COMPANY ANALYSIS

Ravi IBA

Fundamental analysis at Company

level
Involves analysis the following
1.Firms competitive position in the industry
2.Labour relations
3.Management
4.Technological changes
5.Financial analysis of which the variables
include sales, profitability, tax rate,sources
of financing,asset utilization and other
factors

Company analysis
Fundamental analysis expects an invest
analyst to derive an understanding of a
company in terms of
i. its strengths and risks
ii. computing the fundamental intrinsic value of
the firms stock
iii. comparing the intrinsic value of a stock to its
market value to determine if the companys
stock should be purchased

Company analysis
The stock of a firm with superior
management and strong performance
measured by
i. sales
ii. earnings growth
can be priced so high that the intrinsic
value of the stock is below its current
market price
and should not be acquired.

Company analysis
In contrast, the stock of a company with
less success based on its sales and
earnings growth may have a stock market
price that is below its intrinsic value.
In this case, although the company is not
as good, its stock could be the better
investment

Company analysis
Growth Companies and Growth Stocks
financial theorists define a growth
company as a firm with the
management ability and the
opportunities to make investments that
yield rates of return greater than the
firms required rate of return
This required rate of return is the firms
weighted average cost of capital (WACC).

Growth Companies and Growth Stocks

1. for example, a growth company might be able to

acquire capital at an average cost of 10 percent
2. This growth company has the management
ability and the opportunity to invest those funds at
rates of return of 15 to 20 percent.
3. As a result of these investment opportunities, the
firms sales and earnings grow faster than those
of similar risk firms and the overall economy.
4. In addition, a growth company that has aboveaverage investment opportunities
i. retains a large portion of its earnings to fund
these superior investment projects (i.e., they
have low dividend payout ratios).

A Growth stock
A growth stock is a stock with a higher rate of return than
other stocks in the market with similar risk characteristics
The growth stock achieves this superior risk-adjusted
rate of return because at some point in time the market
undervalued it compared to other stocks
Growth stocks are not necessarily shares in growth
companies
Although the stock market adjusts stock prices relatively
quickly and accurately to reflect new information, available
information is not always perfect or complete
Therefore, imperfect or incomplete information may cause a
given stock to be undervalued or overvalued at a point in
time

Defensive Companies and

Stocks
Defensive companies are those whose
future earnings are likely to withstand an
economic downturn.
Defensive stocks have relatively low
business risk and not excessive financial
risk.
Typical examples are public utilities or
grocery chains firms that supply basic
consumer necessities

Defensive stock
There are two closely related concepts of a defensive stock
First, a defensive stocks rate of return is not expected to
decline during an overall market decline, or decline less than
the overall market.
Second, THE CAPM(capital asset pricing model ) topic to be
discussed later under technical analysis and portfolio theory
indicates that an assets relevant risk is its covariance with the
market portfolio of risky assetsthat is, an assets systematic
risk.
A stock with low or negative systematic risk (a small positive or
negative beta) may be considered a defensive stock according
to CAPM theory because its returns are unlikely to be
harmed significantly in a bear market.

Cyclical Company
A cyclical companys sales and earnings will be
heavily influenced by aggregate business activity
Examples would be firms in the steel, auto, or
heavy machinery industries
Such companies will do well during economic
expansions and poorly during economic
contractions
This volatile earnings pattern is typically a function
of the firms business risk (both sales volatility and
operating leverage) and can be compounded by
financial risk.

A cyclical stock
A cyclical stock will experience changes in its rates
of return greater than changes in overall market
rates of return.
In terms of the CAPM, these would be stocks that
have high betas.
The stock of a cyclical company, however, is not
necessarily cyclical.
A cyclical stock is the stock of any company that
has returns that are more volatile than the overall
market
that is, high-beta stocks that have high correlation
with the aggregate market and greater volatility.

Speculative Companies and

Stocks
A speculative company is one whose assets involve
great risk but that also has a possibility of great gain.
A good example of a speculative firm is one involved
in oil exploration
A speculative stock
i. possesses a high probability of low or negative rates
of return
ii. a low probability of normal or high rates of return
A speculative stock is one that is overpriced, leading to
a high probability that during the future period when the
market adjusts the stock price to its true value, it will
experience either low or possibly negative rates of
return.

Value versus Growth Investing

Investment Analysts divide stocks into
growth stocks and value stocks
As we have discussed, growth stocks are
companies that will have positive earnings
surprises and above-average risk adjusted
rates of return because the stocks are
undervalued.
If the analyst does a good job in identifying
such companies, investors in these stocks will
reap the benefits of seeing their stock prices
rise after other investors identify their
earnings growth potential.

