Ch 6 Fundamental Analysis_2

7/29/2019 Ch 6 Fundamental Analysis_2

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FUNDAMENTAL ANALYSIS

The are three stages in the FundamentalAnalysis

1. Economic analysis2. Industry analysis

3. Company analysis


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ECONOMIC ANALYSIS

- What to buy and sell will also depend on the fair valueof a share and the extent of overvaluation andundervaluation.

- As per research studies available so far, nearly 50%of

the stock price changes can be attribute to marketinfluence which are general and are caused by theeconomic & industry factor.

1. Cost Benefit Analysis

- The major costs are the risk involved and majorbenefits are the returns involved.

- The costs are the expenses to be incurred in acquiringthe assets say registration brokerage charged etc.


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- Uncertainties and risks involved due to possible nonpayment of interest or dividend or capital loss etc

- Benefits capital appreciation, safety and security offunds, marketability and liquidity of investment.

2. Environmental Consideration- Rural side people are not more aware about corporate

securities they purchase real assets gold etc

- Urban metropolitan centre is different they are invested

in consumer durable, mutual fund, corporate securitiesother instrument

3. Tax planning in investment mngt.

ECONOMIC ANALYSIS


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- Income tax = interest & dividend income up to Rs.2500is not subject to TDS

- Wealth tax = Investment in shares & debenture aretotally exempt from wealth tax without limit .

4. TDS

The current rate of tax deduction at source is 10% forinterest income and 20% for dividend income

5. Capital gains tax

Long term capital gains are taxable at 20% forindividual and 30% for corporate unties.

6. Gift tax

Gift made by NRI to resident relatives and friends

ECONOMIC ANALYSIS


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7. GDP

Measure to qualify national income and is the totalvalue of the output of goods and services produced inthe economy.

8. Total saving & investment of country

How much individual to can save money and it isnecessary to 5% of total national income can be save.

9. Sources of investment information

The securities market is a perfect auction market where

demand supply pressures determine the price.A World affair = wars, political affairs, FIIs

B Domestic Economic and Political factor (monsoon, moneysupply and agriculture output)

ECONOMIC ANALYSIS


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C Industry information

International demand and market share

D Company Information

Corporate data, annual data, pore files

E Security market information

SMA, Listing of the company and beta, book closure

F Security price quotation

Price indices, price & volume and volatility

G Data on related market

money market and forex market, ADR, GDR, G sec.

H Data on mutual fund

NAV and repurchase price

I New Issue

ECONOMIC ANALYSIS


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Analysis Of the dataThe broker firms, sub broker, investment consultancy firms

Inflation adjustment (price level)

Additional depreciation

Cost of salesMonetary working capital

Agriculture & monsoon situation

Monsoon is good increase saving ratio

Monsoon is bad, harmful to the economyBalance of payment situation

Interest structure and rate

Government budget

ECONOMIC ANALYSIS


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Infrastructure

Communication, power, service centre, mechanicalfacility and technology.

Monetary and Fiscal Policy

Fiscal concern with saving and investment & expenditure

= Barometric and Economic indicators1 Leading indicators

Data series of the variable that reach their high points aswell as their low points in advances of the economic

activity.- Contract of plant and machinery

- Index of consumer expectation

- Average weekly hours of manufacturing production w.

ECONOMIC ANALYSIS


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INDUSTRY ANALYSIS

= In India assets based industry grouping used to exist

under MRTP act and FERA act= Normal size wise classification

A small scale industries ( paid up capital 1 corer)

B Medium scale industries ( paid up capital 5 corer)

C Large sized industries ( paid up capital 10 corer or more)= Proprietary based classification

A Private sector industries

B Public sector industries

C Joint sector (both private and public)= use based classification

A Basic industries (coal, cement, steel, chemical)

B Capital goods industries ( equipment, wires, cables)


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C Intermediate goods (automobile parts, tubes, bolts)

D Consumer goods industries (silk, cotton, tobacco, sugar)

= Input based classification

A Agro based products = papers, wood, plywood

B Forest based products = fisheries

C Metal based industries = copper, gold

D Chemical based industries = fertilizer, drug, plastic

Industrial Life Cycle

I Pioneering stage

perfect both the way product & technology

risk level is also very high many compound could notsurvive in this stage.

INDUSTRY ANALYSIS


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II Expansion StageIn this stage few companies continue to get stronger, bothin share of the market and financially.

Strong companys and steadier, more efficient firmsbecome more attractive for investment purpose.

Paying dividend interest for that making them an evenmore desirable investment.

III Maturity Stage

The investor or analyst must monitories industries

development constantlyHigh labor cost, change in technology, demand also high.

INDUSTRY ANALYSIS


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= Industrial Policy

I) Industrial Licensing

- 18 industries specified for compulsory licensing,registration, import export license.

