FUNDAMENTAL ANALYSIS

Fundamental Analysis
• It is the cornerstone of Investment
(particularly Long term Investment)
• It is the analysis of the macro economic
factors, industrial factors and the company
related factors.
• It make use of both quantitative and
qualitative data (It involve both quantitative
and qualitative analysis)
 Fundamental Security Analysis
• The Objective of FSA is to appraise the intrinsic
value (True economic worth) of a security by
focusing on the underlying factors
• Intrinsic Value is the present value of the future
stream of income from that share discounted at
an appropriate risk related interest.
• The FA has to analyse the current condition of the
economy and its implications for investment
decisions.
 Fundamental Analysis consist of
1. Macro –economic Analysis
2. Industry Analysis
3. Company analysis :
- Marketing
- Accounting policies
- Profitability
- Dividend policy
- Capital Structure
- Financial Analysis
- Operating Efficiency
- Management
 Two approaches to FA
Top Down Fundamental Analysis:
• It starts with the analysis of the various macro
economic factors.
• After analysing the economy, the sector wise
analysis of the industry and company is made
Bottom Up Fundamental Analysis:
• It is conducted in the reverse order of Top-
down analysis. It starts with company analysis
and ends with economic analysis.
 Three Steps of Top-Down Fundamental
Analysis
Macroeconomic analysis:
• Evaluates current economic environment and its
effect on industry and company fundamentals
Industry analysis:
• Evaluates outlook for particular industries.
Sector-wise index of stock exchanges can be used
for the purpose
Company analysis:
• Evaluates company’s strengths and weaknesses
within industry
 Macro Economic Analysis
(Analysis of the Economy)
• Investors are concentrate with those variables
in the economy which effect the performance
of the company in which the intend to invest.
• A study of these economic variables would
give an idea about future corporate earnings
and the payments of dividends.
• following are the key economic variables that
an investors must monitor as the part of his
fundamental analyses.
Growth rates of national income
Investment climate in an economy can be observed form
the Gross National Product, the estimated value of the
total goods and services produced in the national
economy (By citizens of country) for a period of one
year
• GDP is the estimated value of the total goods and
services produced by its nationals and foreigners
• GDP= consumption + investment + (government
spending) + (exports − imports)
• GNP = GDP + NR (Net income inflow from assets
abroad or Net Income Receipts) - NP (Net payment
outflow to foreign assets)
• It is used to determine where the national economy is,
where it has been, and where it is going.
 Macroeconomic Analysis
• Business Cycles
– Depression: DD is low and companies are forced to
reduce production, shut down plant and lay off
workers.
– Recovery: DD picks up leading to more invt in
economy.
– Boom: high DD, pdn and invt are maintained at high
level.
– Recession: the economy slowly begins to experience a
downturn in dd, pdn, employment etc.
 Fiscal & Monetary Policy
• Fiscal Policy
– Government expenditures (demand)
– Tax & Debt policies
• Monetary Policy
– Interest rates
– Money supply (Open market ops)
– Reserve requirements (commercial banks)
– Margin requirements
• Foreign Investment (FDI and FII)
• Employment
• Price Stability (control inflation)
– Interest Rates
– Money Supply
• Economic Growth
• Rainfall
• Agricultural production
• Inflation – A sustained increase in general
price level – It leads to the decrease in the
purchasing power of the economy.
 Industry Analysis
• Classifying industries
– Cyclical industry - performance is positively
related to economic activity
– Defensive industry - performance is insensitive to
economic activity
– Growth industry - characterized by rapid growth in
sales, independent of the business cycle
 Industry Analysis
• Qualitative Issues
– Competitive Structure
– Permanence (probability of product obsolescence)
– Vulnerability to external shocks (foreign
competition)
– Regulatory and tax conditions (adverse changes)
– Labor conditions (unionization)
 Industry Analysis
• End use analysis
– identify demand for industry’s products
– estimates of future demand
– identification of substitutes
• Ratio analysis
– examining data over time
– identifying favorable/unfavorable trends
• Regression analysis
– determining the relationship between variables
 Company Analysis: Qualitative Issues

• Sales Revenue (growth)

• Profitability (trend)
• Product line (turnover, age)
– Output rate of new products
– Product innovation strategies
– R&D budgets
• Pricing Strategy
• Patents and technology
 Company Analysis: Qualitative Issues

• Organizational performance
– Effective application of company resources
– Efficient accomplishment of company goals
• Management functions
– Planning - setting goals/resources
– Organizing - assigning tasks/resources
– Leading - motivating achievement
– Controlling - monitoring performance
 Company Analysis: Qualitative Issues
• Evaluating Management Quality
– Age and experience of management
– Strategic planning
• Understanding of the global environment
• Adaptability to external changes
– Marketing strategy
• Track record of the competitive position
• Sustainable growth
• Public image
– Finance Strategy - adequate and appropriate
– Employee/union relations
– Effectiveness of board of directors
 Company Analysis: Quantitative Issues
• Operating efficiency
– Productivity
– Production function
• Importance of Q.A.
– Understanding a company’s risks
• Financial, operating, and business risks
• Financial Ratio Analysis
– Past financial ratios
– With industry, competitors, and
• Regression analysis
– Forecast Revenues, Expenses, Net Income
– Forecast Assets, Liabilities, External Capital Requirements
 Company Analysis: Quantitative Issues

• Balance Sheet
– Snapshot of company’s Assets, Liabilities and
Equity.
• Income statement
– Sales, expenses, and taxes incurred to operate
– Earnings per share
• Cash flow statement
– Sources and Uses of funds
 Company Analysis: Quantitative Issues

• Financial Ratio Analysis

– Liquidity (ability to pay bills)
– Debt (financial leverage)
– Profitability (cost controls)
– Efficiency (asset management)
• DuPont Analysis
– Top-down analysis of company operations
– Objective: increase ROE
 Liquidity Ratios
• Measure ability to pay maturing obligations
• Current ratio
– Current assets / current liabilities
• Quick ratio
– (Current assets less inventories) / current liabilities
 Debt Ratios
• Measure extent to which firm uses debt to finance asset
investment (risk attribute)
• Debt-equity ratio
– Total long-term debt / total equity
• Total debt - total assets ratio
– (Current liabilities + long-term debt) / total assets
• Times interest earned
– EBIT / interest charges
• Fixed charge coverage ratio
– (EBIT + Lease Exp.) / (Int. Exp. + Lease Exp.)
 Profitability Ratios
• Measure profits relative to sales
• Gross profit margin ( % ) = Gross profit / sales
• Operating Profit Margin = Operating profits /
sales
• Net profit margin = Net profit after taxes /
sales
• ROA = Net Profit / Total Assets
• ROE = Net Profit / Stockholder Equity
 Efficiency Ratios
• Measure effectiveness of asset management
• Average collection period (in days)
– Average receivables / Sales per day
• Inventory turnover (times per year)
– Cost of Goods Sold / average inventory
• Total asset turnover
– Sales / average total assets
• Fixed asset turnover
– Sales / average net fixed assets
 Other Ratios
• Earnings per share (EPS): (Net income after taxes –
preferred dividends)/ number of shares
• Price-earnings (P/E): Price per share/expected EPS
• Dividend yield: Indicated annual dividend/price per share
• Dividend payout: Dividends per share/EPS
• Cash flow per share: (After-tax profits + depreciation and
other non cash expenses)/number of shares
• Book value per share: Net worth attributable to common
shareholders/number of shares