MODULE 4

FUNDAMENTAL & TECHNICAL ANALYSIS

 Fundamental and technical analysis are two common ways to sort and pick stocks. How
and when to use them can be a matter of personal style, but each has its strengths.
 Fundamental analysis attempts to identify stocks offering strong growth potential at a
good price by examining the underlying company's business, as well as conditions within
its industry or in the broader economy. Investors have traditionally used fundamental
analysis for longer-term trades, relying on metrics like earnings per share (EPS), price-to-
earnings (P/E) ratio, P/E growth, and dividend yield.
 Fundamental Analysis in simple terms in the art of evaluating any business to its basics
and getting an accurate picture of how financially healthy and sustainable it is.
 It involves studying a company’s potential for future growth by considering various micro
and macroeconomic factors. This analysis assists in deriving at an intrinsic value of stock
that aids investment decisions.

Prof. Ningambika G Meti Dept of MBA, SVIT

  Intrinsic value is a measure of what an asset is worth. This measure is arrived at by
means of an objective calculation or complex financial model.

 Intrinsic value is different from the current market price of an asset. However,
comparing it to that current price can give investors an idea of whether the asset is
undervalued or overvalued.

 Discounted cash flow analysis is used for many intrinsic value calculations.

 Intrinsic value is a core concept that value investors use to uncover hidden investment
opportunities

UNDERVALUED & OVERVALUED

● Undervalued is a financial term referring to a security or other type of investment that

is selling in the market for a price presumed to be below the investment's true intrinsic
value.

● The intrinsic value of a company is the present value of the free cash flows expected
to be made by the company.

● An undervalued stock can be evaluated by looking at the underlying company's

financial statements and analyzing its fundamentals, such as cash flow, return on
assets, profit generation, and capital management to estimate the stock's intrinsic
value.

● In contrast, a stock deemed overvalued is said to be priced in the market higher than
its perceived value. Buying stocks when they are undervalued is a key component of
famed investor Warren Buffett's value investing strategy.

Prof. Ningambika G Meti Dept of MBA, SVIT

 ● An overvalued stock has a current price that is not justified by its earnings outlook,
known as profit projections, or its price-earnings (P/E) ratio. Consequently, analysts
and other economic experts expect the price to drop eventually.

● Overvalued stocks are ideal for investors looking to short a position. This entails
selling shares to capitalize on an anticipated price declines. Investors may also
legitimately trade overvalued stocks at a premium due to the brand, superior
management, or other factors that increase the value of one company's earnings over
another.

COMPONENTS OF FUNDAMENTAL ANALYSIS

Fundamental analysis is the examination of various factors such as earnings of the company,
growth rate and risk exposure that affects the value of shares of a company.

Fundamental analysis consists of:( EIC FRAMEWORK)

● Economic analysis

● Industry analysis

● Company analysis

Fundamental analysis is an extremely comprehensive approach that requires a deep

knowledge of accounting, finance, and economics. For instance, fundamental analysis
requires the ability to read financial statements, an understanding of macroeconomic factors,
and knowledge of valuation techniques. It primarily relies on public data, such as a
company’s historical earnings and profit margins, to project future growth.

MACROECONOMIC ANALYSIS:

 Macroeconomic factors are broad market factors that affect the economy as a whole.

 These factors may or may not be external to a country and are often man-made or natural
but have the potential to change the course of an economy.

 Some examples of such macroeconomic factors are natural disasters like earthquakes,
famines, droughts, or manmade situations like war, global inflation, recession, etc.

 These factors impact the key parameters or pillars of an economy like its GDP growth
rate, stock market trends, major industries, etc. Therefore, it is important to understand
these factors and ascertain their impact on the economy as a whole.

KEY VARIABLES/ FACTORS:

It is the analysis of various macro economic factors that have a significant bearing on the
stock market. The various macro economic factors are:

 Gross Domestic Product (GDP):

Prof. Ningambika G Meti Dept of MBA, SVIT

  Economic forecasting

 Savings and investment

 Inflation

 Interest rates

 Govt Budget

 Govt debt

 Forex & Exchange rate

Gross Domestic Product (GDP):

 GDP measures the output of all goods and services in an economy.

 As the stock market rises and falls, so too, does sentiment in the economy.

 As sentiment changes, so do people's spending, which ultimately drives GDP growth;

however, the stock market can have both negative and positive effects on GDP.

 A rising GDP level indicates a positive outlook for the economy, thereby boosting stock
prices. Companies reporting positive financial results in a rising GDP boosts the
confidence of the investors (retail and institutional investors) which further creates
a bullish market.

 A fall or a rise in the GDP of a country has a long-lasting impact on such an economy but
the stock markets react promptly and adjust to the news in a negative or positive manner
respectively indicating a direct relationship between the two.

