Financial Analysis and

Valuation
Introduction:
• Investments in capital markets primarily involve
transactions in Shares, bonds, debentures and other
financial products issued by companies. The decision to
invest in these securities is thus linked to the evaluation
of these companies, their earnings and potential for
future growth. The fundamental valuation of any asset is
an examination of future returns i.e. the cash flows
expected from the asset. The value of the asset is
therefore present discounted value of future cash flows. It
is all about how well we predict these cash flows, their
growth in future, taking into account future risks
involved.
Analysis of Financial Statements
• A Company’s financial statements provide the most accurate
information to its management and shareholders about its
operations, efficiency in the allocation of its capital and its earning
profile. Three basic accounting statements forms the backbone of
financial analysis of a company namely:-
• a. Income Statement (Profit & Loss)
• b. Balance Sheet
• c. Statement of Cash Flow
Income Statement (profit & Loss)
• A Profit & Loss statement provides an account of the total revenue generated
by a firm during a period, the expenses involved and the money earned.
Operating expenses include the costs of these goods and services and the
costs incurred during the manufacture. Beyond operating expenses are
interest costs based on the debt profile of the company. Taxes payable to the
Government are then debited to provide the Profit after tax or the net Income
to the Shareholders of the company.
STATEMENT OF PROFIT AND LOSS
Name of the Company_____________
Profit and Loss statement for the year ended______ Rupees in _____________

Particulars Note no.. Figures (Current Figures (Last

year) year)
I. Revenue from Operations

II. Other Income (interest received from investments, rent received, etc.)

III. Total Revenue (I + II)

IV. Expenses

a. Cost of Materials Consumed

b. Purchases of Stock in Trade

c. Changes in inventories of finished goods, WIP and Stock in Trade

d. Employee benefit expenses (Salaries paid, contribution towards

provident funds, employee welfare expenses etc)
f. Finance costs

g. Depreciation and amortization expenses

h. Other expenses (Administration, Selling,)

Total Expenses
Particulars Note no.. Figures Figures
(Current year) (Last year)

V. Profit before Exceptional and Extraordinary items and Tax (III – IV)

VI. Exceptional items (profit/loss on disposal of FA, settlement of

insurance claim etc.)
It arises from ordinary activity of the business but are non-
recurring in nature)
VII. Profit before Extraordinary items and Tax (V – VI)

VIII. Extraordinary Items (distinct from ordinary business, non-

recurring, sale in subsidiary and associated company, change in
govt. policy, discontinuance of business segment)
IX. Profit Before Tax (VII – VIII)

X. Tax Expense:
a. Current tax
b. Deferred tax

XV. Profit or Loss for the period

Earnings Per Share

The Balance Sheet
• Assets owned by a company are financed either by equity or debt and the
balance sheet of a company is a snapshot of capital structure of the firm
at a point in time. A company owns fixed assets (machinery and other
infrastructure), current assets (manufacturing goods in progress, money
it expects to receive from debtors, inventory etc), cash and other
financial investments. In addition, a company could also own other
assets which carry value, but are not directly marketable like patents,
trademarks and goodwill. These tangible and intangible assets are
financed either by the company’s equity or by debt.
 Statement of Balance Sheet
Name of Company___________________________
Balance Sheet as at___________ Rupees in __________________
Particulars Note no.. Figures Figures (Last
(Current Year) year)

I. EQUITY AND LIABILITIES

1. Shareholder’s Funds
a. Share Capital
b. Reserves & Surplus
c. Money received against share warrants
2. Share application money pending allotment
3. Non-Current Liabilities:
a. Long term Borrowings
b. Deferred tax liabilities (provision for future tax payments arising
due to depreciation methods)
c. Long term Provisions (gratuity, leave encashment, provident
fund etc)
4. Current Liabilities: (less than 12 months)
a. Short term borrowings
b. Trade payables
c. Other Current Liabilities
d. Short term Provisions
TOTAL
Particulars Note no.. Figures (Current Year) Figures (Last
year)

II. ASSSETS
1. Non-Current Assets:
a. Fixed Assets
i. Tangible assets
ii. Intangible assets
iii. Capital Work-In –Progress
iv. Intangible Assets under development
b. Non-Current Investments
c. Deferred tax asset
d. Long term loans and advances
e. Other non-current assets

