Fundamental Analysis

• For estimating the price of a stock, the security
analyst must forecast the earnings and cash
flows that can be expected from the firm.
• This is primarily known as fundamental analysis.
The performance of a particular stock or
company is affected – rather determined – by
numerous factors associated with economy,
industry and the company itself.
• That is why fundamental analysis is also known
as economy-industry-company [EIC] analysis.

Fundamental Analysis
• Fundamental Analysis is to evaluate a lot
information about the past performance
and the expected future performance of
companies, industries and the economy
as a whole before taking the investment
• Such evaluation or analysis is called
fundamental analysis.

Fundamental Analysis (con’t)
• Fundamental analysis is really a logical and
systematic approach to estimating the future dividends
and share price.
• Fundamental analysis is performed on historical and
present data, but with the goal of making financial
forecasts. There are several possible objectives:
• To conduct a company stock valuation and predict its
probable price evolution, to make a projection on its
business performance, to evaluate its management
and make internal business decisions, to calculate its

Fundamental analysis Fundamental analysis includes: • Economic analysis • Industry analysis • Company analysis .

Fundamental Analysis The Analysis of economy. And can be viewed as different stages in investment decision making process. industry and company constitute the main activity in the fundamental approach to security analysis. Company Analysis Industry analysis Economy Analysis Three tier analysis depict that company performance dependent not only on its own effort but also on the general industry and economy factor. .

Economy Analysis Boom Economy: Income rise and demand for goods will increase the industries and companies in general tend to be prosperous. Recession Economy: Income decline and demand for goods will decrease the industries and companies in general tend to be bad performance .

recovery.Economy analysis (con’t) • Growth rates of national income(GRNI) • GRNI is an important variable can be calculated by GDP. . and GDP to analysis the growth rate of economy. boom and Recession.e depression. NNP. • Four stages of economy or economic cycle i. • Recession of economy of nation also impact on security performance.

. production and employment. demand pick up leading. • Boom: High demand with high investment and production. profits are also decline. companies usually reduce activities and securities performance is poor. production and activities increase. • Recovery: Economy begin to revive after depression.• Depression: At this stage demand is low and declining inflation often high and so are interest rate. companies earn more profit • Recession: Companies slowly begins downturn in demand.

high inflation impact company performance adversely.Inflation: Inflation prevailing significant impact on company performance. High inflation upset company plan. Demand goes down because purchasing power fall. Inflation is measured both in WPI (Wholesale price index) CPI (Consumer price index) .

Interest Rate Interest rates determine the cost and availability of credit for companies operating in an economy. => lower cost of finance => high profitability High interest rate => higher cost of production =>lower profitability =>Lower demand . Low interest rate=> easily and cheaply available credit.

.Government revenue. expenditure and deficit have significance impact on the performance of industries and companies. (budget deficit). most expenditure are spent on infrastructure. • The excess of expenditure over revenue is deficit. • Expenditure stimulate demand and creates job. and deficit financing fuel inflation. expenditure and deficit • Government is the largest investor in economy of any country thus revenue.

. • Depreciation of local currency improve the competitive position in foreign market the performance of exported product but it would also make the imported product more expensive. • A foreign Exchange reserves is needed to meet several commitments such as payment for import and servicing of foreign depts.Exchange rate • The balance of trade in import and export determine the rate of exchange rate.

• Development of a economy depends very much on the infrastructure available. low productivity wastages and delay.Infrastructure. Communication channels help supplier and customers. • Bad infrastructure lead to inefficiencies. . Industry needs electricity for its manufacturing activities road and railways to transport raw material and finished good. • Good infrastructure is symptoms of development. • Investors should analysis the infrastructure of any economy.

optimistic forecasting of weather condition will prosper the economy condition. • Weather forecasting becomes a matter of great concern for investor in the economy of agricultural country. the economy is also depend the performance of agriculture.Seasonal impact • Pakistani economy depends on agriculture sectors. .

Since the economies are interrelated – thus the firms across economies. or the profits it makes on investments abroad .Global Economy Global Economy: The economic analysis should start from the global economy. the international economy can affect a firm’s prospects. It affects the price competition it faces from competitors.

