry in which thecompany operates

3.Finally, the analysis of the companyshould be considered.


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A study of economic trends as indicated bythe rate of growth in GDP, employment,aggregate corporate profits, personaldisposable income, balance of paymentposition, inflation, money supply etc

A study of economic policies of theGovernment

An analysis of the relationship betweeneconomic trends and economic policies andthe stability of such relationships.

A study of world economic trends and their


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GDP - Rapidly growing GDP indicates an expandingeconomy with ample opportunity for a firm to increasesales.

Employment Unemployment rate - of total laborforce yet to find work. indicates whether theeconomy is operating at full capacity.

Inflation Increase in prices low purchasing power. Interest rates demand for sectors like housing and

high priced consumer durables such as automobiles ishighly sensitive to interest rates. High interest ratehigh cost of funding for companies.

Budget deficit difference between governmentspending and revenues.

Industrial production Growth of Infrastructure

Agricultural output.


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The economy recurrently experiences periods ofexpansion and contraction although the length andbreadth of the cycles can be irregular.

The recurring pattern of recession and recovery iscalled the business cycle.

The transition points are called peaks and troughs.

As the economy passes through different stages ofbusiness cycle, the relative performance of variousindustry groups might be expected to vary.


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You want to identify the industries thatwill be most helped or hurt in anymacro economic scenario you envision.

Suppose the forecast is a tightening ofthe money supply, you might want to

avoid industries such as automobileproducers that might be hurt by thelikely increase in interest rates.


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The leading indicators are those time seriesof data that historically reach their highpoints (peaks) or their low points (troughs) in

advance of total economic activity.The roughly coincidental indicators reach

their peaks or troughs at approximately thesame time as the economy.

Finally, the lagging indicators reach theirturning points after the economy has alreadyits own.


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peak Trough

(Measure of

GNP)

Level of

economicactivity

T I m e

leading

lagging

coincidental


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Short-term forecasters of the nationaleconomy have constructed a vastmultitude of models and indices,

designed mainly to help identify andpredict turning points in thebusiness cycle.


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Since the early signs of a recessionor recovery are of keen interest tobusinessmen, policymakers,

investors, and workers, monthlyindicator models have the addedbenefit of generating more

frequent data revisions andreports


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While this approach is most valuable insuggesting the direction of change ineconomic activity.

it does not convey any information on themagnitude of change.

Signals provided by different lead indicatorscan be mixed. i.e Some might signal a turnwhile the others might not, resulting in a

serious problem of interpretation.


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Econometric models

Trend analysis


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Once the analyst forecasts the state ofthe macro economy, it is necessary todetermine the implication of that

forecast to specific industries.Not all industries are equally sensitive

to the business cycle.

Let us look at the plot of commercialvehicles and tea production in India .


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Surprisingly beer industry seems to bedoing well whenever the stock marketis up and vice versa.

People seem to be drinking more whenthey are happy than when they are not.

Conclusion The industriesrespond differently


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Past performance of the Industry

Permanence of the product andtechnology of the Industry

Role of govt. in the Industry

Labor conditions

COMPETETION

Overall SWOT Analysis to

determine the above factors


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Pioneering stage

Expansion stage

Stagnation stage

Decay stage


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Although the relevant environment for anyfirm is very broad, encompassing social aswell as economic forces; the key aspect ofthe firms environment is the industry

or the industries in which it competes.

Industry structure has a strong influencein determining the competitive rules of thegame as well as strategies potentiallyavailable to the firm.


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1. Threat of New Entrant New entrants bring new capacity, the desire to gain

market share, and often substantial resources. Pricescan be bid down or incumbents costs inflated as a

result of reducing profitability.

2. Intensity of rivalry among existing competitors

Rivalry occurs because one or more competitors

either feels the pressure or sees the opportunity toimprove the position.

Using tactics like price competition, advertisingbattles, product introductions, and increased

customer services or warranties.


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All firms in an industry are competing, in abroad sense, with industries producingsubstitute products.

Substitutes limit the potential returns in anindustry by placing a ceiling on the pricesfirms in the industry can profitably charge.


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Buyers compete with the industry by forcing downprices, bargaining for higher quality or more services,and playing competitors against each other all atthe expense of industry profitability.

A buyer group is powerful if the followingcircumstances hold true.

If it is concentrated or purchases large volumesrelative to seller sales.

If the products purchased are undifferentiated andstandard and always other suppliers can be found.


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Buyers pose a credible threat of backwardintegration. They use threat of selfmanufacture as a bargaining lever.

The buyer has full information


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Suppliers can exert bargaining powerover participants in an industry bythreatening to raise prices or reduce

the quality of purchased goods andservices.

A supplier group is powerful if thefollowing apply.


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It is dominated by a few companies and ismore concentrated than the industry it sellsto.

The industry is not an important customer ofthe supplier group.

The suppliers product is an important input

to the buyers business.


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The supplier groups products aredifferentiated or it has built upswitching costs.

The supplier group poses a crediblethreat of forward integration.


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Financial Statements

- Balance sheet

- Income Statement

FINANCIAL STATMENT ANALYSIS

it helps the analyst understand a firms currentcondition

where it is headed

what factors affect it


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FINANCIAL STATMENT ANALYSISRATIO ANALYSIS

Common-size financial statementsComparative financial statements

Trend analysis


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liquidity ratios: indicate the ability of the firm to meet

future short-term financial obligations

some liquidity ratios:current ratio

quick ratio

cash ratio

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operating performance ratios: indicate how well the management is

operating the business

some examples:total asset turnover

net fixed asset turnover

equity turnover


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risk analysis/ leverage ratios: indicates the uncertainty of income flows

for the total firm and for the individual

sources of capital (debt and stock)some examples:

debt to equity ratio

long-term debt/total capital ratio


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Profitability ratios: indicate the profitability

it involves analysis using several other

ratiosnet profit margin

ROI

ROA

ROCE

2.fundamental analysis

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