FUNDAMENTAL ANALYSIS

( Understanding the Broad Picture )

PART-1
Prof. Seema Chakrabarti

Economies and Markets 

A strong relationship exists between the economy and the stock market Security markets reflect what is going on in an economy because the value of an investment is determined by  its expected cash flows  required rate of return 

Economic Activity and Security Markets
Stock Market As A Leading Indicator  Stock prices reflect expectations of earnings, dividends, and interest rates  Stock market reacts to various leading indicator series  Stock prices consistently turn before the economy does

E - I - C FRAMEWORK
ER HAVE FO HA OCK RICE CHA GE A RIB E O HE FO OWI G FAC OR : y y y y ECONOMY-WIDE FACTORS : 30-35 PERCENT INDUSTRY FACTORS : 15-20 PERCENT COMPANY FACTORS : 30-35 PERCENT OTHERS FACTORS : 15-25 PERCENT CA BE

BASED ON THE ABOVE EVIDENCE, A COMMONLY ADVOCATED PROCEDURE OF FUNDAMENTAL ANALYSIS INVOLVES A THREESTEP EXAMINATION, WHICH CALLS FOR: y UNDERSTANDING OF THE MACRO-ECONOMIC ENVIRONMENT AND DEVELOPMENTS y ANALYSING THE PROSPECTS OF THE INDUSTRY TO WHICH THE FIRM BELONGS y ASSESSING THE PROJECTED PERFORMANCE OF THE COMPANY.

T E

LO AL ECONOMY

In a globalised business environment, the top down analysis of the prospects of a firm must begin with the global economy. The global economy has a bearing on the export prospects of the firm, the competition it faces from international competitors, and the profitability of overseas investors. its

T E

LO AL ECONOMY
LO AL ECONOMY EAR IN

W ILE MONITORIN T E MIND T E FOLLOWIN

‡ Although the economies of most countries are linked, economic performance varies widely across countries at any time. ‡ From time to time countries may experience turmoil due to a complex interplay between political and economic factors. ‡ The exchange rate is a key factor affecting the international competitiveness of a country¶s industries.

Central overnment Policies ‡ The overnment employs two broad classes of macroeconomic policies, viz. demand side policies and supply side policies. ‡ Traditionally, The Focus Was Mostly On Fiscal And Monetary Policies, The Two Major Tools Of Demand-side Economics. From 1980s Onward, owever, Supply-side Economics as Received A Lot Of Attention.

FISCAL POLICY
‡ Fiscal policy is concerned with the spending and tax initiatives of the government. It is the most direct tool to stimulate or dampen the economy. ‡ An increase in government spending stimulates the demand for goods and services, whereas a decrease deflates the demand for goods and services. ‡ y the same token, a decrease in tax rates increases the consumption of goods and services and an increase in tax rates decreases the consumption of goods and services.

MONETARY POLICY
Monetary policy is concerned with the manipulation of money supply in the economy. Monetary policy affects the economy mainly through its impact on interest rates. T E MAIN TOOLS OF MONETARY POLICY ARE ‡ Open Market Operation ‡ ank Rate

‡ Reserve Requirements ‡ Direct Credit Controls

Monetary Variables, the Economy, and Stock Prices 

Money supply and the economy Money supply and stock prices Excess liquidity and stock prices  

Money Supply and the Economy 

Declines in the rate of growth of the money supply have preceded business contraction. Increases in the rate of growth of the money supply have preceded economic expansions. 

Money Supply and Stock Prices
Excess Liquidity 

Excess liquidity causes interest rates to fall. Fall in the interest rates leads to encouraging investment climate. Encouraging investment climate leads to increased economic activity and capacity building and restructuring. restructuring. Economic activity leads to improvement in the stock prices.   

Money Supply and Stock Prices
Tight liquidity 

Tight liquidity leads to less money being available for the industry Causes increase in the interest rates Discourages investment climate and affects economic activity Leads to negative sentiments in the market   

Also . 