Value stocks
Value stocks are those that appear to be undervalued
for reasons other than earnings growth potential
Value stocks are usually identified by analysts as
having low price-earning or price-book value ratios
A Growth stock is generally specified as a stock of a
company that is experiencing rapid growth of sales and
earnings (e.g., Intel and Microsoft).
As a result of intel and microsoft high performance
due to the rapid growth in personal computers industry
which required the chips from intel and software from
microsoft , the stock s of these two companies typically
had and have high P/E and price-book-value ratio

Economic and Industry Influences

on a company
If economic trends are favorable for an industry, the
company analysis should focus on firms in that
industry that are well positioned to benefit from the
economic trends
Research analysts should become familiar with the
cash flow and risk attributes of the firms they are
studying
Firms in an industry will have varying sensitivities to
economic variables, such as economic growth, interest
rates, input costs, and exchange rates.
Because each firm is different, an investor must
determine the best candidates for purchase under
expected economic conditions.

Structural Influences
Factors such as social trends, technology, and
political and regulatory influences, can have a
major effect on some firms in an industry
Some firms in the industry can try to take
advantage of ;
a) demographic changes
b) shifts in consumer tastes
c) lifestyles, or invest in technology to lower costs
and better serve their customers
Such firms may be able to grow and succeed
despite unfavorable industry or economic
conditions.

Structural Influences

i.
ii.

For example, Wal-Mart became the leading retailer in

the 1990s in usa because it benefited from
smart management.
The geographic location of many of its stores allowed it
to benefit from rising regional population and lower
labor costs.
Its strategy, which emphasized everyday low prices,
was appealing to consumers who had become
concerned about the price and value of purchases
Wal-Marts technologically advanced inventory and
ordering systems and the logistics of its distribution
system gave the retailer a competitive advantage.

Structural Influences
Even if the economy plays a major role in
determining overall market trends and
industry groups display sensitivity to
economic variables.
other structural changes may
counterbalance the economic effects, or
company management may be able to
minimize the impact of economic events
on a company

COMPANY ANALYSIS- Firm Competitive

Strategies
In describing competition within industries, we
identified five competitive forces that could
affect the competitive structure and profit
potential of an industry.
(1) current rivalry,
(2) threat of new entrants
(3) potential substitutes,
(4) bargaining power of suppliers
(5) bargaining power of buyers

competitive strategy
After you have determined the competitive
structure of an industry,
An investment analyst should attempt to
identify the specific competitive strategy
employed by each firm evaluate these
strategies in terms of the overall
competitive structure of the industry

Companys competitive strategy

A companys competitive strategy can either
be defensive or offensive
A defensive competitive strategy involves
positioning the firm so that its capabilities
provide the best means to deflect the effect
of the competitive forces in the industry.
Examples may include investing in fixed
assets and technology to lower production
costs or creating a strong brand image with
increased advertising expenditures

A companys competitive
strategy
An offensive competitive strategy is one in which the firm
attempts to use its strengths to affect the competitive forces in
the industry
For example, Microsoft dominated the personal computer
software market by preempting, rivals and its early affiliation
with IBM because it became the writer of operating system
software for a large portion of the PC market
Wal-Mart used its buying power to obtain price concessions
from its suppliers. This cost advantage, coupled with a
superior delivery system to its stores, allowed Wal-Mart to
grow against larger competitors until it became the leading
U.S. retailer.
Shoprite is doing the same strategy in Zambia , this is
reflected by the inability by SPUR to compete against shoprite
in terms of lowering prices for goods and services . Spurs
prices are very high compared to shoprite

Porters competitive strategy

Porter suggests two major competitive
strategies: low-cost leadership and
differentiation.
These two competitive strategies dictate
how a firm has decided to cope with the
five competitive conditions that define an
industrys environment.
The strategies available and the ways of
implementing them differ within each
industry.

Low-Cost Strategy
The firm that pursues the low-cost strategy
is determined to become the low-cost
producer and the cost leader in its industry
Cost advantages vary by industry and
might include
i. economies of scale
ii. proprietary technology
iii. preferential access to raw materials.

Low-Cost Strategy
In order to benefit from cost leadership, the firm must
command prices near the industry average, which
means that it must differentiate itself about as well as
other firms.
If the firm discounts price too much, it could erode the
superior rates of return available because of its low
cost.
Wal-Mart was considered a low-cost source. The firm
achieved this
i. by volume purchasing of merchandise
ii. lower-cost operations.
As a result, the firm charged less but still enjoyed
higher profit margins and returns on capital than many
of its competitors.

Differentiation Strategy
With the differentiation strategy, a firm seeks to
identify itself as unique in its industry in an
area that is important to buyers
the possibilities for differentiation vary widely by
industry
A company can attempt to differentiate itself
based on its distribution system (selling in
stores, by mail order, or door-to-door) or some
unique marketing approach
A firm employing the differentiation strategy will
enjoy above-average rates of return only if the
price premium attributable to its differentiation
exceeds the extra cost of being unique.

SWOT Analysis
Strengths, Weaknesses, Opportunities and
Threats (SWOT) analysis is a strategy
development tool that matches internal
organizational strengths and weaknesses with
external opportunities and threats
SWOT analysis helps you balance idealism
and pragmatism, and obtain a balanced
perspective of your internal strengths and
weaknesses and external opportunities and
threats to develop an effective strategy.

