what is fundamental analysis[1]

8/8/2019 What is Fundamental Analysis[1]

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Fundamental analysis definedFundamental analysis defined

Fundamental analysis is a stock valuation methodthat uses financial and economic analysis topredict the movement of stock prices.

It includes analysis of financial and non-financial

information

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Fundamental AnalysisFundamental Analysis

Attempts to find out the true value of the securitiesso that the investors can decide to buy or not to buythe securities at the current market prices.

Philosophy:

If an investor invests one rupee in buying a share of acompany,how much expected return from this

investment he has.

These future expected returns when discounted at

the required rate of return of the investor give thefair value of the shares.

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Steps InvolvedSteps Involved

Understanding macroeconomic environment

Analysing prospects of theindustry

Assessing the projectedperformance of the

company

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BottomBottom up Approachup ApproachFor small investors

The under valued shares would provide superior and

better returns irrespective of the overall economicand industry position.

This is a narrow approach towards fundamentalanalysis.

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TopTop down Approachdown Approach

Also known as EconomicAlso known as Economic--IndustryIndustry--Company Approach (EIC).Company Approach (EIC).

ECONOMY

INDUSTRY

COMPANY

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Economic AnalysisEconomic Analysis

Business Cycles

Monetary Policy

Fiscal Policy

Inflation

Interest rate structure

GDP growth

Unemployment

Foreign Trade

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Business cyclesBusiness cycles

Cyclical movement of a business in the economicactivity in a country as a whole.

Phases:

Depression

Recovery

Boom

Recession

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Monetary PolicyMonetary Policy

Concerned with manipulation of money supply in the

economy.

It affects the economy mainly through its impact on

interest rates, thereby stimulating investment andconsumption demand.

It is designed to maintain a balance in liquidity

position.

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Tools of Monetary PolicyTools of Monetary Policy

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Tools (Tools (contdcontd))Open market operation:

Involves buying or selling of Government securities

by RBI.

Bank rate:

Rate at which RBI provides financial acomodation toscheduled commercial and cooperative banks.

Reserve requirements:

CRR: Refers to the cash as a percentage of demand

and time liabilities that banks maintain with RBI.SLR: Ratio of cash in hand, balances in current

account with PSU and the RBI,gold and approvedsecurities to the demand and time liabilities.

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Direct credit controlsDirect credit controls

RBI asking banks to lend a certain percentage of theirfunds to priority sectors.

Whatever may be the merit of such controls ,theytend to breed inefficiency and diminish competition.

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Fiscal PolicyFiscal Policy

Concerned with the spending and tax initiatives ofthe Government.

Direct tool to stimulate or dampen the economy.

An increase in Govt spending stimulates the demand

for goods and sevices, whereas a decrease deflatesthe demand for goods and services.

A decrease in tax rates increases the consumption of

goods and services and an increase in tax rates

decreases the consumption of goods and services.

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InflationInflation

General increasing trend in prices.Inflationary pressure in the economy decreases the

purchasing power of the consumers.

High inflation rate indicates slow growth rate

Low inflation rate positive sign for expansionaryphase.

Relation with capital market:

Nominal required rate of return on investors goes up

resulting in the decrease in bond and equity prices.

Measured in terms of Wholesale price index /

Consumer price index.

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Interest ratesInterest ratesDirectly affects the cost of funds to the industry.

High interest rates increase the cost of funds

squeezes companies income.

Lower interest rates reduce the cost of fundshigher profit.

Affects the bond and equity prices

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GDP growthGDP growth

GDP measure of the total production of final goods

and services in the economy during a specified periodusually a year.

The growth rate represents the average of the

growth rates of the three principal sectors of theeconomy agriculture, industry and service sectors.

Change in GDP results due to:

Change in availability of resources

Change in usage of these resources

Change in efficiency with which factors of production

are used.

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Industry AnalysisIndustry AnalysisIndustry can be defined as a homogenous group of

firms which compete with one another with a similartype of product , goods and services.

Basics of Analysis:

Industry life cycle analysis

Study of the structure and characteristics of anindustry

Profit potential of industries

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Pioneering stage

Rapid growth stage

Maturity and stabilisationstage

Decline stage

Stages involvedStages involved

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Investment implicationsInvestment implications

Give industry analysis prior attention in yourinvestment selection process.

Display caution during the pioneering stage thisstage has an appeal primarily for speculators.

Respond quickly and expand your commitmentsduring the rapid growth stage.

Moderate your investment during the maturity stage.

Sensibly disinvest when signals of decline are evident.

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Study of the structure andStudy of the structure and

characteristics of an industrycharacteristics of an industry

Structure of the industry and nature of competition

Nature and prospects of demandCost, efficiency and profitability

Technology and research

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Profit potential of industriesProfit potential of industriesPorters model:

Threat of new entrants

Rivalry among the existing firms

Pressure from substitute products

Bargaining power of buyers

Bargaining power of sellers

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Key factors in industrial analysisKey factors in industrial analysis

Past performance of the industryPermanence of the product and technology of the

industry

Role of Government in the industry

Labour conditions

Competitive conditions in the market

Inter-linkages with other industries

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Company analysisCompany analysis

Discovering the fundamental value of a company;

what is its business worth?