Increase in money supply puts more money in the hands of consumers Stimulates increased spending Businesses increase production Raises demand for labor and capital goods Capital markets improve    

And 

If output growth reaches capacity limits prices begin to rise Expect inflation Lenders increase the lending rates Interest rates rises Stock market turns negative    

Inflation, Interest Rates, and Security Prices 

Inflation and interest rates  generally move together  investors are not good at predicting inflation Inflation rates and bond prices  negative relationship  more effect on longer term bonds Interest rates and stock prices  not direct and not consistent  effect varies over time  

Cyclical Indicator Approach to understand the Economy 

This approach contends that the aggregate economy expands and contracts in discernable periods Cyclical indicator categories:  leading indicators  coincident indicators  lagging indicators 

Cyclical Indicator Categories 

Leading indicators Economic series that usually reach peaks or troughs before corresponding peaks or troughs in aggregate economy activity Coincident indicators Economic series that have peaks and troughs that roughly coincide with the peaks and troughs in the business cycle 

Cyclical Indicator Categories 

Lagging indicators Economic series that experience their peaks and troughs after those of the aggregate economy Other series Economic series that do not fall into one of the three main groups 

Lead Indicators 
     

Manufacturers order book Capital goods order book Index of stocks Money Supply Interest Rate Spreads Consumers Business Confidence Index Unemployment rate

Coincident Indicators 
  

IIP Corporate earnings Employees payrolls Inflation

Lag indicators 
 

Credit expansion Bank PLR Inventories to sales

MACRO ECONOMIC ANALYSIS
E MACROECONOMY IS E O ERALL ECONOMIC IC ALL IRMS O ERA E E EY EN IRONMEN IN ARIA LES COMMONLY SE O ESCRI E ES A EO E MACROECONOMY ARE y y y y y y y y GROWTH RATE OF GROSS DOMESTIC PRODUCT INDUSTRIAL GROWTH RATE AGRICULTURE AND MONSOONS SAVINGS AND INVESTMENTS GOVERNMENT BUDGET AND DEFICIT PRICE LEVEL AND INFLATION INTEREST RATES BALANCE OF PAYMENT, FOREX RESERVES, AND EXCHANGE RATE y INFRASTRUCTURAL FACILITIES AND ARRANGEMENTS y SENTIMENTS

Industry Analysis
Approaches to industry analysis: 

Sensitivity to business cycle Study of structure & characteristics of the industry Industry Life cycle Profit potential of industries : Porter model   

Industry Analysis 

SENSITIVITY TO BUSINESS CYCLE is determined by: Sensitivity of Sales Operating Leverages Financial Leverage Study of structure & characteristics of the industry Structure of the industry & nature of competition Nature & prospects of demand Cost, Efficiency & Profitability Technology & Research 

INDUSTRY ANALYSIS 
INDUSTRY LIFE CYCLE ANALYSIS ‡ PIONEERIN STA E ‡ RAPID ROWT STA E ‡ MATURITY & STA ILIZ¶N STA E ‡ DECLINE STA E 
PROFIT POTENTIAL OF INDUSTRIES ‡ FORCES DRI IN COMPETITION PORTER MODEL
POTENTIAL ENTRANTS AR AININ SUPPLIERS POWER OF SUPPLIERS TREAT OF NEW ENTRANTS INDUSTRY AR AININ RI ALRY UYERS AMON POWER OF FIRMS UYERS

T REAT OF SU STITUTE PRODUCTS SU STITUTES

INDUSTRY ANALYSIS 
INDUSTRY LIFE CYCLE ANALYSIS ‡ PIONEERIN STA E ‡ RAPID ROWT STA E ‡ MATURITY & STA ILIZ¶N STA E ‡ DECLINE STA E 
PROFIT POTENTIAL OF INDUSTRIES ‡ FORCES DRI IN COMPETITION PORTER MODEL
POTENTIAL ENTRANTS AR AININ SUPPLIERS POWER OF SUPPLIERS TREAT OF NEW ENTRANTS INDUSTRY AR AININ RI ALRY UYERS AMON POWER OF FIRMS UYERS

T REAT OF SU STITUTE PRODUCTS SU STITUTES

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