Economic Forecasting:

Forecasting the future state of the economy is needed for decision making.

The following forecasting methods are used for analyzing the state of the economy:

1. Economic indicators: Indicate the present status, progress or slow down of the economy.

2. Leading indicators: Indicate what is going to happen in the economy. Popular leading
indicators are fiscal policy, monetary policy, rainfall and capital investment.

3. Coincidental indicators: Indicate what the economy is — GDP, industrial production,

interest rates and so on.

4. Lagging indicators: Changes occurring in leading and coincidental indicators are

reflected in lagging indicators. Unemployment rate, consumer price index and flow of foreign
funds are examples of such indicators.

Prof. Ningambika G Meti Dept of MBA, SVIT

5. Diffusion index: It is a consensus index, which has been constructed by the National
Bureau of Economic Research in USA.

Savings & Investment:

 The demand for corporate securities has an important bearing on stock price movement.

 The level of investment in the economy is equal to:

 Domestic savings + inflow foreign capital(investment made abroad).

 The savings are you should also know how the same are allocated over various
instruments like equities, bonds, BD, small savings schemes. Its more favourable for the
stock market as we invest higher in the above instruments.

Inflation:

 The simple explanation of rising inflation is the rise in the cost of living or reduction in
the purchasing power of money.

 Inflation is always viewed as a villain for an economy but the fact is that a healthy
inflation level is considered to be good for the economy, especially for a developing
economy. However, the stock markets have traditionally seemed to have an inverse
relationship with rising inflation.

 An increase in inflation will see a reduction in the disposable income for investors at
large which will lead to a lowering of their investments in stocks and other investment
options. This leads to a general decrease in the demand for stocks and therefore a bearish
mood.

 Central banks influence interest rates to control inflation and stimulate or cool down
economic activity. Lower interest rates encourage borrowing and spending, while higher
rates can curb inflation but may slow down economic growth.

Forex & Exchange rate:

 The currency rates around the world have been tumbling for a long time now. Many
giants like the Japanese Yen, the Euro, and Sterling Pound have all seen a sharp decrease
in their values in recent times.

 The Indian Rupee is no different. Although many experts say that the INR has performed
far better than the currencies of other major economies, it is a fact that the rupee is at an
all-time low against the dollar. The direct impact of the exchange rate fluctuations is seen
in the stock markets. Any rise in the dollar sees a sharp decline in the stock markets and
vice versa.

 The rise in the value of the dollar implies that ,get more returns for their investment in the
US markets than in India and hence they pull out of the Indian markets, thereby triggering
a fall in the broad market indices.

Prof. Ningambika G Meti Dept of MBA, SVIT

Interest Rates

 One of the many actions taken by governments to fight rising inflation is an increase in
interest rates.

 Central banks influence interest rates to control inflation and stimulate or cool down
economic activity.

 Lower interest rates encourage borrowing and spending, while higher rates can curb
inflation but may slow down economic growth.

Govt budget:

 Investment analyst examine the govt budget asses how it is likely to impact on the stock
market.

 Favourable influence of budget: Balanced budget, a tax structure which provides

incentive for stock market.

 Unfavourable influence of budget: budget with higher surplus or deficit, a tax structure
which provides disincentive for stock market.

INDUSTRY ANALYSIS:

It is used to analyze the performance of the industries over the years. An industry is a group
of firms that are engaged in the production of similar goods and services.

1. Industry life cycle analysis stages: Investors look for industries with high growth
potential and disruptive technologies. They assess the scalability of business models
and the regulatory environment. Appeal primarily for speculators.
2. Growth Stage: The focus is on identifying early leaders and potential disruptors.
Investors seek companies with innovative products/services and strong market
demand. Regulatory trends and industry consolidation are monitored closely.
3. Maturity Stage: Investors scrutinize market saturation levels and assess the
sustainability of growth. Differentiation becomes critical, and companies may explore
new markets or diversification strategies. Regulatory compliance and industry
standards play a significant role.
4. Saturation Stage: Investors monitor signs of decline, such as stagnant demand and
margin erosion. Mergers and acquisitions may increase as companies seek synergies
or diversification. Regulatory risks and disruptive technologies are closely watched.
5. Decline Stage: Investors may avoid or short companies in declining industries. Focus
shifts to emerging sectors or defensive plays. Regulatory interventions and industry
shakeouts become more pronounced. Investors may avoid or short companies in
declining industries. Focus shifts to emerging sectors or defensive plays. Regulatory
interventions and industry shakeouts become more pronounced.

