Chapter 1 Introduction to Fundamental Analysis 1.

1 Introduction
Capital markets provide lucrative investment opportunities since they help in earning a return without actually indulging in economic activities. Economic activities are, in fact, the base without which the supporting functions of capital markets will not find an existence. Nobody invests to lose money. However, investments always entail some degree of risk either in productive economic activity or in an intermediary role. There are certain specific features that relate to investments in terms of securities in the capital market. They a re as follows: 1. The higher the expected rate of return, the greater the risk. 2. Some investments cannot be sold or converted to cash. Sometimes, investments carry with them the characteristics of a penalty or charge if one disposes off an investment before a maturity date. 3. Investments in securities issued by a company with a little or no operating history or published information may involve greater risk. 4. Security investments, including mutual funds, cannot be legally insured against a loss in market value.
5. Securities may be subject to tender offers, mergers, re-organisation, or

third-party actions that can affect the value in terms of ownership interest. 6. The past success of a particular investment is no guarantee of future performance. The unique nature of capital market instruments forces investors to depend strongly on other fundamental factors to help them in their investments

decisions. It can be presumed that if not for investments through capital markets, investors would have to invest in economy directly. Companies are part of industrial and business sector, which in turn is part of overall economy. The performance of security that represents the company is said to depend on the performance of the company itself. The selection will hence start from fundamental analysis. Fundamental analysis examines the economic environment, industry performance, and company performance before making an investment decision. A fundamental analyst believes that analysing the economy, strategy, management, product, financial status, and other related information will help choose share that will outperform the market and provide consistent gains to the investor. Fundamental analysis is the examination of the underlying forces that affect the interests of the economy, industrial sectors, and companies. It tries to forecast the future movement of the capital market using signals from the economy, industry and company. Fundamental analysis requires an examination of the market from a broader prospective. The presumption behind fundamental analysis is that a thriving economy fosters industrial growth which leads to development of companies. Fundamental Analysis involves examining the economic, financial and other qualitative and quantitative factors related to a security in order to determine its intrinsic value. It attempts to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and individually specific factors (like the financial condition and management of companies).

Fundamental analysis, which is also known as quantitative analysis, involves delving into a companys financial statements (such as profit and loss account and balance sheet) in order to study various financial indicators (such as revenues, earnings, liabilities, expenses and assets). Such analysis is usually carried out by analysts, brokers and savvy investors. Many analysts and investors focus on a single number--net income (or earnings)--to evaluate performance. When investors attempt to forecast the market value of a firm, they frequently rely on earnings. Many institutional investors, analysts and regulators believe earnings are not as relevant as they once were. Due to nonrecurring events, disparities in measuring risk and management's ability to disguise fundamental earnings problems, other measures beyond net income can assist in predicting future firm earnings.

1.2 Two Approaches of Fundamental Analysis

While carrying out fundamental analysis, investors can use either of the following approaches: 1. Top-down approach: In this approach, an analyst investigates both international and national economic indicators, such as GDP growth rates, energy prices, inflation and interest rates. The search for the best security then trickles down to the analysis of total sales, price levels and foreign competition in a sector in order to identify the best business in the sector. 2. Bottom-up approach: In this approach, an analyst starts the search with specific businesses, irrespective of their industry/region.

1.3 How Does Fundamental Analysis Works?

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Fundamental analysis is carried out with the aim of predicting the future performance of a company. It is based on the theory that the market price of a security tends to move towards its 'real value' or 'intrinsic value.' Thus, the intrinsic value of a security being higher than the securitys market value represents a time to buy. If the value of the security is lower than its market price, investors should sell it. The steps involved in fundamental analysis are: 1. Macroeconomic analysis, which involves considering currencies,

commodities and indices. 2. Industry sector analysis, which involves the analysis of companies that are a part of the sector. 3. Situational analysis of a company. 4. Financial analysis of the company. 5. Valuation The valuation of any security is done through the discounted cash flow (DCF) model, which takes into consideration: 1. Dividends received by investors. 2. Earnings or cash flows of a company. 3. Debt, which is calculated by using the debt to equity ratio and the current ratio (current assets/current liabilities).

1.4 Benefits of Fundamental Analysis

Fundamental analysis helps in: 1. Identifying the intrinsic value of a security.

2. Identifying long-term investment opportunities since it involves real- time data.

1.5 Drawbacks of Fundamental Analysis

The drawbacks of fundamental analysis are: 1. Too many economic indicators and extensive macroeconomic data can

confuse novice investors. 2. The same set of information on macroeconomic indicators can have

varied effects on the same currencies at different times. It is beneficial only for long-term investments.

1.6 Fundamental Analysis Tools

These are the most popular tools of fundamental analysis.

Earnings per Share EPS Price to Earnings Ratio P/E Projected Earning Growth PEG Price to Sales P/S Price to Book P/B Dividend Payout Ratio Dividend Yield Book Value Return on Equity

1.7 Technical Analysis

Technical analysis is the practice of anticipating price changes of a financial instrument by analyzing prior price changes and looking for patterns and relationships in price history. Since all the investors in the stock market want to make the maximum profits possible, they just cannot afford to ignore either fundamental or technical analysis. The price of a security represents a consensus. It is the price at which one person agrees to buy and another agrees to sell. The price at which an investor is willing to buy or sell depends primarily on his expectations. If he expects the security's price to rise, he will buy it; if the investor expects the price to fall, he will sell it. These simple statements are the cause of a major challenge in forecasting security prices, because they refer to human expectations. As we all know firsthand, humans expectations are neither easily quantifiable nor predictable. If prices are based on investor expectations, then knowing what a security should sell for (i.e., fundamental analysis) becomes less important than knowing what other investors expect it to sell for. That's not to say that knowing what a security should sell for isn't important--it is. But there is usually a fairly strong consensus of a stock's future earnings that the average investor cannot disprove.

1.8 Why Only Fundamental Analysis

Long-Term Trends

Fundamental analysis is good for long-term investments based on long-term trends, very long-term. The ability to identify and predict long-term economic, demographic, technological or consumer trends can benefit patient investors who pick the right industry groups or companies. Value Spotting

Sound fundamental analysis will help identify companies that represent a good value. Some of the most legendary investors think long-term and value. Graham and Dodd, Warren Buffet and John Neff are seen as the champions of value investing. Fundamental analysis can help uncover companies with valuable assets, a strong balance sheet, stable earnings, and staying power.

Business Insights One of the most obvious, but less tangible, rewards of fundamental analysis is the development of a thorough understanding of the business. After such pains taking research and analysis, an investor will be familiar with the key revenue and profit drivers behind a company. Earnings and earnings expectations can be potent drivers of equity prices. Even some technicians will agree to that. A good understanding can help investors avoid companies that are prone to shortfalls and identify those that continue to deliver. In addition to understanding the business, fundamental analysis allows investors to develop an understanding of the key value drivers and companies within an industry. A stock's price is heavily influenced by its industry group. By studying these groups, investors can better position themselves to identify opportunities that are high-risk (tech), low-risk (utilities), growth oriented (computer), value driven (oil), non-cyclical (consumer staples), cyclical (transportation) or income-oriented (high yield).

 Knowing Who's Who Stocks move as a group. By understanding a company's business, investors can better position themselves to categorize stocks within their relevant industry group. Business can change rapidly and with it the revenue mix of a company. This has happened with many of the pure internet retailers, which were not really internet companies, but plain retailers. Knowing a company's business and being able to place it in a group can make a huge difference in relative valuations. The charts of the technical analyst may give all kinds of profit alerts, signals and alarms, but theres little in the charts that tell us why a group of people make the choices that create the price patterns.

