CHAPTER 7

COMPANY ANALYSIS - BUSINESS & GOVERNANCE

Learning objectives

• Role of company analysis

• Different kinds of Business Models
• Pricing power & sustainable of pricing power
• Critical success factors of a company
• SWOT analysis
• How to understand quality of mang & governance model of a
company
• Why is it important to understand the risks to a business
• Importance of knowing history of credit rating of a company &
changes over time
• ESG framework for company analysis

7.1. ROLE OF COMPANY ANALYSIS IN FUNDAMEN TAL RESEARCH

.

A company's success depends upon macroeconomic, industry-specific factors, and its

company-specific factors.

Key considerations while analyzing a company:

• Define and analyze the business model, Identify competitive advantages

• Evaluate the capability to exploit opportunities and manage threats.

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 • Analyze management and determine their vision for short-term performance and
long-term goals.

• Ensure the company has a governance structure prioritizing the company and
shareholder's interests.

7.2. UNDERSTAND BUSINESS AND BUSINESS MODELS

.

The starting point of qualitative research on any business has to be questions such
as:

• What does the company do and how does it do?

• Who are the customers and why do customers buy those products and services?
• How does the company serve these customers?

Each sector has distinct evaluation parameters;

eg: footfalls and same-store sales are vital for retail, while banking relies on metrics
like Net Interest Income (NII)/Net Interest Margin (NIM).

Each company operates uniquely. The efficiency in producing and delivering products
or services varies across businesses and significantly affects their financial
performance.

7.3. PRICING POWER AND SUSTAINABILITY OF THIS POWER

.

• Pricing power refers to a company's ability to determine and charge the price of its
products independently. It is important for the profit sustainability and growth of a
company.

• Competition intensity in the industry, the price elasticity of the product, and the level
of commoditization of the product affects pricing power.

• Company-specific factors like leadership status, brand affinity, and cost efficiency
help sustain pricing power.

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7.4. COMPETITIVE ADVANTAGE / POINTS OF DIFFERENTIATION OVER THE COMPETITORS
.

The differentiating factors for a company compared to its competitors can be categorized
into three areas:

1) Differentiation in product features:

• Incorporating better features and improving the quality or functionality of the

product creates a unique value proposition and attracts more customers.

• Strong R&D and constant introduction of new products and innovations help in
differentiation.

2) Competitive pricing:

• A competitive strategy is pricing their products attractively, particularly when

products seem similar to customers.

• Lower prices attract customers but sustaining low prices is difficult.

3) Better execution:

• Companies that communicate better with their customers or execute a better sales
strategy can do better than their competitors.

7.5. SWOT ANALYSIS

.

SWOT analysis helps evaluate business fundamentals by focusing on strengths,

weaknesses, opportunities, and threats.

Analysts use SWOT by first finding strengths and weaknesses, then looking at
opportunities and threats. This order fits well for external observers like equity
analysts.

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 • In SWOT analysis, "Strengths" are the
internal advantages that give a company a
competitive edge.
• The strengths include a strong financial
position, valuable intellectual properties, a
diverse customer base, cost-effectiveness,
high margins, support from a parent
company, and a proven track record.
• Apple AirPods are tiny,
wireless earbuds.
• They have great sound
quality and work well
with Apple devices like
iPhones and iPads.
• Apple can make even
better AirPods with new
features, like longer
battery life.
• They can make AirPods in
different colors or designs
to make them more fun.
• Opportunities are the external factors
or situations that can be advantageous
for a company's growth.
• These opportunities include market
trends, technological advancements,
changing consumer preferences,
industry developments, new
partnerships, etc.
• Weakness refers to internal issues that
make the company vulnerable to external
events.
• Weaknesses include a weak financial
position, high fixed costs, low margins,
heavy customer concentration, legal cases
diverting focus, and insufficient
experience in executing strategies.
• AirPods can be expensive,
and not everyone can afford
them.
• They might not work as well
with non-Apple devices, like
Android phones.
• Other companies make wireless
earbuds too, and they might
have similar features.
• If something better than
AirPods comes along, people
might stop buying them.
• Sometimes, people worry about
radiation from wireless devices
like AirPods.
• Threats are external challenges that
can negatively impact a company's
performance.
• Threats can include market competition,
economic downturns, regulatory changes,
technological disruptions, shifting
consumer preferences, etc.
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7.6. QUALITY OF MANAGEMENT & GOVERNANCE STRUCTURE

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Analysts should scrutinize the qualifications of independent directors since companies often
appoint individuals with personal ties rather than relevant expertise.Evaluating their
qualifications, experiences, attendance, and contributions is important.

A) Evaluating Management Competency:

Analyzing the capabilities of top leaders of a company like the CEO, CFO, and others is tough
for analysts. Analysts can ask the following questions to analyze management capabilities:

1) Does the top management have relevant educational qualifications and experience?

2) Do they have a track record of successful performance and provide a long-term vision?

3) Can they execute current strategies effectively and ensure regulatory compliance?

B) Evaluating Corporate Governance:

• Corporate governance is like a set of rules that a company follows to make sure all the
stakeholders are treated fairly. In India, SEBI's Clause 49 sets basic rules that companies
must meet to run things properly. Strong governance helps prevent agency risks.

• Analysts evaluate corporate governance by analyzing board compositions, the separation of

roles between Chairman and CEO, nomination committees, auditor fees, audit committee
composition, related party transactions, and independent director remuneration.

C) Promoter holdings;

• Promoters are individuals involved in a company's initial founding or controlling

shareholders.

• Promoters are likely to have a higher level of control over the management. This increases
the likelihood of management acting in the best interest of shareholders.

• Promoters often pledge shares to raise funds, a usual practice not directly tied to
governance concerns.
7.7. RISK IN THE BUSINESS
.

• Every business has risks involved from its operations to execution. These risks can be
known or unknown.

• Analysts should focus on evaluating these risks in various business dimensions.

• Promoters who claim there are no risks might need more awareness about potential
problems. Avoiding such promoters is important.

7.8. HISTORY OF CREDIT RATING

.

• Credit ratings evaluate a borrower's ability to repay debts and are provided by credit
rating agencies for short and long-term debts.

• Checking a company's past credit ratings tells us how well its management responded
to external feedback and tackled important issues highlighted by credit rating
agencies.

7.9. ESG FRAMEWORK FOR COMPANY ANALYSIS

.
• The ESG (Environment, Social, Governance) framework evaluates companies based on
their environmental impact, social initiatives, and governance standards.

• It helps investors prioritize sustainability and ethical practices alongside financial

returns.

• Companies with lower environmental impact, positive social contributions, and strong
governance rank higher.

• The framework offers financial benefits like reduced regulatory risks, increased brand
value, cost savings, and lower capital costs.

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• SEBI's proposed regulations aim to enhance ESG disclosures among listed entities,
providing investors with better information.

• Overall, the ESG framework serves as a guideline for investors to assess a company's
sustainability, ethical practices, and long-term viability beyond just financial metrics.

7.10. SOURCES OF INFORMATION FOR ANALYSIS

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• Annual/Quarterly reports, Conference call transcripts, and Investor presentations

• Management interviews

• Ministry of Corporate Affairs website

• Research reports from credit rating agencies and other sources

• Print media reports

• Discussions with suppliers, vendors, consumers, and competitors

• BRSR Report for ESG disclosures

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