2. Current Assets
a. Current Investments
b. Inventories
c. Trade Receivables
d. Cash and Cash Equivalent
e. Short term loans and advances
f. Other Current Assets
TOTAL
Cash Flow Statement
• The Cash flow statement is the most important among the three financial statements, particularly
from a valuations perspective. It is used to track the cash flows in the company over a period. Cash
flows are tracked across Operating, investing and financing activities. Cash flow from operations
include net income generation adjusted for changes in working capital (like inventories, receivable
and payables) and non-cash transactions (like depreciation, provision for dividend, provision for
tax etc.). A Firm’s Investment activities comprise buying and selling of fixed assets, long term
Investments etc. and generally represents negative cash flows. Whereas Cash Flows in financing
activities are the net result of the firm’s borrowing and payments during the period. The sum total
of cash flows from these three heads represent the net change in cash balances of the firm over
period.
CASH FLOW STATEMENT
Particulars Amount
Cash Flow from Operating Activities :
a. Reported Net Income
(+ / -) Adjustment of non-cash exps, losses, Income and gains
Changes in working capital
(-) tax paid
Cash flow from Operations (I)
Cash flow from Investing Activities:
a. Sale of Fixed Asset or investment
b. Purchase of Fixed Asset or Investment
Cash flow from Investments (II)
Cash flow from Financing Activities:
a. Issue of Share Capital
b. Redemption of Share capital
c. Payment of dividend, Interest etc.
d. Interest received from Investments.
Cash flow from Finance (III)
Net Cash Inflow or Outflow (I + II + III)
(+) Opening Cash
= Closing Cash
 Financial Ratios
• Financial ratios are meaningful links between different entries of
financial statements. In addition to providing information about the
financial health and prospects of a company, financial ratios also allow
a company to be viewed in comparison with its own historical
performance, or between any two companies in general.
• Profitability ratios
• Liquidity ratios
• Solvency ratios
• Operating performance ratios
• Asset Utilization ratios
Profitability ratios:
• The Profitability ratios help the analyst measure the profitability of
the company. The ratios convey how well the company is able to
perform in terms of generating profits. Profitability of a company also
signals the competitiveness of the management. As the profits are
needed for business expansion and to pay dividends to its shareholders
a company’s profitability is an important consideration for the
shareholders.
• Return on Assets - it denotes firm’s ability to generate profit on assets. ROA gives a
manager, investor, or analyst an idea as to how efficient a company's management is at using its
assets to generate earnings.
• ROA = Net Profit after tax + Net Interest paid * 100
Average Total assets
Cont..
• Return on Equity (ROE):- return to the Equity shareholders.
• ROE = Net Income after tax
• Shareholders Fund
• Return on Average Equity (ROAE) = to account for recent capital
raising by the firm:
• ROAE = Net Income after tax
• Average Shareholder’s funds

• Return on Total Capital = NPAT + Net Interest

• Average Total capital
Q1.A Company has opening Equity Share capital of Rs 5,00,000 and closing share capital of Rs 7,80,000.Net Profit before tax for the year is Rs 90,000. Tax is deducted @ 30%. The company has issued 12% debenture of Rs 2,00,000 in the current year. Opening balance of Total assets is Rs
5,50,000 and Closing balance is Rs 8,00,000. Find Return on Assets, Return on Equity, Return on Average Equity.

• RoA = Net Profit After Tax + Net Interest * 100

Average Total Assets
ROA = (63,000 + 16,800) * 100 = 11.82%
6,75,000
ROE = NPAT = 63,000 * 100 = 8.08%
Shareholders fund 7,80,000

ROAE = NPAT = 63,000 * 100 = 9.84%

Avg Shareholders Funds 6,40,000
Liquidity Ratios
• Current Ratio = Current Assets / Current Liabilities

• Quick ratio = Current Assets – Stock – Prepaid expenses

Current Liabilities

• Acid test ratio or Cash ratio = Cash + Marketable Securities

Current Liabilities
Capital Structure and Solvency Ratios
• The Leverage ratios also referred to as solvency ratios/ gearing ratios
measures the company’s ability (in the long term) to sustain its day to day
operations. Leverage ratios measure the extent to which the company uses
the debt to finance growth. Remember for the company to sustain its
operations, it has to pay its bills and obligations. Solvency ratios help us
understand the company’s long term sustainability, keeping its obligation in
perspective.