SWOT Analysis
Strengths and weaknesses involve
identifying the firms internal abilities or
lack thereof
Opportunities and threats include external
situations, such as competitive forces,
discovery and development of new
technologies, government regulations, and
domestic and international economic
trends

The strengths of a company

The strengths of a company give the firm a comparative
advantage in the marketplace
Perceived strengths can include
i. good customer service
ii. high-quality products
iii. strong brand image,
iv. customer loyalty
v. innovative R&D
vi. market leadership
vii. strong financial resources.
To continue having strengths, a firm must continue to be
developed, maintained, and defended through prudent capital
investment policies

Weaknesses
Once weaknesses are identified, the firm
can select strategies to mitigate or correct
the weaknesses.
For example, a firm that is only a domestic
producer in a global market can make
investments that will allow it to export or
produce its product overseas.
Another example would be a firm with
poor financial resources that would form
joint ventures with financially stronger firms

Opportunities
Opportunities, or environmental factors that
favor the firm, can include;
i. a growing market for the firms products
(domestic and international),
ii. shrinking competition,
iii. favorable exchange rate shifts,
iv.a financial community that has confidence in
the outlook for the industry or firm,
v. or identification of a new market or product
segment.

Threats
Threats are environmental factors that can hinder the firm in
achieving its goals.
Examples would include
i. a slowing domestic economy (or sluggish overseas
economies for exporters),
ii. additional government regulation,
iii. an increase in industry competition,
iv. threats of entry,
v. buyers or suppliers seeking to increase their bargaining power,
vi. or new technology that can obsolete the industrys product
By recognizing and understanding opportunities and threats,
an investor can make informed decisions about how the firm
can exploit opportunities and mitigate threats

Quality of management
Board of directors who are the members
of the board of directors
Quality of management
Market share
Industrial relations
Corporate governance
Type of technology used by the firm

Financial analysis
Analyzing Key Ratios
Valuation

P/E
PEG
P/S
P/B

Financial analysis
Analyzing Key Ratios
Financial Ratios

Profit Margin
ROA
ROE
EPS
Debt/Equity
Current Ratio
Dividend Rate

Valuation
Understanding Price to Earnings Ratio P/E
The P/E looks at the relationship between
the stock price and the companys earnings
You calculate the P/E by taking the share
price and dividing it by the companys EPS.
(earnings per share )
P/E = Stock Price / EPS

Valuation

For example, a company with a share price of $40 and an

EPS of 8 would have a P/E of 5 ($40 / 8 = 5).
What does P/E tell you?
The P/E gives you an idea of what the market is willing to
pay for the companys earnings.
The higher the P/E the more the market is willing to pay for
the companys earnings.
Conversely, a low P/E may indicate a vote of no
confidence by the market or it could mean this is a sleeper
that the market has overlooked.
What is the right P/E? There is no correct answer to this
question, because part of the answer depends on your
willingness to pay for earnings

Understanding the PE
The P/E is the most popular way to compare the relative
value of stocks based on earnings because you calculate it
by taking the current price of the stock and divide it by the
Earnings Per Share (EPS). This tells you whether a stocks
price is high or low relative to its earnings
Some investors may consider a company with a high P/E
overpriced and they may be correct. A high P/E may be a
signal that traders have pushed a stocks price beyond the
point where any reasonable near term growth is probable.
However, a high P/E may also be a strong vote of
confidence that the company still has strong growth
prospects in the future, which should mean an even higher
stock price

Understanding the PEG

(PROJECTED GROWTH IN EARNINGS)
The market is usually more concerned about
the future than the present, it is always
looking for some way to project out.
Another ratio you can use will help you look
at future earnings growth is called the PEG
ratio.
You calculate the PEG by taking the P/E and
dividing it by the projected growth in earnings
PEG = P/E / (projected growth in earnings

Understanding the PEG

(PROJECTED GROWTH IN EARNINGS)
For example, a stock with a P/E of 30 and
projected earning growth next year of 15%
would have a PEG of 2 (30 / 15 = 2).
What does the 2 mean? Like all ratios, it
simply shows you a relationship
In this case, the lower the number the less
you pay for each unit of future earnings
growth.
So even a stock with a high P/E, but high
projected earning growth may be a good
value.

Price to Book Ratio

Investors looking for hot stocks arent the only ones
trolling the markets
A group of investors called value investors go about
their business looking for companies that the market
has passed by.
Some of these investors become quite wealthy
finding sleepers, holding on to them for the long term
as the companies go about their business without
much attention from the market, until one day they
pop up on the screen, and some analyst discovers
them and bids up the stock.

Price to Book Ratio

Meanwhile, the value investor pockets a
hefty profit.
Value investors look for some other
indicators besides earnings growth and so
on. One of the metrics they look for is the
Price to Book ratio or P/B
.You calculate the P/S by dividing the
market cap of the stock by the total
revenues of the company.

Price to Book Ratio

You calculate the P/B by taking the current
price per share and dividing by the book
value per share.
P/B = Share Price / Book Value Per
Share

What is Dividend Yield

Dividend yield is an easy way to compare the relative
attractiveness of various dividend-paying stocks
. It tells an investor the yield he / she can expect by
purchasing a stock.
This allows a basis of comparison between other
investments such as bonds, certificates of deposit, etc.