Chapter 2 - Economic Analysis 2.1 Introduction

The economic analysis aims at determining if the economic climate is conducive and is capable of encouraging the growth of business sector, especially the capital market. When the economy expands, most industry groups and companies are expected to benefit and grow, when the economy declines, most sectors and companies usually face survival problems. Hence, to predict share prices, an investor has to spend time exploring the forces operating in the overall economy. Exploring the global economy is essential in international investment setting. The selection of a country for investment has to focus itself to the examination of a national economic scenario. It is important to predict the direction of national economy because economic activity affects corporate profits, not necessarily through tax policies but also through foreign policies and administrative procedures. A zero growth rate or a slow growth rate of the economy can lead to lower business profits, a prospect that can endanger investor outlook and lower share prices. Economic analysis implies the examination of GDP, government financing, government borrowing, consumer durable goods market, non-durable goods and capital goods market, savings and investment pattern, interest rate, inflation rates, tax structure, foreign direct investment, and money supply.
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A discussion of macro economy usually has two components: 1. 2. The national economy and The effect of international economy on the national economy.

The growth of the national economy is mainly determined by the domestic consumption pattern. Economists point that higher consumption leads to the economic growth. This is based on the argument that growth in consumption pattern fosters sales, which in turn induces production of goods and services in the economy. In addition, the interaction of other economies with the domestic economy has a large influence on a nations economic growth. The international trade policies, global demand/supply factors, and so on, hinder or foster relationship with other countries. A domestic economy which has freely let in international players into its economic environment will be subject to global trends more drastically than an economy that restricts the entry of foreign participants in domestic market.

2.2 TOOLS FOR ECONOMIC ANALYSIS

The most used tools for economic analysis are: 1. 2. 3. 4. 5. 6. 7. Gross Domestic Product Monetary policy and liquidity Inflation Interest rates International influences Consumer sentiment Fiscal policy

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8.
9.

Influences on long-term expectations Influences on short-term expectations

1. Gross Domestic Product Goss Domestic Product (GDP) is one measure of economic activity. This is the total amount of goods and services produced in a country in a year. It is the market values of all final goods and services produced in a year.

It is gross measurement because it includes the total amount of

goods and services produced, of which some merely replace goods that have worn out or depreciated. It is domestic production because it includes only goods and services

produced within a country. It measures the current production because it includes only what is

produced during the year.

It is a measurement of the final goods produced because it does not

include the value of a good when it is sold by a producer, again when it is sold by a distributor, and once more it is sold by the retailer to the final customer. GDP counts only the final sale. The charts (figure 2.1) explain the movement between the average BSE Index from 2006-2011 and shows the relationship that when the GDP growth rate fell the stock exchange index also showed a major downfall (decline) which indicates that stock exchanges bullish and bearish period are caused due to fall in the GDP growth rate. In the figure 2.1, the GDP growth rate and average BSE index show a similar movement. This can be interpreted to mean that the movement of GDP and capital markets is highly co-related and prediction of capital market movement through GDP expectations can be very useful and relevant for investors.

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GDP Growth % 12 GDP growth(%) 10 8 6 4 2 0 2006 2007 2008 Year 2009 2010 2011 GDP Growth %

Average 25000 20000 BSE Index 15000 Average 10000 5000 0

Ja n06 Ju l-0 Ja 6 n07 Ju l-0 Ja 7 n08 Ju l- 0 Ja 8 n09 Ju l- 0 Ja 9 n10 Ju l- 1 Ja 0 n11 Ju l- 1 1

Years

Source: BSEindia.com and World Bank data

Fig 2.1 Chart showing GDP (%) comparison with BSE Index

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2. Monetary Policies and Liquidity

Businesses need access to funds on order to borrow, raise capital and invest in assets. Likewise, individuals also may need access to funds to purchase house, car and other high-priced durable goods. If the monetary policy is very tight and banks have little excess reserve to lend, the source of capital becomes scarce and economic activity may slow down or decline. Although a good monetary policy and liquidity is essential for the economy, excess liquidity can be harmful. Excess money supply growth can lead to inflation, higher interest rates, and higher risk premium leading to costly sources of capital and slow growth. Money supply can be measured through M1, M2, and M3. M1 is the amount of currency in circulation, demand deposits, travellers cheques, and other deposits. M2 is defined as M1 plus large time deposits, repos at commercial banks, and institutional money market accounts. M3 is likely to reflect economic performance better then M1 and M2.

3. Inflation
Inflation can be defined as a trend of rising prices caused by demand exceeding supply. Over time, even a small increase in prices of say 1% will tend to influence the purchasing power of the nation. In other words, if prices rise steadily, after a number of years, consumers will only be able to buy only fewer goods and services assuming income level does not change with inflation. Although, inflation is a monetary phenomenon, at times, outside factors, such as raw material shortages can also increase the inflation rate. Inflation occurs when shortterm economic demand exceeds the long-term supply constraint. The effects of inflation on capital markets are numerous. In terms of valuing financial assets, inflation reduces the value of fixed-income securities. An increase in expected rate of inflation is expected to cause a nominal rise in interest rates. Also, it increases
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uncertainty of future business and investment decisions, which in turn, increases risk premiums. As inflation increases, it results in extra cost to businesses, thereby squeezing their profit margins and leading to real declines in profitability.
Inflation 14 12 Inflation 10 8 6 4 2 0 2006 2007 2008 Year 2009 2010 2011 Inflation

Average 25000 20000 BSE Index 15000 Average 10000 5000 0

Ja n06 Ju l-0 Ja 6 n07 Ju l-0 Ja 7 n08 Ju l- 0 Ja 8 n09 Ju l- 0 Ja 9 n10 Ju l- 1 Ja 0 n11 Ju l- 1 1

Years

Source: BSEindia.com and World Bank data

Figure 2.2 Chart showing inflation rates

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The charts in figure 2.2 explain the movement of the average BSE Index and the inflation rate prevailing in India. Hence, as interest rate expectations influence the market prices, inflation rate expectations also are theoretically expected to influence the stock market prices. A constant inflationary situation in an economy will be foreseen as a positive influence on the investor and hence, market prices are likely to go up under such circumstances (figure 2.2)

4. Interest Rates
Interest rate is the price of credit. It is the percentage fee received or paid by individual or organisations when they lend or borrow money. Increase in interest rates, whether caused by inflation, government policy, rising risk premium or any other factors, will lead to reduced borrowings and economic slowdown. Rising interest rates lead to decline in bond prices and typically lead to a fall in share prices. When interest rise, the investors required rate of return on shares rise as well, causing the prices of securities to fall. Rising interest rates also make bond yields look more attractive relative to share dividend yields.

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Interest Rate 8 7 Real Interest Rate 6 5 4 3 2 1 0 2006 2007 2008 Year 2009 2010 2011 Interest Rate

Average 25000 20000 BSE Index 15000 Average 10000 5000 0

Ja n06 Ju l-0 Ja 6 n07 Ju l-0 Ja 7 n08 Ju l-0 Ja 8 n09 Ju l-0 Ja 9 n10 Ju l-1 Ja 0 n11 Ju l-1 1

Years

Source: BSEindia.com and World Bank data

Figure 2.3 Chart showing comparison of Interest rates and BSE Average Index

The interest rate in India is also an equivalent measure of prevalent interest system in the economy. The interest rate movement in India during 2006-2011 (Figure 2.3)

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was comparatively lower than in previous years which led to the rise in the price of shares. Further increase in the interest rates pulled the share prices down. A further increase in interest rate is likely to influence the down-trend in the share market.

5. International Influences
Rapid growth in the overseas market can create surge in demand for exports, leading to growth in export sensitive industries and overall GDP. In contrast, the erection of trade barriers, quotas, nationalistic favour and currency restriction can hinder the free flow of currency, goods, and services, and harm the export sector of an economy. Although some attempts at policy coordination have been made by the G7 nations, most coordination has focused on strengthening or weakening the exchange rates of some of its members, most notably those of United States and Japan. The business cycles of the developed, developing, and less developed nations do not rise and fall together. Therefore, a strong economy as that of US can, at times, assist economies experiencing a recession by importing their products, and vice versa.

6. Consumer Sentiments
Optimistic consumer sentiment may lead consumers to make a long delayed purchase of durable goods or to be freer with their money at gift giving or vacation time. Such variations in consumers sentiment will lead to alternating periods of sales growth and decline for consumer- oriented industries, particularly manufacturers of consumer durables. It is also known that risk premium is influenced by consumers and hence lead to change in investor attitudes over the course of a business cycle. As a result, consumer sentiment can be expected to affect both cash flow as well as required risk premium on financial market investments. Consumer sentiment is usually expressed in terms of future expenditure planned and feeling about the future economy. A high interest rate and no tax saving opportunities would induce a consumer sentiment of current purchases. This would
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to high current demand for products. A favourable savings environment with high interest rates would induce the consumers to postpone current purchases for future spending.

7. Fiscal Policies
The fiscal policy of the government involves the collection and spending of revenues. In particular, fiscal policy refers to efforts by the government to stimulate economy directly through spending. Fiscal policy mostly affects short-run demand. Government spending can directly affect economic sectors and geographic regions. Assuming all other parameters as constant, some economists believe that a larger than expected increase in government spending may increase short-run demand while smaller than expected increase may harm short-run demand. Tax changes strongly influence the incentives to save, and invest and may, therefore, affect both short-term expectations as well as long-term supply. Decisions by the government, usually relating to taxation and government spending, with the goals of full employment, price stability, and economic growth lead to a positive or negative outlook of the share market.

8. Long Term Growth Expectations

The long term growth path of the economy is determined by supply factors, growth will be constrained in the long run by limits in technology, size and training of labour force, and adequate resources and incentives to expand. The rate of growth of output can be separated into two distinct categories: 1) growth from an increase in the factor inputs to production and 2) growth in output relative to the growth of all factor inputs, or total factor productivity (TFP). The implementation of technology acts to increase TFP, as does increased education and

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training of the workforce, reallocation of resources to their highest and most valued use, and increasing economies of scale.

9. Influence on short term expectations

In contrast to long-term expectations, mainly driven by supply factors, short-term expectations about the economy are mainly caused by demand factors. Fluctuations in demand relative to long-term supply constraints create fluctuation in real GDP, which are known as business cycles. When demand is less than supply, rising unemployment and recession may occur. Short-term economic forecasting focuses on sources of demand as a means to predict future trends in economic variables. Increase and decrease in demand, relative to long-term constrained supply growth result in business cycles and associated fluctuations in cash flow and associated fluctuations in cash flows, interest rates, and risk premiums. As part of top-down investment approach, analyst hence examines short-term demand trends and influences. These influences can then be evaluated to estimate their influence on different economic sectors, industries and investments. A business confidence index (BCI) is published periodically by various organisations/institutions to assess the short-term expectations from economic perspective. The National Council of Applied Economic Research (NCAER) computes a business index confidence through business expectation surveys based on business perceptions of four indicators: current investment climate, current capacity utilisation, overall economic conditions and financial performance of firms in the next six months. Of these four components, three pertain to the outlook specific to the respondents financial position, capacity utilisation and investment climate. These perceptions are based on questionnaires and interview responses to surveyed companies. The BCI is published quarterly and is expectation of short-term expectations of the business. The components change is also examined to assess the overall future impact on business. The improvement/decline in the index hence is

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analysed in terms of micro/macro-level business performance. The extent of support from capacity utilisation and perception of investment environment to a large extent determines the fundamental economic backup of the BCI.

Behaviour of Economic Indicators and Their Suggestive Impact on Share Market

Economic Indicators Situation Impact on Share Market Positive (Bullish market) Negative (Bearish market) Positive (Bullish market) Negative (Bearish market)

1. Gross Domestic Product Growth Decline 2 Inflation Constant Prices Inflationary/ deflationary prices 3 Unemployment Increase Decline 4 Individual savings Increase Decline 5 Interest rate High Low 6 Exchange rate Favourable Unfavourable 4 Domestic corporate tax Rate 8 Balance of trade High Low Positive trade Balance

Negative (Bearish market) Positive (Bullish market) Positive (Bullish market) Negative (Bearish market) Negative (Bearish market) Positive (Bullish market) Positive (Bullish market) Negative (Bearish market) Negative (Bearish market) Positive (Bullish market) Positive (Bullish market)

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Negative trade Balance

Negative (Bearish market)

Table 2.1 Economic Indicators and their impact on Stock Exchange

Chapter 3 Industry Analysis 3.1 Introduction

Irrespective of specific economic situations, some industries might be expected to perform better, and share prices in the industry may not decline as much as in other industries. This identification of economic and industry specific factors influencing
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share prices will help investors to identify the shares that fit well to individual expectations. Industry analysis is a type of business research that focuses on the status of the industry or an industrial sector (a broad industry classification like manufacturing). The industry classification is economy specific. The boundary of each industry may vary from country to country or from analyst to analyst. A complete industrial analysis usually includes a review of an industrys recent performance, its current status and outlook for the future. Many industry analyses include a combination of qualitative and statistical data. Industry classification is mostly on the basis of product offered. As per product based classification an industry is a set of business that produces similar products used by customers for similar purpose. We can define an industry broadly or narrowly, depending upon the purpose of analysis. The computer industry includes a variety of speciality areas: software, hardware, peripheral devices, as well as personal computers, servers and mainframe computers. An overly broad definition will not meet the practical needs of investment analysis, since it is very difficult to analyse all manufacturers and technologies of different types of product on a single base. The Bombay Stock Exchange Industry groups are an example of industry categorisation that is popular among the investment community. Major sub categorisations of industry groups could be as follows: Agriculture Steel Defence Electronics Retail Tourism Automobiles Chemicals Drugs FMCG Housing Telecom Banking Computer Energy Health care Infrastructure Biotechnology Construction Entertainment Food Processing Manufacturing

Financial services Real Estate

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Fertilisers Coal Hotel

Cement Machinery

Mining Petroleum

Textile Software Utilities

Paper & Printing Shipping

Investors could define their own industry classification. Usually for investment purpose, a broad category grouping competitive business might be desired by the investor. Such industry definition should include: Economic sector-manufacturing, distribution, services and so on. Products or services-a list of what is offered by the industry. Geographic scope-local, regional, national or international.

The industry definition may also include a listing of market segments. For example, a computer manufacturer may divide into four market segments: personal computers, microcomputers, mini computers and mainframes. Few competitors operate in multiple segments. There are several businesses that are engages in multi-product, multi-sector activities covering a wide geographical area. It is difficult to bring such businesses under a single sectoral classification and can rather be viewed as separate industry.

3.2 Standard Industrial Classification (SIC)

A common method of classifying businesses or industries by type is Standard Industrial Classification (SIC), commonly referred to as the SIC code. It divides virtually all economic activities that are further broken up into numbered, major groups. SIC codes get progressively more specific as the number of digits increases. A two digit SIC code indicates the broad industry category (e.g. furniture). Adding a third digit might further indicate a type of furniture (e.g. home

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furniture or office furniture). The fourth digit narrows the industry category still further (wooden household furniture or metal household furniture). As security analysts are trying to find undervalued securities or sectors, the information contained in a sector forecast is valuable. Presumably higher growth sectors will have faster earnings and cash flow growth than other sectors. Higher forecasted cash flows lower risk perception of such sectors may lead analysts to believe that their share prices or bond credit quality will have greater appreciation potential than those of other sectors. Industry analysis usually tries to find answers to the following questions: Is there a difference between the returns for alternative industries during

specific time periods?

Will an industry that performs well in one period continue to perform well in

the future? That is, can we use past relationships between the market and an industry to predict future trends for the industry? time? Industry analysis is more relevant than economic analysis since the final investment decision is to identify investment opportunities. There is a need to analyse the current status of the industry and forecast the conditions in which the business now operates or will operate in the future. There are two strong reasons to do an industry analysis. First, it provides an awareness of the market performance and ability to anticipate the future of the industry. Second, it is an important part of any companys business plan. Capital providers such as financial markets and Do companies within an industry show consistent performance over time? Are there risk differences between different industries? Does the risk for individual industries vary or does it relatively constant over

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financial institutions hence require an industry analysis before agreeing to participate in any companys capital.

3.3 The Stock Market and Business Cycle

Business cycles are observed fluctuations in the economy: economic expansion followed by economic decline (a recession or in severe case a depression) and then recovery. Business cycles are identified through changes in several economic measures, such as output, employment, stock prices, wages, spending and money supply. While examining the performance of an industry over time it is important to be aware of business cycles and how they may impact investment analysis. Especially, when deciding on choice of an industry, it is important to select that are at the same point in a business cycle. For example, analysing an industry for two years in which the company is expanding will be correct rather than examining a year of depression and year of boom. The difference arising between the comparative data are not out of industry specific reasons, but out of the inherent nature of the economy itself.

3.4 Product/Business Life Cycle

Fig 3.1 Product Life Cycle

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The concept of product cycle clearly defines the changes in growth patterns among the industries. The rise and fall in customer interest is known as the product life cycle and is depicted in fig 3.1. The introductory stage creates an interest in the product in the minds of customers. The growth stage is where product awareness spreads and customer interest shows a rise. In the maturity stage, the product acquires in the market. The saturation stage sees an almost stable situation with no new customers showing no interest in the product. The decline stage sees a withdrawal of customer interest from the product. Unless there is product modification/innovation it is difficult for the product life cycle to show an up trend from the decline stage. New products and markets emerge as industries evolve. In any stage of the business life cycle the organisation may face product life cycle. The product life cycle curve will depend on the extent of technology and innovation prevalent in the industry.

Market Behaviour and Competition over the Industry Life Cycle

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Introduction
Buyers and buyer behaviour High income purchases. convinced to buy the product. Products and product change Poor quality. Product design and development is the key. Many different product Frequent design changes. Marketing Very high advertising. Skimming price strategy. High marketing costs

Growth
Widening buyer group. uneven quality.

Maturity

Decline

Mass market. Saturation. Customers are Choosing among brands. buyers of product. the

Buyers must be Consumer accepts sophisticated or loyal Table 3.2 Table showing market behaviour Repeat buying. life cycle over industry

Products have technical and performance. Differentiation. Reliability is essential Product improvement. quality. Higher advertising, but lower percent of sales than previous phase.

Superior quality. Less product differentiation. Standardisation. Less product changes, but minor annual model

Little product differentiation.

variations. No standards. for products.

Good changes.

Market segmentation. Efforts to extend life cycle. Service and deals more prevalent. Packaging important. Advertising lower

Low advertising and marketing costs.

Manufacturing and distribution

Under-capacity. Short production runs. High skilled labour content.

Under-capacity. Shift towards mass production. Mass channels.

Optimum capacity. Increasing stability of manufacturing process. Lower labour skills. Distribution channels combine to improve their margins. High physical distribution costs. Mass channels

Substantial over capacity. Mass production. Specialised channels.

Overall strategy

Best period to increase market share. R&D technologies are key functions.

Possible to change price or quality image. Marketing is the key function. Entry. Many competitors. Lots of mergers and causalities

Marketing effectiveness, Cost control key key function. function.

Competition

Fewer companies

Price competition

Exits. Fewer competitions.

Risk

High risk

Risk can be taken here because growth covers them up.

Cyclicality sets in.

Very high risk.

Margins and profits

High prices and margins. Low profits.

High profits, highest margins, fairly high prices, but lower prices than previous phase. High P/Es.

Falling prices, lower profits, lower margins, lower dealer margins, increased stability or market share and price structure.

Low profits and margins, falling prices.

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3.5 Data Needs for an Industry Analysis

Industry analysis requires various types of quantitative and qualitative data. Though one single source for all the data need might not be found, industry association, business publication and the Department of Economic Analysis perform a comprehensive industry analysis. Suggestive though not exhaustive lists of data categories that are utilised for performing industry analysis are listed below:

Product lines Complementary products Product growth Product pattern (seasonal, cyclical) Technology of production and distribution Economies of scale Labour Logistics Product rate

3.6 Tools for Industry Analysis

Industry analysis examines the performance in terms of certain established accounting parameters, and quality grading. In other words, industry analysis involves the analysis of data in terms of:
1.

Cross sectional industry performance,

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2. 3. 4.

Industry performance over time, Difference in industry risk, Prediction about market behaviour, and

Cross-Sectional Industry Performance Cross-sectional industry performance is aimed at finding out if the rates of return among different industries varied during a given time period. Analysts usually compare the performance measured in terms of growth in sales, profits, market capitalisation and dividend of various industries. Similar performances during specific time periods for different industries would indicate that such type of industry analysis is unnecessary. As an example, assuming the market registered a growth of 10% and analysis of all industries showed a uniform growth rate of 5% to 8%, it might seem futile to find to find out an individual industry that is best performer. On the other hand, a wide variation in growth across industries, ranging from 80% to -20% to a stock market growth rate of 50%, would require the examination of those industries that contribute heavily toward a stock market up trend. Industry Performance over Time Analysts also perform a detailed exploration of industry performance over time, to identify the stage of product life cycle that the industry is expected to face. Usually time duration of 3 to 5 years is considered to determine whether that performs well in one time period would continue to perform well in subsequent time periods. In many economies, the forecast of industrial performance has been the most difficult task. The compositional change in the industry and the product definition variation, due to technological change and innovation, restrict the ability to successfully forecast the future performance of the industry. Difference in Industry Risk

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Industry analysis besides focusing on industry rate of return also has to consider industry risk measures. Industry risks specifically investigate two questions: 1. 2. Does risk differ across industries in a given time period? Are industry risks stable over time?

Risk is measured in terms of variability in returns/productive value. Business risks inherent in industries measured through the operating profit margin deviations, usually confirm a wide variation in the risk pattern of industries. Risk can also be expected to vary depending on the economic situation/expectations associated with that time duration. Stability of risk measures over time hence would examine the nature of risk. Prediction about Market Behaviour Prediction about market behaviour can be done through a qualitative assessment of strengths and weaknesses of an industry as a whole. Assessing strengths (S) and weaknesses (W) also leads to the evaluation of opportunities (O) and threats (T). this is termed as SWOT analysis. A SWOT analysis places an industry between environmental trends (opportunities and threats) and internal capabilities. SWOT analysis is equally applied in industrial analysis as well as in evaluating individual organisations. SWOT analysis involves an examination of industries Strengths (internal), Weaknesses (internal), Opportunities (external), and Threats (external). It helps to evaluate an industrys position to exploit its competitive advantage or defend against its weaknesses. Strengths and weaknesses involve identifying the industrys own (internal) abilities or lack thereof. Opportunities and threats include external situation such as competitive forces, technologies, governments regulations, domestic and international trends and so on.

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Strength is a resource or capacity the industry can use effectively to achieve

its objectives. The strengths of an industry provide a comparative advantage in the marketplace.

Weakness is a limitation, fault, defect, or defect in the industry that will keep

it away from achieving its objectives. Weaknesses result when competitors have potentially exploitable advantage over the industry. Opportunity is any favourable situation in the industrys environment. It is

usually a trend or change, or an overlooked need that increases demand for a product or service and permits the industry to enhance its position. Opportunities are environmental factor that favour the industry.

Threat is any unfavourable situation in the industrys environment that is

potentially damaging to its strategy. The threat may be barrier, constraint, or anything external that might cause problem to the industry. Threats are environmental factors that can hinder the industry in achieving its goals. In general, an effective investment strategy is one that takes advantage of the industrys opportunities by employing its strengths and ward off threats by correcting or compensating for weaknesses.

3.7 Evaluation of Indian Banking Industry 3.7.1 History of Indian Banking

Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades India's banking system has several outstanding achievements to its credit. It is no longer confined to only metropolitans or cosmopolitans in India; in fact, Indian banking system has reached even to

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the remote corners of the country. This is one of the main reasons of India's growth process. The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India. Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dial a pizza. Money has become the order of the day. Post independence In 1948, the Reserve Bank of India, India's central banking authority, was nationalized, and it became an institution owned by the Government of India. In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bank of India (RBI) "to regulate, control, and inspect the banks in India." The Banking Regulation Act also provided that no new bank or branch of an existing bank may be opened without a license from the RBI, and no two banks could have common directors. Liberalisation The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the 4-6-4 method (Borrow at 4%; Lend at 6%; Go home at 4) of functioning. In the early 1990s the then Narsimha Rao government embarked on a policy of liberalisation and gave licenses to a small number of private banks, which came to be known as New Generation tech-savvy banks, which included banks such as Global Trust Bank (the first of such new generation banks to be set up)which later amalgamated with Oriental Bank of Commerce, UTI Bank(now re-named as Axis Bank), ICICI Bank and HDFC Bank.
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3.7.2 Current Situation

Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks (that is with the Government of India holding a stake), 29 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by Investment Information and Credit Rating Agency of India Limited (ICRA Ltd.), a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.

Over the last four years, Indias economy has been on a high growth trajectory, creating unprecedented opportunities for its banking sector. Most banks have enjoyed high growth and their valuations have appreciated significantly during this period. Looking ahead, the most pertinent issue is how well the banking sector is positioned to cater to continued growth. A holistic assessment of the banking sector is possible only by looking at the roles and actions of banks, their core capabilities and their ability to meet systematic objectives, which include increasing shareholder value, fostering financial inclusion, contributing to GDP growth, efficiently managing intermediation cost, and effectively allocating capital and maintaining system stability.

3.7.3 Banking structure in India

The banking institutions in the organized sector, commercial banks are the oldest institutions, some of them having their genesis in the nineteenth century. Initially, they were set up in large numbers, mostly as corporate bodies with shareholding with private individuals. Today, 27 banks constitute a strong Public Sector in Indian Commercial Banking.
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Commercial Banks operating in India fall under different sub categories on the basis of their ownership and control over management; Public Sector Banks: Public Sector Banks emerged in India in three stages. First the conversion of the then existing Imperial Bank of India into State Bank of India in 1955, followed by the taking over of the seven associated banks as its subsidiary. Second the nationalization of 14 major commercial banks in 1969and last the nationalization of 6 more commercial Bank in 1980. Thus, 27 banks constitute the Public Sector Banks. New Private Sector Banks: After the nationalization of the major banks in the private sector in 1969 and 1980, no new bank could be setup in India for about two decades, though there was no legal bar to that effect. The Narasimham Committee on financial sector reforms recommended the establishment of new banks of India. RBI thereafter issued guidelines for setting up of new private sector banks in India in January 1993. These guidelines aim at ensuring that new banks are financially viable and technologically up to date from the start. They have to work in a professional manner, so as to improve the image of commercial banking system and to win the confidence of the public. Eight private sector banks have been established including banks sector by financially institutions like IDBI, ICICI, and UTI etc. Local Area Banks: Such Banks can be established as public limited companies in the private sector and can be promoted by individuals, companies, trusts and societies. The minimum paid up capital of such banks would be 5 crores with promoters contribution at least Rs. 2 crores. They are to be set up in district towns and the area of their operations would be limited to a maximum of 3 districts. At present, four local area banks are functional, one each in Punjab,
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Gujarat, Maharashtra and Andhra Pradesh. The South Gujarat Local Area bank is functional in Gujarat with its head office at Navsari. Foreign Banks: Foreign commercial banks are the branches in India of the joint stock banks incorporated abroad. There number was 47 as on 31.03.2011. Scheduled Commercial Banks in India: The commercial banking structure in India consists of: Scheduled Commercial Banks in India Unscheduled Banks in India Scheduled Banks in India constitute those banks which have been included in the Second Schedule of Reserve Bank of India (RBI) Act, 1934. RBI in turn includes only those banks in this schedule which satisfy the criteria laid down vide section42 (6) a) of the Act. "Scheduled banks in India" means the State Bank of India constituted under the State Bank of India Act, 1955 (23 of 1955), a subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959), a corresponding new bank constituted under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970), or under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980), or any other bank being a bank included in the Second Schedule to the Reserve Bank of India Act, 1934 (2 of 1934), but does not include a co-operative bank". "Non-scheduled bank in India" means a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank". Co-operative Banks:

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Besides the commercial banks, there exists in India another set of banking institutions called co-operative credit institutions. These have been made in existence in India since long. They undertake the business of banking both in urban and rural areas on the principle of cooperation. They have served a useful role in spreading the banking habit throughout the country. Yet, there financial position is not sound and a majority of co-operative banks has yet to achieve financial viability on a sustainable basis. The co-operative banks have been set up under various Co-operative Societies Acts enacted by State Governments. Hence, the State Governments regulate these banks. In 1966, need was felt to regulate their activities to ensure their soundness and to protect the interests of depositors. According to the RBI in March 2011, number of all Scheduled Commercial Banks (SCBs) was 163 of which, 82 were Regional Rural Banks and the number of Non-Scheduled Commercial Banks including Local Area Banks stood at 4. Taking into account all banks in India, there are overall 90,380 branches or offices, 838769 employees and 31078 ATMs. Public sector banks made up a large chunk of the infrastructure, with 87.7 per cent of all offices, 82 per cent of staff and 60.3 per cent of all automated teller machines (ATMs).

Key Players
Andhra Bank Allahabad Bank Punjab National Bank Axis Bank Kotak Mahindra Bank State Bank of India Union Bank of India HDFC Bank ICICI Bank Bank Of India

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Citibank HSBC Bank American Express Bank

Canara Bank Bank of Baroda ABN AMRO

3.7.4 SWOT Analysis of Indian Banking Industry

STRENGTH Indian banks have compared favorably on growth, asset quality and profitability with other regional banks over the last few years. The banking index has grown at a compounded annual rate of over 51 per cent since April 2001 as compared to a 27 per cent growth in the market index for the same period. Policy makers have made some notable changes in policy and regulation to help strengthen the sector. These changes include strengthening prudential norms, enhancing the payments system and integrating regulations between commercial and co-operative banks. Bank lending has been a significant driver of GDP growth and employment. The vast networking & growing number of branches & ATMs. Indian banking system has reached even to the remote corners of the country. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. WEAKNESS Public Sector Banks need to fundamentally strengthen institutional skill levels especially in sales and marketing, service operations, risk

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management and the overall organisational performance ethic & strengthen human capital.
Old private sector banks also have the need to fundamentally strengthen

skill levels. The cost of intermediation remains high and bank penetration is limited to only a few customer segments and geographies.
Structural weaknesses such as a fragmented industry structure, restrictions

on capital availability and deployment, lack of institutional support infrastructure, restrictive labor laws, weak corporate governance and ineffective regulations beyond Scheduled Commercial Banks (SCBs), unless industry utilities and service bureaus. The government has refused to dilute its stake in PSU banks below 51% thus choking the headroom available to these banks for raining equity capital. Opposition from Left and resultant cautious approach from the North Block in terms of approving merger of PSU banks may hamper their growth prospects in the medium term. OPPORTUNITY The market is seeing discontinuous growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in fee-based income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations. With increased interest in India, competition from foreign banks will only intensify.

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 Given the demographic shifts resulting from changes in age profile and household income, consumers will increasingly demand enhanced institutional capabilities and service levels from banks. New private banks could reach the next level of their growth in the Indian banking sector by continuing to innovate and develop differentiated business models to profitably serve segments like the rural/low income and affluent/HNI segments; actively adopting acquisitions as a means to grow and reaching the next level of performance in their service platforms. Attracting, developing and retaining more leadership capacity Foreign banks committed to making a play in India will need to adopt alternative approaches to win the race for the customer and build a value-creating customer franchise in advance of regulations potentially opening up post 2009. Reach in rural India for the private sector and foreign banks. The government also liberalised the ECB norms to permit financial sector entities engaged in infrastructure funding to raise ECBs. This enabled banks and financial institutions, which were earlier not permitted to raise such funds, explore this route for raising cheaper funds in the overseas markets. In an attempt to relieve banks of their capital crunch, the RBI has allowed them to raise perpetual bonds and other hybrid capital securities to shore up their capital. If the new instruments find takers, it would help PSU banks, left with little headroom for raising equity. THREATS Threat of stability of the system: failure of some weak banks has often threatened the stability of the system. Rise in inflation figures which would lead to increase in interest rates.

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 Increase in the number of foreign players would pose a threat to the Public Sector Bank as well as the private players.