• Total debt to Total Capital = (Current Liabilities + long-term Liabilities)

• (Equity + Long term Liabilities)

• Long term Debt – Equity = Long term Liabilities

• Equity
Operating Performance
• Gross profit margin = Gross Profit
• Net Sales
• Operating Profit Margin = Operating income
• Net Sales

• Net profit Margin = Net Income

• Net Sales
Asset utilization ratios
• Inventory Turnover ratio = COGS / Average Inventory
• Working Capital Turnover ratio = Sales / Working Capital
• Total Assets Turnover = Net Sales
• Average Total Assets

• Fixed Asset Turnover = Net Sales

• Average Net Fixed Assets
 Valuation of Common Stocks
• Common stock valuation is the process of determining the value of a
share or stock in a company. The holder of one share in a company
that has one million shares outstanding is actually the owner of one-
millionth of the company; the value of that share should represent that
percentage of the company's worth. Stock valuation is typically done
using one of two basic approaches. The first is based on looking at
fundamentals such as discounted cash flow and earnings analysis.
This is similar to bond valuation, but the cash flows are more
difficult to predict making stocks a riskier investment. The second
is by studying market conditions — supply of and demand for the
stock and general trends of the financial markets.
Absolute (intrinsic )Valuation
• Intrinsic Value or the fundamental value refers to the value of a security, which
is intrinsic to or contained in the security itself. It is defined as the present
value of all expected cash flows to the company. Absolute value, also known
as an intrinsic value, refers to a business valuation method that uses discounted
cash flow (DCF) analysis to determine a company's financial worth. The
absolute value method differs from the relative value models that examine
what a company is worth compared to its competitors. Absolute value models
try to determine a company's intrinsic worth based on its projected cash flows.
Discounted Cash Flows
• The discounted cash flow method values the share based on the expected
dividends from the shares. The price of a share according to the discounted cash
flow method is calculated as under:
• Po = ∑ Div t

• ( 1 + r)t

• Since the profit of the firm are not certain, the actual future dividends are not known in advance.
However the market forms an expectation of the future dividends and the value of a share is the
present value of expected future dividends of the company.
Cont.. Constant Dividend Growth (also known as Gordon Growth Model)
• The Gordon Growth Model (GGM) is used to determine the intrinsic value of a
stock based on a future series of dividends that grow at a constant rate. It is a
popular and straightforward variant of a dividend discount model (DDM). The
Gordon Growth Model values a company's stock using an assumption of constant
growth in payments a company makes to its common equity shareholders. The
three key inputs in the model are dividends per share, the growth rate in dividends
per share, and the required rate of return.
• Dividends (D) per share represent the annual payments a company makes to its
common equity shareholders, while the growth rate (g) in dividends per share is
how much the rate of dividends per share increases from one year to another. The
required rate of return (r) is a minimum rate of return investors are willing to
accept when buying a company's stock, and there are multiple models investors
use to estimate this rate.
Cont..

• The Gordon Growth Model assumes a company exists forever and pays dividends per
share that increase at a constant rate. The growth in the future dividend arises because
the firms, instead of distributing 100% of the earnings as dividends, plowbacks and
invests certain portion of the current year profit on projects whose yield will be greater
than the market expected rate of return.
• Growth rate in dividend = Plowback ratio * ROE

• The GGM attempts to calculate the fair value of a stock irrespective of the prevailing
market conditions and takes into consideration the dividend payout factors and the
market expected returns. If the value obtained from the model is higher than the current
trading price of shares, then the stock is considered to be undervalued and qualifies for a
buy, and vice versa.
Sum
• RNL has paid a dividend of Rs 10 per share last year (D0) and it is
expected to grow at 5% every year. If an investor’s expected rate of
return from RNL share is 7%, calculate the market price of the share
as per the dividend discount model.
• Po = Div1
• r–g
• Given Info = Do = 10, Therefore D1 = 10 * 1.05 = 10.50 (as growth rate is 5%), r (expected rate of
return) = 0.07, g (growth rate) = 0.05

Po = 10.50 = Rs 525
0.07 – 0.05
Cont..
• If we know the market price of the share, the dividend amount and the
dividend growth rate, then expected rate of return can be found out.
• r = Div1 + g
• Po
• What will be the value of r if market price of the share as per the dividend
discount model is Rs 560 :- Do = 15 Rs, growth rate (g) = 7%, expected return.
• => r = 16.05 + 0.07
• 560
• r = 0.028 + 0.07 => 0.098 or 9.8%
Extra Sums:-
• Avenue Supermart Ltd has paid a dividend of Rs 8 per share last year (D 0)
and it is expected to grow at 7% every year. If an investor’s expected rate
of return from RNL share is 10%, calculate the market price of the share as
per the dividend discount model.
• (Rs 285.33)
• ITC had paid dividend of 575% on its Face Value of Re 1 last year and it is
expected to grow at 11.65% every year. If an investor’s expected rate of
return is 15%, calculate the market value of the share as per the dividend
discount model.
• (Rs 191.64)
• Crisil Ltd paid dividend of 600% on its Face value of Re 1 last year and it
is expected to grow at 13.50% every year. If the market value of the share
is Rs 1767, what should be Investor’s expected rate of return?
• ( r = 13.88%)
Present Value of Growth Opportunities (PVGO)
• Value of the Shares as computed in the constant growth model can be
divided into two parts – present value of share assuming level stream
of earning (current income extrapolated into the future, with no
growth, in which case there is no need to retain any of the earnings)
and the present value of growth opportunities. The value of growth
opportunities is positive if the firm and the market believes that the
firm has avenues to invest which will generate a return that is more
than the market expected rate of return. Now when the firm’s income
potential from additional investment is more than the market expected
rate of return, then for every penny re-invested will generate a return
that is higher than the market expectation. The value of such excess
return is referred to as present value of growth opportunities.
Cont..

PVGO = Share Price – Earnings Per Share

r

No.. Name of the Current EPS R ( expected PVGO

Company Market Price rate of return)

1. Reliance Rs 1992 Rs 42.09 0.09 Rs 1524.33

Industries

2. Britannia Rs 3722 Rs 71.40 0.09 Rs 2929

Industries

3. HDFC Bank Ltd Rs 1411 Rs 51.78 0.09 Rs 836

4. CEAT Ltd Rs 1115 Rs 67.60 0.09 Rs 751.11

 VALUATION OF FIRM
(Intrinsic Value of Stock using DCF for the Company )
Free Cash Flow to Firm (FCFF)
• FCFF, or Free Cash Flow to Firm, is the cash flow available to all
funding providers (debt holders, preferred stockholders, common
stockholders, convertible bond investors, etc.). This can also be
referred to as unlevered free cash flow, and it represents the surplus
cash flow available to a business if it was debt-free.

• FCFF = EBIT*(1 – Tax Rate) + D&A – Δ Net WC – CAPEX

• Where: 
EBIT = Earnings before Interest and Tax ,
• D&A = Depreciation and Amortization
• CAPEX = Capital Expenditures
• Δ Net WC = Net Change in Working capital
WACC Formula

• WACC = Equity * Ke + Preference Capital * Kp + Debt * Kd

• Total Capital Total Capital Total Capital

• Ke = Div1 * 100 or Ke = Rf + β (RM – Rf)

• CMP
Value of the Firm (Vo)
• V0 = FCFF1 + FCFF2 + FCFF3 + ………+ FCFFN + (Terminal Value N)
• 1 + rWACC (1 +rWACC)2 (1 +rWACC)3 (1 +rWACC)N (1 +rWACC)N

• When building a Discounted Cash Flow / DCF model there are two major components: (1) the forecast period
and (2) the terminal value. The forecast period is typically 3-5 years for a normal business because this is a
reasonable amount of time to make detailed assumptions.  Anything beyond that becomes a real guessing game,
which is where the terminal value comes in.

