Company Analysis

The focal point of Company Analysis is the relationship of

revenues and expense to the economic and industry
changes, and the resulting earnings of the company.

It helps the analyst work with interrelationships to

evaluate performance of the company and understand the
chemistry of earnings and then to form expectations
about its level, trend and stability of earnings, dividends
and stock prices.
Evaluating Performance of A Company

 Stability of Earnings: EPS over 10-year period can be

compared with most recent 3-year average EPS.
 Growth of EPS: Can be compared with market index as
a whole.
 Profitability: Straight Profitability, Profit per rupee of
sales and Operating income as % age of sales.
 History of Dividend Payment: Uninterrupted,
preferably fixed ratio of earnings with study growth.
 Price history of the company.
 Information for Company Analysis

 Internal: From annual reports and public

and private statements of officers and
managers.
 External (As supplement to Internal
Sources): Not found in internal source and
used to overcome biases in company
generated information.
Approaches to Company Analysis

 Ratio Analysis Approach

 Market Share/Profit Margin Approach

 Financial Statement Analysis Approach

 Ratio (ROTA) Analysis
ROTA = OPM  TATR
Where,
OPM = Operating Profit Margin
TATR = Total Assets Turnover Ratio
 
The drivers of profit margin are the cost items in
P&L account
 
The drivers of TATR are different assets in the
balance sheet
 Ratio (ROE) Analysis

ROE = PAT/ Sales × Sales/ TA

× TA/NW
= PAT/PBT × PBT/PBIT ×
PBIT/Sales × Sales/TA ×
TA/NW
 Precautions in Using Financial
Ratios
 Most Ratios have been intuitively designed
without a theoretical framework
 We should consider window dressing and
historical values in Financial Statements
 Multiple Accounting Policies should be kept in
mind
 Many ratios are correlated. This calls for use of
few selected ratios
 Beware of situations where ROTA like ratios are
high. This may mean both ways.
 Market Share/Profit Margin
Approach
EPS = (Si × Mc × fc) / Nc
Market Share depends on historical market
share, any significant steps being taken,
current market share and average of last few
years.
NPM depends on current NPM, Average of last
few years and any significant changes
anticipated in efficiency, leverage and tax
rate.
 Financial Statement Analysis
Approach

EPS = [(EBIT – iD) (1-T) – dP] / N

= [{r (A) – iD} (1-T) – dP] / N
= [{r (NW + P + D) – iD} (1-T) – dP]/ N
= [NW { r (1 + P/NW) + D/NW (r-i) }
(1-T) – dP] / N
 Illustration
You are analyzing the shares of two companies Crude Oil and
EZ Software. Selected information is given below:
C. Oil EZ Software
CMP Rs.20.00 Rs.40.00
Current Ratio 3.20 1.50
Estimated EPS Re.1.00 Rs.4.00
Fixed/Total
Operating Costs 0.40 0.80
Exp. Growth 0.15 0.12
Beta () 1.10 1.60
Estimated DPS 0.00 Rs.0.80
Assets/Equity 1.20 2.00
Shares O/S 50 lakhs 400 lakhs
It is estimated that the share price after 1 year for Crude Oil will be either
Rs.19 or Rs.25 and for EZ Software, either Rs.36 or Rs.50, each being
equally likely. How can one account for difference in P/E for two shares?
Which is a better investment choice for one holding period?