FUNDAMENTAL ANALYSIS

By Anand Shankar(49)

Saurabh suman (35) Shaurya punit (38)

WHAT IS FUNDAMENTAL ANALYSIS?

• Fundamental analysis is a technique that attempts to determine a security‘s value by focusing on underlying factors that affect a company's actual business and its future prospects.

WHY FUNDAMENTAL ANALYSIS

• Fundamental analysis answers the following question

• Is the company’s revenue growing? • Is it actually making a profit? • Is it in a position strong-enough to outrun its

competitors in the future? • Is it able to repay its debts? • Is management trying to "cook the books"?

FUNDAMENTAL ANALYSIS

• The fundamental school of thought appraises the intrinsic value of shares through

ECONOMY ANALYSIS

The first step to this type of analysis includes looking at the macroeconomic situation.

• GDP/growth rate• Inflation• Interest rates• Exchange rates• Agricultural production/monsoon• FDI/FII

ECONOMIC INDICATORS AND THEIR IMPACT ON THE STOCK MARKET

INDICATOR FAVOURABLE IMPACT UNFAVOURABLE IMAPACT

GDP/GROWTH RATE HIGH GROWTH RATE SLOW GROWTH RATE

DOMESTIC SAVINGS RATE HIGH LOW

INTEREST RATES LOW HIGH

TAX RATES LOW HIGH

INFLATION LOW HIGH

IIP/INDUSTRIAL PRODUCTION HIGH LOW

BALANCE OF TRADE POSITIVE NEGATIVE

BALANCE OF PAYMENTS POSITIVE NEGATIVE

ECONOMIC INDICATORS AND THEIR IMPACT ON THE STOCK MARKET

INDICATOR FAVOURABLE IMPACT UNFAVOURABLE IMAPACT

FOREIGN EXCHANGE POSITION

HIGH LOW

DEFICIT FINANCING/FISCAL DEFICIT

LOW HIGH

AGRICULTURAL PRODUCTION HIGH LOW

INFRASTRUCTURAL FACILITIES

GOOD NOT GOOD

Industry analysis

• Industry analysis is a type of investment research that begins by focusing on the status of an industry or an industrial sector.

• Why is this important?• Each industry is different, and using one cookie-cutter

approach to analysis is sure to create problems. Imagine, for example, comparing the P/E ratio of a tech company to that of a utility. Because you are, in effect, comparing apples to oranges, the analysis is next to useless.

2. Industry Analysis

• INDUSTRY ANALYSIS LOOKS AT a) Past sales and earning performanceb) Labor condition within the industryc) Attitude of government towards industryd) Competitive conditione) Stock prices of firm in the industry

Michael Porter’s 5 Force Model

• Threat of New Entrants - The easier it is for new companies to enter the industry, the more cutthroat competition there will be. Factors that can limit the threat of new entrants are known as barriers to entry. Some examples include:

• Existing loyalty to major brands • Incentives for using a particular buyer (such as frequent shopper programs) • High fixed costs • Scarcity of resources • High costs of switching companies • Government restrictions or legislation

• Power of Suppliers - This is how much pressure suppliers can place on a business. If one supplier has a large enough impact to affect a company's margins and volumes, then it holds substantial power. Here are a few reasons that suppliers might have power:

• There are very few suppliers of a particular product • There are no substitutes • Switching to another (competitive) product is very costly • The product is extremely important to buyers - can\'t do without it • The supplying industry has a higher profitability than the buying industry

• Power of Buyers - This is how much pressure customers can place on a business. If one customer has a large enough impact to affect a company's margins and volumes, then the customer hold substantial power. Here are a few reasons that customers might have power:

• Small number of buyers • Purchases large volumes • Switching to another (competitive) product is simple • The product is not extremely important to buyers; they can do without the product for a period of

time • Customers are price sensitive

• Availability of Substitutes - What is the likelihood that someone will switch to a competitive product or service? If the cost of switching is low, then this poses a serious threat. Here are a few factors that can affect the threat of substitutes:

• The main issue is the similarity of substitutes. For example, if the price of coffee rises substantially, a coffee drinker may switch over to a beverage like tea.

• If substitutes are similar, it can be viewed in the same light as a new entrant.

• Competitive Rivalry - This describes the intensity of competition between existing firms in an industry. Highly competitive industries generally earn low returns because the cost of competition is high. A highly competitive market might result from:

• Many players of about the same size; there is no dominant firm • Little differentiation between competitors products and services

Semiconductor Industry

• Threat of New Entrants. • setting up a chip fabrication factory requires billions of dollars in investment. • Semiconductor companies are forming alliances to spread out the costs of

manufacturing. Meanwhile, the appearance and success of "fabless" chip makers suggests that factory ownership may not last as a barrier to entry.