II) Policies for PSU

- some reservation for public sector is being retained

gradual opening of the area of private sector &privatization of some PUS is being followed

III) Foreign Investment

The government has assured automatic directinvestment approved upto 51 % of the total equity inIndian companies by foreigner in selected industrygroup.

INDUSTRY ANALYSIS


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- FDI is now allowed even up to 74 % to 100 %

IV) Foreign Technology

- A list of industries with 34 categories in it is providedautomatic approved of foreign technology

agreements by the govt.V) MRTP Control

- MRTP companies and dominant undertaking has

gone and government control on their activates

have disappeared.- Its also emphasis controlling & regulating their

monopolistic restrictive and unfair trade practies.

INDUSTRY ANALYSIS


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VI) Industrial Growth

- Competition- Capacity to used

- Technology innovation

- Higher rate than average

= Industrial groups listed on stock exchanges

The C.S.O. publisher data on industrial production under

38 majors groups

= Financial Data On IndustriesI In term of efficiency of capital structure

II Sources and uses of funds data such as externalsources to the total funds employed.

INDUSTRY ANALYSIS


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III Growth rates of fixed assets, gross block

IV Activity and Liquidity ratios, inventory turn over

V Profitability ratio

Tax planning, dividend distribution

= Backward Area Development

1. Infrastructure development strategy

2. Growth centre strategy

3. Capital subsidy

4. Provision of transport subsidy

5. Income tax concession, tax holding

6. Preference in granting license

INDUSTRY ANALYSIS


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7. Provision for SEZs

8.Preferential allotment of electrical connections, provision ofinfrastructure facility

9. Project Making

10. Entrepreneurship development programmed

Other pointsMarkets

Competitive Strategy

Threat of entry

Economic of scale

Product differentiation

Switching cost

Exit barriers

INDUSTRY ANALYSIS


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The investor takes the investment decision givenhis goal of return maximization

Buy the share at a low price

Sale the share at a high price

Estimation of future price :

Investor always looks for increasing his returns

from the investments, return are composed ofcapital gains and a stream of income in the from

of dividend.

COMPANY ANALYSIS


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Calculation of the capital gains:

Rt = (Pt P1 1) + Dt

Rt = Return of the holding period

Pt = Price of the share at the end of the year

P1 1 = Price of the share at the end of the year

Dt = Dividend received at the end of the year

Holding Period ReturnHPY = ( Pt P1 1 ) + Dt * 100

Pt 1

COMPANY ANALYSIS


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A) Quantitative Analysis

B) Quality Analysis

A) Quantitative Analysis

a) Dividend Discounted Methods

The dividend discounted methods based on thepremise that the value of an investment is the presentvalue of its future returns

PV = D1

K g

COMPANY ANALYSIS


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D1 = Dividend Per ShareK = Discounted Rate

G = Growth Rate

b) Price Earning Approach

The P/E ratio or Multiple is an important ratiofrequently used by analyst in determining the value

of the share

P = EPS * P/E Ratio

Decision Rules

1. Higher the P/E ratio, other things remaining the same,

Higher would be the value of an equity.

COMPANY ANALYSIS


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2. Lower the P/E ratio, other things remaining the same,

Lower would be the value of an equity.

Dividend Payout

Growth

Risk Free Rate

Business Risk

Financial Risk

How to forecasting earning per share1 Concept of financial statement

2 Concept of income statement

COMPANY ANALYSIS


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I) Return On Assets

Return on assets = EBIT / Assets

Assets turnover = sales / assets

Profit margin = EBIT / sales

Rate of return on equity = R + (R I) L/E

R = Return on assets

I = Effective interest rate

L/E = Total outside liabilities / equity

The ROA approach provides a framework for analyzing the

Effects and interaction between the return a firm earns on

its assets and the manner it is financed.

EPS = [(1-T){R+(K-I)L/E}E] + [ no. of share outstanding ]

COMPANY ANALYSIS


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Income statement for the year endedSales revenue

Less Operating Expense

EBIT

Less InterestEarning before tax

Less Tax

Earning after tax

Number of the share outstanding

EPS/Number of the share outstanding

COMPANY ANALYSIS


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= Variable Consideration1. Net sales

2. Other incomes

3. Cost of sales

4. EBIT5. Taxes

6. EAT

7. Average share outstanding

8. EPS

9. DPS

COMPANY ANALYSIS


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= Relevant Information1. Total Assets

2. Current Debts

3. Long term Debts

4. Equity Shares5. Total debts & Equity

COMPANY ANALYSIS


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II) Market Share Approach

1.Estimate the industrys total sales

2.Estimate the firms share in the total sales in the industry

3.Estimate the profit margin

4.Multiply sales by profit margin to get total earning5.Divided earning by number of share outstanding

6.Multiply EPS by P/E ratio

7.HPY

III) Independent Methods Estimate ApproachEach and every time of revenue & expense is estimated

separately.

