Fundamental analysis defined

Fundamental analysis is a stock valuation method

that uses financial and economic analysis to
predict the movement of stock prices.
It includes analysis of financial and non-financial
information

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Fundamental Analysis
Attempts to find out the true value of the securities so
that the investors can decide to buy or not to buy the
securities at the current market prices.
Philosophy:
If an investor invests one rupee in buying a share of a
company,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 the fair
value of the shares.

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Steps Involved

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Bottom – up Approach
For small investors
The under valued shares would provide superior and
better returns irrespective of the overall economic and
industry position.
This is a narrow approach towards fundamental
analysis.

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Top – down Approach
Also known as Economic-Industry-Company Approach (EIC).

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Economic Analysis
Business Cycles
Monetary Policy
Fiscal Policy
Inflation
Interest rate structure
GDP growth
Unemployment
Foreign Trade

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Business cycles
Cyclical movement of a business in the economic
activity in a country as a whole.
Phases:
† Depression
† Recovery
† Boom
† Recession

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Monetary Policy
Concerned with manipulation of money supply in the
economy.
It affects the economy mainly through its impact on
interest rates, thereby stimulating investment and
consumption demand.
It is designed to maintain a balance in liquidity
position.

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Tools of Monetary Policy

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Tools (contd)
Open market operation:
Involves buying or selling of Government securities
by RBI.
Bank rate:
Rate at which RBI provides financial acomodation to
scheduled 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 approved
securities to the demand and time liabilities.
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Direct credit controls
RBI asking banks to lend a certain percentage of their
funds to priority sectors.
Whatever may be the merit of such controls ,they tend
to breed inefficiency and diminish competition.

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Fiscal Policy
Concerned with the spending and tax initiatives of the
Government.
Direct tool to stimulate or dampen the economy.
An increase in Govt spending stimulates the demand
for goods and sevices, whereas a decrease deflates the
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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Inflation
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 expansionary
phase.
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 rates
Directly 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 funds
higher profit.
Affects the bond and equity prices

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GDP growth
GDP – measure of the total production of final goods
and services in the economy during a specified period
usually a year.
The growth rate represents the average of the growth
rates of the three principal sectors of the economy –
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 Analysis
Industry can be defined as a homogenous group of
firms which compete with one another with a similar
type of product , goods and services.
Basics of Analysis:
Industry life cycle analysis
Study of the structure and characteristics of an
industry
Profit potential of industries

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Stages involved

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Investment implications
Give industry analysis prior attention in your
investment selection process.
Display caution during the pioneering stage – this
stage has an appeal primarily for speculators.
Respond quickly and expand your commitments
during 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 and
characteristics of an industry
Structure of the industry and nature of competition
Nature and prospects of demand
Cost, efficiency and profitability
Technology and research

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Profit potential of industries
Porter’s 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 analysis
Past performance of the industry
Permanence 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 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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Objective
To study and understand the company in which you
are planning to invest your hard earned money and
get excellent returns.
To determine what stock to buy and at what price
To conduct a company stock valuation and predict
its probable price evolution,
To make a projection on its business performance,
To evaluate its management
To calculate its credit risk

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Where Do I Begin?
What does the company do?
How big is it?
Company Goals
Financial Health
Competitive Landscape
Economic Conditions

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 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?
Micro-cap: $100 million or less
Small-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 Statements
Income Statement
Cash Flow Statement
Balance Sheet

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What you should look for in a company to
invest?
About the company
Earnings
Current valuation
Future earnings growth
Debt status

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Earnings
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 the
higher the better is the stock.

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Current 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 Earnings

Share Price
P/E 
Earnings Per Share
•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 Book

Share Price
P/B 
Total Assets - Intangible Assets &Liabilities

•Compares the company’s share price to their

book value
•A low P/B ratio could mean:
•Stock undervalued
•Something very wrong…

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Dividend payout ratio
DPR = Dividends Per Share / EPS

Growing companies will typically retain more profits

to fund growth and pay lower or no dividends.
Companies that pay higher dividends may be in
mature industries where there is little room for growth

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Future earnings Growth

Projected Earning Growth ratio - PEG ratio

Price to sales ratio

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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 Sales
•P/S
ratio can be used in comparison to other
companies
•How much is being paid for per share of sales
•IfP/S < 1, it means investors are paying less for each
unit of sales

Share Price
P/S 
Revenue Per Share

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Debt status
Debt ratio
Dividend Yield

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 Total Debts
Debt ratio 
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
Current Assets

Current Liabilities
•Measure of ability to pay short-term
liabilities
•Higher ratios means the more capable
a company is to paying back short-
term debt

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Is This Company Profitable?
•Gross Margin/Profit/Income, Net Income
•Look at company’s 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 volatile
performance?

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Going beyond the numbers
Analysis of financial statistics must be supplemented
with an appraisal , mostly of qualitative nature, of the
company’s present situation and prospects and the
quality of its management.

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Sizing up the company’s present
situation and prospects
Availability and cost of inputs
Order position
Regulatory framework
Technological 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 the
stock 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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Conclusions
Fundamental analysis can be valuable, but it should be approached with
caution. If you are reading research written by a sell-side analyst, it is
important to be familiar with the analyst behind the report. We all have
personal biases, and every analyst has some sort of bias. There is nothing
wrong 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 deep
end. 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 PR tool
for companies. Investors should become skilled readers to weed out the
important information and ignore the hype.

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