Prof. Ningambika G Meti Dept of MBA, SVIT

PROFIT POTENTIAL OF INDUSTRIES PORTER MODEL:

Porter's Five Forces model can indeed be applied to fundamental analysis in the context of
evaluating stocks. By incorporating Porter's Five Forces analysis into fundamental stock
analysis, investors can gain insights into the competitive dynamics of industries and evaluate
the long-term sustainability of a company's competitive advantage, thereby making more
informed investment decisions. Here's how each force can be considered:

1. Threat of New Entrants: Evaluate barriers to entry for new competitors in the
industry. Factors such as economies of scale, brand loyalty, capital requirements, and
regulatory hurdles are crucial. Companies with strong market presence, proprietary
technology, or patents may have a competitive advantage. Companies operating in
industries with high barriers to entry are more likely to sustain their competitive
position and profitability over the long term. Investors may favor stocks of such
companies due to their moat against new entrants.
2. Bargaining Power of Suppliers: Assess the concentration of suppliers and their
bargaining power over inputs. Companies reliant on unique or scarce resources
controlled by suppliers face higher risks. Evaluate the availability of substitute inputs
and potential cost impacts. Companies with strong supplier relationships, diversified
sourcing strategies, or backward integration are better positioned to mitigate supplier
power. Stocks of companies with secure and cost-effective supply chains may be
more attractive to investors.
3. Bargaining Power of Buyers: Analyze the concentration and power of buyers in the
market. Consider factors such as buyer switching costs, price sensitivity, and
availability of substitute products. Companies with differentiated products or strong
brand loyalty may have more pricing power. Stocks of companies facing fragmented
or less price-sensitive buyer segments may be more resilient to competitive pressures.
Sustainable pricing power can support margins and long-term profitability, making
such stocks appealing to investors.
4. Threat of Substitute Products or Services: Identify potential substitutes that could
erode demand for a company's products or services. Evaluate factors such as relative
price-performance ratios, switching costs, and customer preferences. Companies with
unique value propositions or strong customer lock-in are less vulnerable. Stocks of
companies with differentiated offerings or proprietary technology that create barriers
to substitution are more attractive. Investors may favor stocks of companies with a
strong competitive position relative to substitutes.
5. Rivalry Among Existing Competitors: Assess the intensity of competition within
the industry. Factors such as industry growth rates, capacity utilization, and strategic
rivalry influence competition. Companies with unique capabilities, cost advantages, or
strong market positions are better equipped to withstand rivalry. Stocks of companies
operating in industries with lower competitive intensity or those with sustainable
competitive advantages may offer more stable returns. Investors may favor stocks of
market leaders or companies with differentiated offerings.

Prof. Ningambika G Meti Dept of MBA, SVIT

 An investor must analyze the following factors:

• Growth of the industry ,Cost structure and profitability

• Nature of the product, Nature of the competition

• Government policy

ANALYSIS OF FINANCIAL STATEMENTS:

Analyzing financial statements is crucial for investors to assess the financial health,
performance, and potential risks of a company. Here's a comprehensive guide to financial
statement analysis:

1. Income Statement Analysis:

 Revenue Trends: Analyze revenue growth rates over multiple periods.

Consistent growth may indicate strong demand and market acceptance.

 Profitability Margins: Evaluate gross profit margin, operating profit margin,

and net profit margin. Declining margins may signal pricing pressures or
rising costs.

 Operating Expenses: Scrutinize operating expenses as a percentage of

revenue. Monitor trends in research and development (R&D), sales and
marketing, and general administrative expenses.

 Earnings Per Share (EPS): Assess EPS trends and compare them with
industry peers. Look for sustainable growth in earnings.

 Non-Recurring Items: Identify and adjust for non-recurring or extraordinary

items that may distort profitability metrics.

2. Balance Sheet Analysis:

 Liquidity Ratios: Calculate current ratio and quick ratio to assess short-term
liquidity. Ensure the company has sufficient assets to cover its short-term
liabilities.

 Debt Levels: Evaluate total debt, long-term debt, and debt-to-equity ratio.
Excessive leverage may increase financial risk, while moderate debt levels can
indicate efficient capital utilization.

 Asset Efficiency: Analyze asset turnover ratio and inventory turnover ratio.
Higher turnover ratios indicate efficient utilization of assets.

 Quality of Earnings: Scrutinize accounts receivable and inventory levels.

Increasing receivables or inventory buildup may suggest slowing sales or
potential write-offs.

Prof. Ningambika G Meti Dept of MBA, SVIT

  Book Value: Assess the book value per share and compare it with the market
price. A low price-to-book ratio may indicate undervaluation.

3. Cash Flow Statement Analysis:

 Operating Cash Flow: Evaluate the company's ability to generate cash from
its core operations. Positive operating cash flow is essential for sustaining
business operations.

 Investing Cash Flow: Analyze capital expenditures and investments in long-

term assets. Monitor trends in acquisitions, divestitures, and capital
investments.