Chapter 4 Company Analysis 4.1 Introduction

Analysis of company consists of measuring its performance and ascertaining the cause of this performance. When some companies have done well irrespective of economic or industry failures, this implies that there are certain unique

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characteristics for this particular company that had made it a success. The identification of these characteristics, whether quantitative or qualitative, is referred to as company analysis. Quantitative indicators of company analysis are the financial indicators and operational efficiency indicators. Financial indicators are the profitability indicators and financial position indicators analysed through the income and balance sheet statements, respectively, of the company. Operational efficiency indicators are capacity utilisation and cost versus sales efficiency of the company. These might not be revealed through financial statements, but can e inferred through the annual reports published by the company for the benefit of the investors and general public. An analysis of published statements provides an analysis of the past. Usually the formats, as published by the companies, might not be directly understandable to investors. To overcome this, the investor has to identify the factors/variables that are needed separately. To help an investor in this task, many financial magazines, newsletters, and website supply consolidated reports of the companies. Such consolidated reports would provide items such as net sales, profit before tax, and profit after tax, dividend payment, book value, liquidity position of the company, etc. Besides these, an analysis of future prospects of the company is also to be carried out. The budgets and cash flow statements gives the investor an insight into the future functioning of a company. Future profitability and operational efficiency can be worked out from these statements. Besides the quantitative factors, qualitative factors of a company also influence investment decision to a large extent. Qualitative factors are the management reputation, name of the company, operational plans of the company for the future and so on, as revealed in the auditors/directors report, as also information revealed by the management to the media. The directors report and auditors report scrutiny would help the investor in identifying the strong and weak points of

41

the company. The media reports of the company, while providing a concise view of experts as well as insider information, are questionable in terms of reliability. The most important qualitative factors of a company are management reputation and market position. Though it is difficult to measure the contribution of these factors, it is essential to know the worth of the company in terms of these aspects, since they can have a profound impact on how the company will perform in the future.

4.2 Tools for Company Analysis

Company analysis involves choice of investment opportunities within a specific industry that comprises of several individual companies. The choice of investible company broadly depends on the expectations about its future performance in general. Here, the business cycle a company is undergoing is very useful tool to assess the future performance from that company. Company analysis ought to examine the levels of competition, demand, and other forces that affect the companys ability to be profitable. Of these factors understanding the competitive factors is most important. A business faces five force of competition (Porters model); namely, sellers competition, buyers competition, competition from new entrants, exit competition, and existing competition. Competitive forces include the power of those who sell to the business, those who buy from the business, how easily the new businesses can enter into the industry, how costly it is to exit, and finally, the competition from already in the industry. How well each of these forces will determine whether the company earns above or below average profits? Each of these forces is discussed below.

4.2.1 Porters Five Force Competition Model

1. Threat of New Entrants:

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If the company is working in a niche market with high profits, there is always a threat that new competitors will enter the market. The high profit margins attract prospective players into the industry and not necessarily be interpreted as danger signals for the company. The new entry also suggests that the possibility of profits is quite high. Prospects of healthy competition stepping into the industry will lead to higher growth rates. In many instances, companies that are facing tough times are continuously on the look out for diversification/consolidation. They will be on the watch and if they see any opportunity, they will utilise it. So, company analysis will have to consider the threat from new competition and find out how safe or risk free it is from this and examine if the company can cope with such competitors. The new competitors will however face entry barriers. Determinants of Entry Barriers:
1.

Economies of Scales 3. Brand Identity 5. Capital Requirements 7. Absolute Cost Advantage 9. Government Policy

2. Product differences 4. Switching Costs 6. Access to Distribution 8. Access to necessary inputs

Barriers to an entry in banking industry no longer exist. So, lots of private and foreign banks are entering in the market. Competitors can come from any industry to disintermediate banks. Product differentiation is very difficult for banks and exit is difficult. So, every bank strives to survive in highly competitive market. So, we see intense competition and mergers and acquisition. Government policies are supportive to start a new bank. There are less statutory requirements needed to start a new venture. Every bank tries to

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achieve economies of scale through use of technology and selecting and training manpower.
2.

Threat of Substitute Products and Services:

The issue of whether the prospected goods and services are in danger and are likely to be substituted by new developed products is examined here. An indication from the market that consumers will change their preferences due to new developments is to be appraised. This indicates future business prospects as well as potential loss if the company is not flexible and is not able to adapt to changing market conditions. Determinants of Substitution Threats 1. 2. 3. Relative Price Performance of Substitutes Switching Costs Customer Propensity to Consume

Competition from the non-banking financial sector is increasing rapidly. Sony and Software giants such as Microsoft are attempting to replace the banks as intermediaries. The threat of substitute products is very high. These new products include credit unions and investment houses. One feature of using an investment house is that the fees that the investment house charges are tax deductible, where as a bank it is considered as personal expenses, which are not tax deductible. The rate of return with using investment houses is greater than a bank. There are other substitutes as well for banks like mutual funds, stocks (shares), government securities, debentures, gold, real estate etc. so, there is a high threat fro substitute.

3. Bargaining Power of suppliers:

Supplier bargaining power to a large extent determines if cost reduction is possible within an organisation. It evaluates how strong the bargaining power of the suppliers is and how it will tend to develop in the near future. If

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there is a complete competition between suppliers are likely to join the market, then there will be no risk of increasing cost of inputs. On the other hand, if there are very few suppliers then the companies might face difficulties in the future. Determinants of Supplier Power 1. Differentiation of inputs 3. Importance of volume to suppliers 5. Cost Relative to Total Purchases 7. Threat of Backward Integration Suppliers of banks are depositors. These are those people who have excess money and prefer regular income and safety. In banking industry Suppliers have low bargaining power. Following are the reasons for low bargaining power of suppliers.
a) Nature of Suppliers:

2. Switching Costs of Suppliers 4. Presence of Substitute Inputs 6. Supplier Concentration

Suppliers of banks are generally those people who prefer low risk and those who need regular income and safety as well. Bank is best place for them to deposit their surplus money. They believe that banks are very safe than other investment alternatives. So, they do not consider other alternatives very seriously, which lower their bargaining power.
b) Few Alternatives:

Suppliers are risk averters and want regular income. So, they have few alternatives available with them to invest like Treasury bills, government bonds. So, few alternatives lower their bargaining power.
c) RBI Rules and Regulations:

Banks are subject to RBI rules and regulations. Banks have to behave in the way that RBI wants. So, RBI takes all decisions relating to interest rates. This reduces suppliers bargaining power.
d) Suppliers are not Concentrated:

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Banking industrys suppliers are not concentrated. There are numerous suppliers with negligible portion to offer. So, this reduces their bargaining power. If they were concentrated then they can bargain with banks or can collectively invest in other no-risky projects.
e) Forward Integration:

Forward integration is possible like mutual funds, but only few people now about this. Only educated people can forwardly integrate where as large no. of suppliers are unaware about these alternatives.

4. Customer Bargaining Power:

The bargaining power of customers depends on the local competition, whether or not the buyers can move from one company to another or on their willingness to do so. The companys capability to withstand this shift determines the superiority position occupied by the company in the market. A company that is subject to threat from the suppliers due to the following factors faces relatively more risk. Determinants of Customer Power: 1. Bargaining Strength 3. Customer Concentration 5. Customer Volume 7. Customer Switching Costs
9. Customer Information

2. Ability to backward integrate 4. Substitute Products 6. Price Sensitivity 8. Product Quality Differences
10. Brand Visibility

Customers of the banks are those who take loans, advances and use services of banks. Customers have high bargaining power. Following are the reasons for high bargaining power of customers.
a)

Large Number of Alternatives:

Customers have very large no. of alternatives. There are so many banks, which fight for same pie. There are many non-financial institutions like ICICI, HDFC, and IFCI etc., which has also jumped into this business. There

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are foreign banks, private banks, cooperative banks and development banks together with the specialized financial companies that provide finance to customers. These all increase preferences for customers.
b)

Low Switching Cost: Cost of switching from one bank to another is low. Banks are also providing zero balance account and other types of facilities. They are free to select any banks service. Switching costs are becoming lower with Internet Banking gaining momentum and as a result consumers loyalties are harder to retain.
c)

Undifferentiated Service:

Banks provide merely similar services. There is no much difference in services provided by different banks. So, bargaining power of customers increases. They cannot be charged for differentiation.
d)

Full Information About the Market: Customers have full information about the market due to globalization and digitization consumers have become advance and sophisticated. They are aware with each market conditions. So, banks have to be more competitive and customer friendly to serve them.