• The terminal value at year N is often compounded assuming that the FCFF will grow at a constant growth rate beyond year
N ie.
• Terminal ValueN = FCF N+1 = FCF* (1 + g FCF )
• ( rWACC – gFCF ) ( rWACC – gFCF )

• Terminal value is the estimated value of a business beyond the explicit forecast period
• Where gCF is the expected growth rate of the firms free cash flow.
Valuation of a Firm (Discounted Free Cash Flow) valuation models
Price of the Share (Po) = **Market Value of Equity
No.. Of Shares outstanding

**Market Value of Equity = Value of the firm + Cash in hand – Value of Debt
It is easy to calculate the debt value since the payments to be made to debt holders is
predetermined and certain. However the real problem with determining the value of the
firm. As per the discounted free cash flow model, the value of the firm is the present
value of the future free cash flow of the firm. The discounting rate is the firms weighted
average cost of capital (WACC) and not the market expected rate of return on equity
investment. WACC is the cost of capital that reflects the risk of the overall business and
not the risk associated with the equity investment alone.
Relative Valuation
• Relative valuation models do calculate the share price but they are
generally based on the valuation of comparable firms in the industry. It
compares the company’s value to that of its competitors, industry
average or historical performance to find the company’s financial
worth. Mostly this model is used for evaluation purpose as to whether
a particular stock is overvalued or undervalued and less for actual
valuation of the shares. Tools used by relative valuation are:
• Earnings per Share (EPS)
• = Net Profit – Dividend on Preference Share
Average number of Shares outstanding during the year
Cont..

• Dividend Per Share = Total Dividend

• No.. Of Shares outstanding

• Dividend payout ratio = Dividend Per share

• Earnings Per Share

• Retention ratio = ( 1 – DPR)

Sum:-
• Following is the figure for Asha International during the year 2018-19:
• Net Income = Rs 10,00,000
• No.. Of Equity Shares (2018) : 1,50,000
• No.. Of Equity Shares (2019) : 2,50,000
• Dividend paid : Rs 4,00,000
• Calculate EPS, DPS, DPR and Retention ratio.
Solution:
• Average no.. Of equity shareholders = opening + closing /2
• = 1,50,000 + 2,50,000 / 2
• = 2,00,000
• EPS = NI / No of equity shareholders = 10,00,000 / 2,00,000 = Rs 5

• DPS = Total Dividend / No.. Of equity shares = 4,00,000 / 2,00,000 = Rs 2

• DPR = DPS / EPS = 2/5 = 0.4 or 40%

• Retention ratio = 1 – DPR = 1 – 0.4 = 0.6 or 60%

• Following is the figure for Aman Industries Ltd during the year 2018-
19:
• Net Income = Rs 15,00,000
• No.. Of Equity Shares (2019) : 2,00,000
• No.. Of Equity Shares (2020) : 3,50,000
• Dividend paid : Rs 6,50,000
• Calculate EPS, DPS, DPR and Retention ratio.
Solution
• Average no.. Of equity shareholders = opening + closing /2
• = 2,00,000 + 3,50,000 / 2
• = 2,75,000
• EPS = NI / No of equity shareholders = 15,00,000 / 2,75,000 = Rs 5.45

• DPS = Total Dividend / No.. Of equity shares = 6,50,000 / 2,75,000 = Rs 2.36

• DPR = DPS / EPS = 2.36/5.45 = 0.433 or 43.3%

• Retention ratio = 1 – DPR = 1 – 0.433 = 0.567 or 56.7%

Cont..
• Price – earnings ratio (P/E):
• P/E ratio = Market price per share / Earnings per share
• The EPS is usually last one year’s earnings, but sometimes PE ratio is also
calculated using expected future one year return which is called as Forward
PE or Estimated PE.
• Price – Book ratio
• The price-to-book, or P/B ratio, is calculated by dividing a company's
stock price by its book value per share, which is defined as its total assets
minus any liabilities.
• PB ratio = Market price of the share / Book Value per Share
• Company can increase BVPS by Repurchase common stocks.
• One of the main ways of increasing the book value per share is to buy back
common stocks from shareholders.
• Second way is to Increase assets and reduce liabilities.
Cont..

• Return on Equity = NPAT – PD / Average Equity Shareholders

• Sum:
• XYZ company NPAT was Rs 10 mn and equity share capital was Rs
80mn and Rs 120mn for the years 2017 and 2018 resp. calculate ROE.