 Financing Cash Flow: Assess cash flows from financing activities, including
debt issuance, share buybacks, and dividend payments. Sustainable financing
sources are crucial for long-term viability.

 Free Cash Flow: Calculate free cash flow by subtracting capital expenditures
from operating cash flow. Positive free cash flow indicates the company's
ability to generate excess cash for growth or shareholder returns.

1. RATIO ANALYSIS:
Ratio analysis is a fundamental tool used to evaluate the financial performance,
health, and efficiency of a company. Here are some key ratios commonly used in
financial analysis:

Liquidity Ratios:

 Current Ratio: Current Assets / Current Liabilities. Measures the company's ability to
cover short-term obligations with its short-term assets.
 Quick Ratio (Acid-Test Ratio): (Current Assets - Inventory) / Current Liabilities.
Provides a more stringent measure of liquidity by excluding inventory from current
assets.

Profitability Ratios:

 Gross Profit Margin: (Gross Profit / Revenue) * 100. Measures the percentage of
revenue that exceeds the cost of goods sold.
 Operating Profit Margin: (Operating Income / Revenue) * 100. Indicates the
percentage of revenue that remains after deducting operating expenses.
 Net Profit Margin: (Net Income / Revenue) * 100. Shows the percentage of revenue
that represents net profit after all expenses and taxes.

Efficiency Ratios:

 Asset Turnover Ratio: Revenue / Average Total Assets. Measures the company's
ability to generate revenue from its assets.

Prof. Ningambika G Meti Dept of MBA, SVIT

  Inventory Turnover Ratio: Cost of Goods Sold / Average Inventory. Indicates how
many times the company's inventory is sold and replaced within a given period.
 Accounts Receivable Turnover Ratio: Revenue / Average Accounts Receivable.
Measures how efficiently the company collects cash from its credit sales.

Debt Ratios:

 Debt-to-Equity Ratio: Total Debt / Total Equity. Indicates the proportion of debt
financing relative to equity financing.
 Interest Coverage Ratio: Earnings Before Interest and Taxes (EBIT) / Interest
Expense. Measures the company's ability to cover interest payments with its operating
income.
 Debt Service Coverage Ratio: EBITDA / Total Debt Service. Evaluates the company's
ability to cover its debt obligations with its operating income.

Investment Ratios:

 Price-to-Earnings (P/E) Ratio: Market Price per Share / Earnings per Share (EPS).
Compares the company's stock price to its earnings per share, indicating how much
investors are willing to pay for each dollar of earnings.
 Price-to-Book (P/B) Ratio: Market Price per Share / Book Value per Share. Measures
the market's valuation of the company relative to its book value.
 Dividend Yield: Dividend per Share / Market Price per Share. Indicates the
percentage return on investment from dividends relative to the current stock price.

Coverage Ratios:

 Times Interest Earned (TIE) Ratio: Earnings Before Interest and Taxes (EBIT) /
Interest Expense. Measures the company's ability to meet its interest obligations with
its operating income.
 Dividend Coverage Ratio: Earnings per Share (EPS) / Dividend per Share. Assesses
the company's ability to cover dividend payments with its earnings.

These ratios provide insights into various aspects of a company's financial performance,
helping investors assess its profitability, liquidity, leverage, efficiency, and valuation. It's
essential to analyze ratios in conjunction with other financial metrics and consider
industry benchmarks and historical trends for meaningful interpretation.

2. Comparative Analysis:

 Industry Comparison: Benchmark the company's financial performance

against industry peers. Identify outliers and understand the reasons behind
performance disparities.

 Historical Trends: Analyze financial metrics over multiple periods to identify

trends and patterns. Look for consistency and improvement in key
performance indicators.

Prof. Ningambika G Meti Dept of MBA, SVIT

 3. Qualitative Analysis:

 Management Discussion: Review management commentary in annual reports

and earnings calls. Assess management's strategic vision, operational
challenges, and risk management practices.

 Industry Outlook: Consider industry dynamics, competitive landscape,

regulatory environment, and technological disruptions. Evaluate the
company's positioning and ability to adapt to industry trends.

By conducting a comprehensive analysis of financial statements, investors can gain valuable

insights into a company's financial health, performance drivers, and potential risks, enabling
informed investment decisions.

IMPORTANT QUESTIONS:

1. What is Fundamental Analysis? 3m

2. Explain EIC framework? 7m
3. Explain the Macroeconomic factors in detail? 7m
4. Enumerate the Industry analysis with porters model? 7m
5. Elaborate Industry analysis with lifecycle stages? 7m
6. Differentiate Fundamental analysis and technical analysis? 7m

Prof. Ningambika G Meti Dept of MBA, SVIT