Analyze:Financial Strength (ex. Financial statements)

Past Performance

Growth Potential

Management

Get the grand picture of the company

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ObjectiveObjective

To study and understand the company in which you

are planning to invest your hard earned money andget excellent returns.

To determine what stock to buy and at what price

To conduct a company stock valuation and predictits probable price evolution,

To make a projection on its business performance,

To evaluate its managementTo calculate its credit risk

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Where Do I Begin?Where Do I Begin?

What does the company do?

How big is it?

Company GoalsFinancial Health

Competitive Landscape

Economic Conditions

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What Does the Company Do?What Does the Company Do?

Who are they?Do they make products or sell services?

Who are they targeting?

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How Big Is The Company?How Big Is The Company?

Micro-cap: $100 million or lessSmall-cap: $100 million to $500 million

Mid-cap: $500 million to $5 billion

Large-cap: $5 billion +

Market Cap = Shares Outstanding x Share Price

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Financial StatementsFinancial Statements

Income Statement

Cash Flow Statement

Balance

Sheet

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What you should look for in a company toWhat you should look for in a company to

invest?invest?About the company

Earnings

Current valuationFuture earnings growth

Debt status

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EarningsEarnings

EPS = Net Earnings / Outstanding Shares

what is that you have to look in EPS

of the company?Answer -You should look for high EPS stocks and thehigher the better is the stock.

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Current valuation of sharesCurrent valuation of shares

PE ratio - Price to earning ratio

PB ratio - Price to book value ratio

DPR - Dividend Payout Ratio

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Price to EarningsPrice to Earnings

Share Price/

Earnings Per Share

P E!

Companies with no growth do not have a P/E ratio

A high P/E ratio could mean higher growth in the future

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Price to BookPrice to Book

Share Price/

Total Assets - Intangible Assets &LiabilitiesP B !

Compares the companys share price to their

book value

A low P/

Bratio could mean:

Stock undervalued

Something very wrong

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Dividend payout ratioDividend payout ratio

DPR = Dividends Per Share / EPS

Growing companies will typically retain more profitsto fund growth and pay lower or no dividends.

Companies that pay higher dividends may be inmature industries where there is little room for

growth

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Future earnings GrowthFuture earnings Growth

Projected Earning Growth ratio - PEG ratio

Price to sales ratio

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Projected earnings growth (PEG)Projected earnings growth (PEG)

PEG = P/E / (projected growth in earnings)

Lower the PEG ratio the less you pay for each

unit in future earning growth

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Price to SalesPrice to Sales

P/S ratio can be used in comparison to other

companies

How much is being paid for per share of sales

If P/S < 1, it means investors are paying less for each

unit of sales

Share rice

/ Revenue erShareP S!

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Debt statusDebt statusDebt ratio

Dividend Yield

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Debt ratioDebt ratio Total Debts

Total Assets

!

Debt Ratio > 1= company has more debt than assets

Debt Ratio < 1 = company has more assets than

debt

*Used as a tool to measure risk of companies

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Current Ratio

Measure of ability to pay short-term

liabilities

Higher ratios means the morecapable a company is to paying back

short-term debt

C u r r e n t s s e t sC ur ren t i ab i l i t i e s

!

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Is This Company Profitable?Is This Company Profitable?Gross Margin/Profit/Income, Net Income

Look at companys income statement

Look at historical gross margin

How much does it sell and how much does the company get to

keep?

More income = more for future business operations, return to

investors

Look for companies to perform better than their competitors!

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Stock Performance

What has the stock price done in the past year? 5 years?All of its history?

Does it show solid performance or very volatileperformance?

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Going beyond the numbersGoing beyond the numbers

Analysis of financial statistics must be supplemented

with an appraisal , mostly of qualitative nature, of thecompanys present situation and prospects and the

quality of its management.

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Sizing up the companys presentSizing up the companys present

situation and prospectssituation and prospects

Availability and cost of inputs

Order position

Regulatory frameworkTechnological and production capabilities

Marketing and distribution

Finance and accounting

Human resources and personnel

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Management

Is management stable?

Recent change in management?

Has change in management affected thestock price?

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Competitive Landscape

How are they performing in regards to competitors?

Compare to their industry, compare to the overall market

Compare:

Share price

Profit margins

Financial ratios

Strategies

Target markets

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Strengths

Longtermfunds

Valuespotting

BusinessAcumen

Knowing

who iswho

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Weaknesses

TimeConstraint

Companyspecific

Subjectivity

Analystbiased

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ConclusionsFundamental analysis can be valuable, but it should be approached with

caution. If you are reading research written by a sell-side analyst, it isimportant to be familiar with the analyst behind the report. We all have

personal biases, and every analyst has some sort of bias. There is nothingwrong with this, and the research can still be of great value. Learn what the

ratings mean and the track record of an analyst before jumping off the deepend. Corporate statements and press releases offer good information, but they

should be read with a healthy degree of skepticism to separate the facts from

the spin. Press releases don't happen by accident; they are an important PRtool for companies. Investors should become skilled readers to weed out theimportant information and ignore the hype.

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what is fundamental analysis[1]

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