• ROE = 10 – 0 = 10%
• 100
Cont..
• DuPont Model:- Returns on Shareholder equity are expressed in
terms of a company’s profit margins, asset turnover and its financial
leverage.
• ROE = Net Profit * Sales * Assets
• Sales Assets Equity
= Profit margin * Asset turnover * Financial Leverage
The first component measures the operational efficiency of the firm
through its net margin ratio. The second component measures the
efficiency in usage of assets by the firm and the third component
measures the financial leverage of the firm. It Shows that the firm could
improve its ROE by a combination of profitability, raising leverage, by
using its assets better or a combination of all three.
Sums on DuPont Analysis
• XYZ Ltd has Total Share Capital of Rs 1 Crore and the Debt on the
Company is Rs 40 Lacs. The company made Sales of Rs 50 lakhs in
the current year and its Net Profit is Rs 15 Lakhs. Average Total Assets
of the company for the year is Rs 80 Lakhs. Find out ROE and show
its breakup with the help of DuPont Analysis.
• ROE = NPAT / Equity Share Capital * 100 => 15 / 60 * 100 = 25%
• As per Dupont Model
• ROE = Profit Margin * Asset Turnover * Trading on Equity
• = 30% * 0.625 * 1.33
• = 24.93% or 25%
Extra Sum:-
• Seema Ltd has Total Share Capital of Rs 1.5 Crore and the Debt on the
Company is Rs 80 Lacs. The company made Sales of Rs 80 lakhs in
the current year and its Net Profit is Rs 25 Lakhs. Average Total Assets
of the company for the year is Rs 90 Lakhs. Find out ROE and show
its breakup with the help of DuPont Analysis.
• Solution:
• ROE = 35.71%
• ROE = Profit Margin * Asset Turnover * Trading on Equity (Financial
Leverage)
= 31.25% * 0.8888 * 1.285
= 35.60%
Cont..
• Dividend Yield = Last year dividend / Current Price per share
• Return to Investor = Dividend + capital appreciation or depreciation
• Expected return (r) = Dividends + ∆ market price of share
• opening market price for the year
• Sum:
• The Share price of PQR Ltd on 1st April 2018 and 31st March 2019 is
Rs 80 and Rs 84 resp (which is also Current Market Price). The
company paid a dividend of Rs 6 for the year 2018-19. calculate the
Dividend Yield and Expected Return for a shareholder of PQR
company in the year 2018-19.
• Dividend Yield = 6 / 84 => 0.07 or 7%
• Expected Return = (6 + 4) / 80 * 100 = 12.5%
Extra Sums:

• The Share price of MMM Ltd on 1st April 2019 and 31st March 2020 is
Rs 150 and Rs 385 resp (which is also Current Market Price). The
company paid a dividend of Rs 5.5 for the year 2019-20. calculate the
Dividend Yield and Expected Return for a shareholder of MMM
company.
• Dividend Yield = 1.43% , Expected Return = 160%
• The Share price of ABC Ltd on 1st April 2019 and 31st March 2020 is Rs
105 and Rs 75 resp (which is also Current Market Price). The company
paid a dividend of Rs 7.5 for the year 2019-20. Calculate the Dividend
Yield and Expected Return for a shareholder of ABC company.
• Dividend Yield = 10%, Expected Return = -21.43%
Technical Analysis
• Technical analysis involves making trading decisions by studying
records or charts or past stock prices and volume. The technical
analyst do not attempt to measure a security’s intrinsic value but
believe in making short term profit by analyzing the volume and price
patterns and trends. They use statistical tools like trend analysis,
relative strength index, moving averages, regressions, price
correlations etc. It is based on main 3 assumptions:
• The market discounts everything:- Technical analyst believe that the
market price takes into consideration the intrinsic value of the stocks
along with broader economic factors and the market psychology.
Therefore what is important is an analysis of the price movement that
reflects the demand and supply in the short run.
Cont..
• Price moves in trends: trends are of three types, viz. uptrend, downtrend and
horizontal trend. Analyst believe that once trends are established in the prices, the
price moves in the same direction as the trend suggest.
• History tends to repeat itself: this assumption leads to a belief that current
investors repeat the behavior of the investors that preceded them and therefore
recognizable price patterns can be observed if a chart is drawn.
• Important concepts in Technical Analysis:-
• Support price: refers to the price level through which a stock price rarely falls.
• Resistance: price level through which a stock rarely outperforms.
• Breakout: situation when the price actually falls below the support level or rises
above the resistance level
• Once a breakout occurs, the role is reversed. If the price increases beyond the
resistance level, the resistance level becomes the support level and when the price
falls below the support level, the support level becomes the new resistance level.
• Momentum: refers to the rate at which price of a stock changes.