5. Existing Rivalry:
Existing rivalry indicates the extent of dependence of one company on the other. Many companies are mutually dependent on each other. Many companies are mutually dependent on each other either in terms of products/customers/technology/investment etc. This relationship has to be examined to position the organisation with to others. Rivalry Determinants: 1. Company Growth 3. Intermittent Over Capacity 5. Brand Visibility 2. Fixed (or storage) Costs 4. Product Differences 6. Switching Costs

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7. Concentration 9. Diversity of competitors

8. Informational Complexity 10. Corporate Stakes

Rivalry in banking industry is very high. There are so many private, public, co-operative and non-financial institutions operating in the industry. They are fighting for same customers. Due to government liberalisation and globalization policy, banking sector became open for everybody. So, newer and newer private and foreign firms are opening their branches in India. This has intensified the competition. The no. of factors has contributed to increase rivalry those are:
a) A Large Number of Banks:

There are so many banks and non-financial institutions fighting for same pie, which has intensified competition.
b) High market growth rate:

India is seen as one of the biggest market place and growth rate in Indian banking industry is also very high. This has ignited the competition.
c) Low Switching Cost:

Customer switching cost is very low. They can easily switch from one bank to another bank and very little loyalty exists.
d) Indifference Services:

Almost every bank provides similar services. No differentiation exists. Every bank tries to copy each other services and technology, which increases the level of competition.
e) High Exit Barrier

High exist barriers humiliate banks to earn profit and retain customers by providing world-class services. f) Low government regulations:

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There are low regulation exist to start a new business due LPG policy adopted by India. So, sector is open for everybody. BARGAINING POWER OF SUPPLIERS -Low supplier bargaining power -Few alternatives available -Subject to RBI Rules and Regulations -Not concentrated -Forward integration -Nature of suppliers

THREAT OF NEW ENTRANT -Low barriers to entry -Government policies are supportive -Globalization and liberalisation policy -High exit barriers

INDUSTRY RIVARLY Intense competition Many private, public, Co-operative, foreign banks

THREAT OF SUBSTITUTES High threat from substitutes Like Mutual funds, T-bills, Government securities
.

BARGAINING POWER OF CUSTOMERS

-High bargaining power -Low switching cost -Large no. of alternatives -Homogeneous service by banks -Full information available with customers

4.2.2 Financial Statements of Companies:

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The financial statements pf the company are the base data through which company analysis is performed. Financial statements reflect the nature of business of the company. Financial statements are presented in the form of the income statement and balance sheet. The balance sheet is one of the financial statements that company prepares every year for their shareholders. It is like a financial snapshot, the companys financial situation at a moment in time. It is prepared at the year end, listing the companys current assets and liabilities. It is given in two halves-the top half shows where the money is currently being used in the business (the net assets), and the bottom half shows where that money came from (the capital employed). The value of two halves must be the same, i.e. the capital employed = net assets, hence the term balance sheet. The income statement differs significantly from the balance sheet in that it is a record of the firms trading activities over a period of time, whereas the balance sheet is the financial position at a moment in time. The income statement discloses how well a company has performed over the time period concerned. It basically shows how much the firm has earned from selling its product or service, and how much it has paid out in costs. The net of these two is the amount of profit the company has earned. The extraordinary income/expenses may include profits/loss from selling assets or parts of the company, and so on. The final retained profit figure is one that goes to the balance sheet as a source of funds for the company to use. This retained profit may be used to buy fixed assets or it may remain as current asset. The contents of the statement differ according to the nature of the business of the company. Broadly, the tolls that are used for company analysis can be

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distinguished in terms of whether they are manufacturing companies, financial service companies, trading companies or multinational companies.

4.3 Financial Evaluation of Bank of Baroda (BoB) and State Bank of India (SBI):
4.3.1 Company Profile: a. Bank of Baroda:

It all started with a visionary Maharaja's uncanny foresight into the future of trade and enterprising in his country. On 20th July 1908, under the Companies Act of 1897, and with a paid up capital of Rs 10 Lacs started the legend that has now translated into a strong, trustworthy financial body, THE BANK OF BARODA. It has been a wisely orchestrated growth, involving corporate wisdom, social pride and the vision of helping others grow, and growing itself in turn. The founder, Maharaja Sayajirao Gaekwad, with his insight into the future, saw "a bank of this nature will prove a beneficial agency for lending, transmission, and deposit of money and will be a powerful factor in the development of art, industries and commerce of the State and adjoining territories." It has been a long and eventful journey of almost a century across 25 countries. Starting in 1908 from a small building in Baroda to its new hi-rise and hi-tech Baroda Corporate Centre in Mumbai is a saga of vision, enterprise, financial prudence and corporate governance. It is a story scripted in corporate wisdom and social pride. It is a story crafted in private capital, princely patronage and state ownership. It is a story of ordinary bankers and their extraordinary contribution in the ascent of Bank of Baroda to the formidable heights of corporate glory. It is a story that needs to be shared with all those millions of people - customers, stakeholders, employees & the public at large - who in ample measure, have contributed to the making of an institution.
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Mission To be a top ranking National Bank of International Standards committed to augmenting stake holders' value through concern, care and competence.

Summary of Bank of Baroda:

Description Details

Industry House BSE Code NSE Code Incorporation Year Registered Office ISINNO Phone E-mail URL Chairman Listing

Bank Public Public 532134 BANKBARODA -07 1908 Baroda House, Mandvi, Vadodra, Gujarat, 390006 INE028A01013 91-0265-2361852 Investorservices@bankofbaroda.com www.bankofbaroda.com Shri M.D.Mallya BSE, NSE

b. State Bank of India: The State Bank of India, the countrys oldest Bank and a premier in terms of balance sheet size, number of branches, market capitalization and profits is today going through a momentous phase of Change and Transformation the two hundred year old Public sector behemoth is today stirring out of its Public Sector legacy and moving with an agility to give the Private and Foreign Banks a run for their money. The bank is entering into many new businesses with strategic tie ups Pension Funds, General Insurance, Custodial Services, Private Equity, Mobile Banking, Point of Sale Merchant Acquisition, Advisory Services,

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structured products etc each one of these initiatives having a huge potential for growth. The Bank is forging ahead with cutting edge technology and innovative new banking models, to expand its Rural Banking base, looking at the vast untapped potential in the hinterland and proposes to cover 100,000 villages in the next two years. It is also focusing at the top end of the market, on whole sale banking capabilities to provide Indias growing mid/large Corporate with a complete array of products and services. It is consolidating its global treasury operations and entering into structured products and derivative instruments. Today, the Bank is the largest provider of infrastructure debt and the largest arranger of external commercial borrowings in the country. It is the only Indian bank to feature in the Fortune 500 list. The Bank is changing outdated front and back end processes to modern customer friendly process to help improve the total customer experience. With about 8500 of its own 10000 branches and another 5100 branches of its Associate Banks already networked, today it offers the largest banking network to the Indian customer. The Bank is also in the process of providing complete payment solution to its clientele with its over 21000 ATMs, and other electronic channels such as Internet banking, debit cards, mobile banking, etc. With four national level Apex Training Colleges and 54 learning Centres spread all over the country the Bank is continuously engaged in skill enhancement of its employees. Some of the training programs are attended by bankers from banks in other countries. The bank is also looking at opportunities to grow in size in India as well as internationally. It presently has 82 foreign offices in 32 countries across the globe. It has also 7 Subsidiaries in India SBI Capital Markets, SBICAP

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Securities, SBI DFHI, SBI Factors, SBI Life and SBI Cards - forming a formidable group in the Indian Banking scenario. It is in the process of raising capital for its growth and also consolidating its various holdings. Throughout all this change, the Bank is also attempting to change old mindsets, attitudes and take all employees together on this exciting road to Transformation. In a recently concluded mass internal communication programme termed Parivartan the Bank rolled out over 3300 two day workshops across the country and covered over 130,000 employees in a period of 100 days using about 400 Trainers, to drive home the message of Change and inclusiveness. The workshops fired the imagination of the employees with some other banks in India as well as other Public Sector Organizations seeking to emulate the programme. The CNN IBN, Network 18 recognized this momentous transformation journey, the State Bank of India is undertaking, and has awarded the prestigious Indian of the Year Business, to its Chairman, Mr. O. P. Bhatt in January 2008. The elephant has indeed started to dance.