COMPANY ANALYSIS


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= Modern Methods of forecasting EPS

1. Use of regression and correlation analysis

In order to find out the interrelationships of relevantvariables, the techniques of regression and correlationanalysis are used.

2. Trends Analysis

It is useful to understand the historical behavior of thevariable for the purpose of the security analysis.

3. Decision Tree Analysis

Decision tree analysis the decision is assumed to be

taken sequentially with probability of each sequence.

COMPANY ANALYSIS


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B) Qualitative Analysis

1. Future plans

2. Quality of management

3. Quality of personnel

4. Availability Raw Material inputs5. Marketing & Distribution

6. Product risk

7. Components of cost fixed and variable

8. Order book position9. Availability of infrastructure facility

10. Company annual report

COMPANY ANALYSIS


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11. Companys financial statement

12. Financial press, magazines etc13. Promotional tools

= Components of financial statement

1. Comparison of financial statement over 2 to 5 years

2. Ratio analysis 2 to 3 years3. Fund flow analysis = over short period

4. Trend analysis = over 5 to 10 years

- Figures of one year with that of another year

- Inter firm comparison of figures, within the sameindustry

- Comparison of one products with another

- Comparison of budgeted figures with actual figures

COMPANY ANALYSIS


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Ratio Analysis;

The ratio is a statistical yardstick that provides a measureof relationship between any two variable.

1.Revenue statement ratio;

Gross profit ratio

Expense turnover

Stock turnover

Operating ratio

Net profit ratio

2.Balance Sheet Ratio

Current ratio Liquidity ratio

Debt to equity ratio Assets to equity ratio

COMPANY ANALYSIS


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3. Composite ratioReturn on total resources

Return on own funds

Turnover of fixed assets

Turnover of debtorsFund Flow Statement

1.Additions to assets fixed and current

2.Addition to investment

3.Decrease in liabilities by paying off loans and creditors4.Decrease in net worth by increasing of losses

withdrawal of funds from business & payment ofdividend

COMPANY ANALYSIS


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Cash Flow Statement;

A particular time period how much cash inflows and cashOutflow

Company Reports

I Chairmans speech to the investors

This would bring out the management views of theCompanys performance in the backdrop of the economy

and industrial growth, its plans for expansion or

diversification or problem faced by the company.

II Directors ReportsFinancial results of these operations, profits or loss the

allocation of profit for depreciation, interest, taxes,

dividend

COMPANY ANALYSIS


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IIIAuditor Report

This is a statutory report testifying the correction ness of

the accounts and giving their own commit on the

accounting practice & procedures of the company

Corporate Performance=Nature of manufacture reputation, expansion, plans, tax

Planning, technology, set up, reputation of collaborators

and vocational advantages

=Goodwill also depends

=Government attitude to the management

=Government policy for import take benefits

COMPANY ANALYSIS


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=Honesty, integrity and consistency of management gives

Good rating for the company.

=Intrinsic value of share

=Return on capital employed

=Efficiency of capital use

Types of share in the market

I Growth shares

such companies are very attractive to the long-term

investors as the return to the equity shareholder in suchcompanies are continuously expanding due to dividend

growth in dividends networth, bonus, right etc.

COMPANY ANALYSIS


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II Cyclical Shares

Others categories of shares and cyclical shares whosefortunes may depend upon the business cycle andtrading like shipping business cycle and machines tools.

III Defensive Shares

Another category of companies is defensive shareswhose prices are stable and do not fluctuate widely.

IV Discount Shares

Besides there is a category of discount shares whose

prices are depressed due to low profits but with a hopeof higher profitability in the immediately future due to thechange in the management or in government policies asdue to new technological changes.

COMPANY ANALYSIS


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= Blue Chip

Research on the companies operation and their financialresults is necessary for locating emerging blue chips. This

can be done through fundamental analysis which helps us

to decide what to buy and what to sell.

Features

1.Management Rating = Highly professionalisation

2.Gross Profit Margin = Turnover, After sale services,

Brand equity, quality

3.Dividend Record = Declare reasonable dividend policy of

plouging back of profit, diversification

Expansion

COMPANY ANALYSIS


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4.The capital structure = The companys net worths is highrelative to equity and is expanding year after year

5.The liquidity Position = Current liquidity position is strong

6.Expansion = Relation with tax planning

7.Company vision = The mngt has a vision for future of thecompany and their policy is ambitious expansion &growth

8.Market Price = Rising, Steadily, if its fall than temporary.

9.Fair Price = Servicing for investors, dividend, bonusallotment, share transfer etc.

10.Company rating = Rating by rating agency

COMPANY ANALYSIS


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Summering Table

Earning per share

Relation on assets

Profit margin

Assets turnover

Total equity / outstanding liability

Effective interest rate

Number of share outstandingEffective rate of interest

Retention Rate

COMPANY ANALYSIS

Ch 6 Fundamental Analysis_2

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