• At a particular point of time. there can be variations in the economic performance across countries.Global Economy contd. Fluctuations in currency exchange rate also affect the performance of companies. Similarly. . political risks can be of greater magnitude in other countries compared to domestic political environment.

. One need not be surprised about attraction of investors towards emerging economies.GDP and emerging economy • Figure 13. The emerging economies show higher growth in comparison to developed economies.1 depicts the real GDP growth of developed and emerging economies. One can see that trend is not always similar and the pattern in rate of growth is also different.

GDP Gowth .

a fund manager] can outsmart the peers in showing investment performance. the analyst [for that matter. By this.Domestic Macro Economy • An analyst should be able to forecast about domestic macro economy better than other analysts. • The key macroeconomic variables that an analyst should look at are: .

Gross Domestic Product • Measure of the economy’s total production of goods and services. Growth in GDP reflects opportunities for a firm to increase its revenue by selling more products or services. .

Monsoon and Agriculture: For agrarian economies these two factors are pertinent.Industrial Growth Rate:Although part of GDP growth. . Level of monsoon indicates the likely performance of agriculture sector. Several industries also depend on agriculture for inputs. industry growth rates indicates the activity in manufacturing sector of the economy.

• Employment and Capacity Utilization: The employment of labour as well as other factors of production [like machine capacity] indicates the level of economic activity in the country. .

there can be high inflation. When demand for products and services are higher than the productive capacity. growth and unemployment.• Price Level and Inflation: The general level of price rise is known as inflation. . The governments and monetary regulators like Reserve Bank of India try to draw a balance between inflation.

automobiles and housing are highly sensitive to interest rates. .• Interest Rates: Sectors like consumer durables. High interest rates also reduce the present value of investment.

GDP vs BSE Index .

Analysing Macro Economy Demand and Supply Shocks: The different factors that affect the macro economy can broadly be considered as demand and supply shocks. . Demand shocks are the events that affect the demand for goods and services in the economy.

reduction in tax rates can increase the disposable income of the consumers. • For example. This is expected to increase the demand for products and services. The events that influence production capacity and costs are known as supply shocks. . which in turn can lead to increase in inflation.Demand Shocks • Demand shocks are characterized by aggregate output moving in the same direction as interest rates and inflation.

Natural calamity can adversely affect the production in the economy.Supply Shocks • Supply shocks are usually characterized by aggregate output moving in the opposite direction of inflation and interest rates. thus reducing the aggregate output and increase in the cost of production and output. .

Some of the examples of demand and supply shocks are given below.• Consumers will not be willing to purchase the outputs at higher prices. Analysts need to identify industries based on the demand and supply conditions and devise the switching strategy [from one industry to another] . Overall GDP is likely to fall.


The two major demand-side policies are fiscal and monetary policies. . • Demand-side Policies are expected to stimulate the total demand for goods and services.• Government Policy: Governments and monetary authorities devise policies affecting both demand and supply conditions in the economy.

• Government has to strike the delicate balance between political condition and economic stability. Government may hesitate in curtailing the spending in social sector because of electoral compulsion .• Fiscal policy denotes the spending and tax actions of the government and is part of demand-side management.

• Increase in tax rates can decrease the disposable income of the consumers. the deficit will increase thus leading to borrowing by the government. • Without appropriate tax collection. Monetary policy intends to regulate the money supply to affect the macroeconomy. . • But the increased tax collection can facilitate greater spending by the government for the economy.

the central bank of the country. . thus inflation in long run. Expansionary monetary policy lowers the interest rate and stimulates investment and consumption demand in short run. But it can also lead to higher prices. • Fiscal policy is designed by the government while monetary policy is designed and implemented by the monetary authority i.e.• Primarily the effect of monetary policy is seen in terms of change in interest rate.

• In conclusion. indices etc. we shall discuss the tools for economic forecasting focussing more on the business cycle. In the second part of the module on Economic Analysis. . economic indicators. it is imperative for the investors and analysts to devise models to forecast the market and take investment decision or tweak the existing investments.