Summary of State Bank of India (SBI):

Description Details Industry Bank - Public House Government BSE Code 500112 NSE Code SBIN Incorporation 02-06 1806 Year Registered Office State Bank Bhavan, Madame Cama Marg, Nariman Point
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ISINNO Phone E-mail URL Chairman Listing

Mumbai, Maharashtra-400021. INE062A01012 91-022-22883888/22022678/22830535 investor.complaints@sbi.co.in www.sbi.co.in Shri Pratip chaudhuri BSE, NSE, Ahmedabad, Chennai, Delhi, Kolkata, London

Chapter 5: Interpretation and Analysis of Financial Statements 5.1 Analysis of Financial Statements
The banking companys predominant income is from interest; their expense is also predominantly interest expenditure. This is the basic difference between banking companies and other companies. Apart from this banking
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companies come into existence under a separate regulation, namely Banking Companies Act, 1949 while other companies are formed under the Companies Act, 1956. Financial statement analysis of banking companies should include:
I. Sustenance Ratios:

Capital to Risk Weighted Assets (CRAR) = Total Capital/Risk Weighted Assets (RWAs) Core CRAR = Tier I Capital/RWAs II. Staff Productivity: Net Total Income/Number of Employees Profit Per Employee = Net Profit/Number of Employees Business Per Employee = (Advances + of

Deposits)/Number Employees III. Asset Quality: Gross NPAs/Gross Advances Gross NPAs/Total Assets Provision for Loans Losses/Gross Advances

IV. Other Ratios:

Return on Assets (ROA):

Return on Assets (ROA) is computed as the product of the net profit margin and the total asset turnover ratios. ROA = (Net Profit/Total Income) x (Total Income/Total Assets) This ratio indicates the firms strategic success. Companies can have one of two strategies: cost leadership, or product differentiation. ROA should be rising or keeping pace with the companys competitors if the company is

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successfully pursuing either of these strategies, but how ROA rises will depend on the companys strategy. ROA should rise with a successful cost leadership strategy because of the companys increasing operating efficiency. Earnings Per Share (EPS): This determines what the company is earning for every share. For many investors, earnings are the most important tool. EPS is calculated by dividing the earnings (net profit) by the total number of equity shares. Earnings per Share (EPS) = Net Profit/Number of Equity Shares Outstanding Price/Earnings Ratio (P/E): The P/E multiplier or the price earnings ratio relates the current market price of the share to the earnings per share. Price/Earnings Ratio = Current Market Price/Earnings per share The current market price is expected to reflect the value of shares at present and when compared to the earnings per share, a low P/E multiplier has the implication that the current market price is too low for the earnings declared by the company. Many investors prefer to buy the companys share at a low P/E ratio since the general interpretation is that the market is undervaluing the share and there will be a correction in the market price sooner or later. A very high P/E ratio on the other hand implies that the companys shares are overvalued and the investor can benefit by selling the shares at this high market price. However, P/E multiplier alone will not accurately predict the future price movements of the share. Book Value per Share: The book value per share is computed as per the balance sheet of the company. The book value per share gives a historical valuation of the

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company and sometimes book value indicates the exact amount that the shareholders hold as their stake in the company. Book Value per Share = (Total Assets Intangible Assets)/Number of Shares The book value per share is sometimes referred to as the cost of assets held in the business as on a specific day. It is a more realistic measure of the under valuation/over valuation of a company in the market. The companys shares are expected to have at least the book value as a starting point. However, this measure is subject to a lot of criticism since book value is a historical accounting measure and need not necessarily reflect the true worth of the company. It is more subject to accounting policies and procedures rather than liquidation value or the true worth of the company.

Ratios Net Interest Margin (NIM) 2009 2.91%

Bank of Baroda 2010 2.74% 2011 3.12%

State Bank of India 2009 2.93% 2010 2.66%

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2011 3.32%

Capital to Risk Weighted Assets (CRAR) Core CRAR Profit Per Employee (in

14.05 8.49 6.00 914.00 1.27% 0.98% 61.14 313.82

14.36 9.20 8.00 981.00 1.64% 1.10% 83.96 378.44

14.52 9.99 11.00 1333.00 1.62% 1.18% 116.37 504.43

14.25 8.53 4.74 556.00 2.98% 1.09% 143.77 953

13.39 9.45 4.46 636.00 3.28% 0.88% 144.37 973

11.98 7.77 3.85 704.65 3.5% 0.71% 130.16 1014

Rs. Lakh) Business Per Employee (in Rs. Lakh) Gross NPA Ratio Return on Assets (ROA) Earnings Per Share (EPS) Book Value per Share

5.2 Interpretation of Financial Statements:

The NIM of State Bank of India (SBI) for the year ended March 2011 is 3.32% as against 3.12% of Bank of Baroda. The NIM is one of the tools for measuring the profitability in the banking companies.

CRAR and Core CRAR are the capital adequacy ratios which every bank has to disclose in their annual reports. The CRAR and Core CRAR are measured according to Basel I and Basel II. For our purpose we have used the Basel I disclosures of the banks.

The CRAR of Bank of Baroda was 14.52% as against of State Bank of Indias 11.98%

The Core CRAR is calculated on Tier I assets and the State Bank of India was having 7.77% as against of 9.99% of Bank of Baroda.

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 The Profit per Employee and Business per Employee are an effective measure for valuing the contribution of employees to the profitability of firm wherein both companies have fared well where the group aggregate was 1144.77 Lakh and 6.95 Lakh as Business per Employee and Profit per Employee respectively.

The Gross NPA ratio is measured by dividing Gross NPAs with the Gross Advances made by the bank over a period of time. The NPAs have a negative impact on the profitability as they are not recoverable. The public sector banks in India are facing a severe rise in the NPAs during past years. The Bank of Baroda had 1.64% which was reduced to 1.62% in the year 2011 whereas the State Bank of India, the gross NPA ratio slipped form 3.28% in 2010 to 3.5% in 2011.

The Return on Assets (ROA) of Bank of Baroda was comparatively higher than State Bank of India. The EPS of State Bank of India was higher than the Bank of Baroda where in the EPS of SBI was Rs. 130.16 as against Bank of Barodas Rs. 116.37. The Book Value per Share of Bank of Baroda was 504.43 as on 31 March, 2011 and the market price was 963.15 which was overvalued. The Book Value Per Share of State Bank of India was 1014 on 31 March, 2011 and the market price was 2767. The reason for the higher value of share prices of State Bank of India is because of its huge market share and it has dominated the banking industry from the past.

5.3

Conclusion

The share prices of Bank of Baroda and State Bank of India cannot be viewed only on the basis of their book value per share rather they are to be

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measured against Price Earnings Ratio as the Book Value per Share gives view of historical accounting basis. Hence, share prices are not affected just by the financial performance of a company; it largely depends on the other factors prevailing in the market. The share prices do not have any direction or memory, they move randomly. Therefore, with fundamental analysis technical analysis should also be considered. If fundamental analysis explained the market the market price behaviour of the company fully, then all investors would be able to quote a single price for the company.

5.4 Limitations of Fundamental Analysis

The problem with fundamental analysis is the evaluation of indicators. Economic indicators have to be compare over a period of time to assess the favourable/unfavourable climate. Industry groups are compared against other industry groups and companies against other companies. While analysing companies, usually companies are compared with others in the same industry group to identify performers. For e.g. State Bank of India with Bank of Baroda. Whereas investors in the market look across all share instruments irrespective of the company or industry or economy. The share prices are not just measured overnight, fundamental analysis requires an enquiry into the economy, industry and company. Till the time the investor could analyse and come to a decision there would have been a major change in the prices of shares.

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