• Power of Suppliers. • For the large semiconductor companies, suppliers have little power • many smaller chip makers are becoming increasingly dependent on a handful of large

foundries.

• Power of Buyers. • Most of the industry's key segments are dominated by a small number of large players.

This means that buyers have more bargaining power.

• Availability of Substitutes. • depends on the segment.• Copy-cat suppliers and reverse engg.

• Competitive Rivalry. • Intense rivalries between individual companies• The result is an industry that continually produces cutting-edge technology while riding

volatile business conditions.

Valuation of Stock = +• = + • The intrinsic value of a share is the present value of all future cash

flows Investment decision:

• a) If the market price of a share is currently lower than its intrinsic value, such a share would be bought because it is perceived to be under-priced.

• b) A share whose current market price is higher than its intrinsic value would be considered as overpriced and hence sold.

INTRINSIC VALUE DIVIDENDS CAPITAL APPRECIATION

Company Analysis-Non Financial

Aspects :History, Promoters and Management Review Questions How old is the company? Who are the promoters? Is it family managed or professionally managed? What is the public image and reputation of the company, its promoters and its products? Aspects :Technology, Facilities and Production Review Questions Does the company use relevant technology? Is there any foreign collaboration? Where is the unit located? Are the production facilities well balanced? Is the size the right economic size? What are the production trends? What is the raw material position? Is the process power- intense? Are there adequate arrangements for power?

Aspect:Product range, Marketing, Selling and Distribution Review Question: What is the company‘s product range? Are there any cash cows among the product portfolio? How distribution-effective is the marketing network? What is the brand image of the products? What is the market share enjoyed by the products in the relevant segments? What are the effects and costs of sales promotion and distribution?

Aspect:Industrial relations, Productivity and Personnel Review Question: How important is the labour component? What is the labour situation in general?

Aspect:Environment Review Question: Are there any statutory controls on production, price, distribution, raw material, etc? Is there any major legal constraint? What are the government policies on the industry (domestic as well as related to imports and

exports of the final products and raw materials)?

SWOT ANALYSIS

Internal Strengths Weaknesses Latest Technology Loose controls Lower delivered Cost Untrained labour force Established products Strained cash flows Committed manpower Poor product quality Advantageous location Family funds Strong finances Poor public image Well- known brand names

External Opportunities Threats Growing domestic demand Price War Expanding export markets Intensive competition Cheap labour Undependable component Booming capital markets Suppliers Low interest rates Infrastructure bottlenecks Power cuts

PRICE YESTERDAY’S BLUE CHIPS EMERGING BLUE CHIPS

EVERGREEN STOCK

NON BLUE CHIPS TURN AROUND STOCK

QUALITY

PRICE –QUALITY MATRIX

LQHP

HQHP

LQLP

HQ LP

MQMP

Low – Quality, Low - Price (LQLP): The non-blue chipsThese are not quite blue chips. These shares are of low quality and hence are quoted at low

prices. Just ignore them until there is an upswing in their fortunes. Till then, they are duds.

You should not buy something simply because it is cheap. Remember, what appears cheap may ultimately prove very expensive.

High – Quality, Low - Price (HQLP): Turnaround stocksThese are high quality stocks but quoted at relatively low prices because the market is yet to

recognize their true worth. They are blue chips in the making. You should pick them up as soon as you spot them, before their price shoot up to high levels.

It is in these HQLP shares that one can make a real killing! Often, they represent certain special situations like a turn around after a bad period, takeovers, change of management etc. Relative to their earnings potential, their market price is low. They have not yet attracted the wide attention of the market. One way to recognize them is that their price/earnings (P/E) ratio i.e. market price divided by earnings per share is relatively low when compared to the aggregate P/E ratio of the market as a whole and of that particular industry.

Low – Quality, High - Price (LQHP): Yesterdays blue chipsYou can call these the stocks with the hangover effect‘. Once they had the market

on a high but they are more or less banking on their past glory now. Once this fact is recognized, the market downgrades such stocks and their prices tumble. Such scrips should be sold fast. Do not look at such a share again until the company returns to the growth track.

Medium – Quality, Medium - Price (MQMP): Evergreen super stockThese are steady scrips. They can last for two to three generations fairly intact.

Hold on to them. Don‘t be in a hurry to sell them, not withstanding temporary ups and downs.

High – Quality, High - Price (HQHP): Emerging blue chipsThe current stars are popular and command a high price. As long as their glamour

last, such shares perform well in the market. Hold on to them. But be careful, partial booking of profits at high price may be desirable.

FUNDAMENTAL ANALYSIS OF A COMPANY

THANK

YOU!

Questions

• Q1 : Tell 5 competitive forces of Michel Porter’s 5 force model.

What is balance of payment?

• A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa.