Fundamental AnalysisA method of a evaluating a security by attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factor.Fundamental analyst attempt to study everything that can effect the securitys value.

Investment DecisionsInvestment decisions are a part of our economic life. Everybody makes such decisions in different contexts at different times. Some are able to reap more profits out of them; while others simply lose their money.

So, where does the difference lie?

Intrinsic ValueThe actual value of a company or a security based on an underlying perception ofits true value including all aspects of the business, in termsof both tangible and intangiblefactors. This value may or may not be the same as the current market value. Various investorsuse a variety of analytical techniques in order to estimate the intrinsic value of securities inhopes of finding investmentswhere the true value of theinvestment exceedsits currentmarket value.

Market ValueIt is the value at which the security is currently selling in the market. The market value of a security is determined by the demand and supply forces acting upon it. In fundamental analysis the effort is to identify those securities that one perceives as mispriced in the stock market. It is very commonly seen that the shares are mispriced i.e. their market values and intrinsic values differ and investors should try to make the most of such discrepancy.

Fundamental course of action when the intrinsic value and the market value of a security differs:If IV > MV, security is underpriced, buy the securityIf IV < MV, it is overpriced, sell the securityIf IV = MV, no action.

Researchers have found that stock prices change can be attributed to the following factors:Economy wide factors : 30-35 %Industry factors : 15-20 %Company factors : 30-35 %Other factors : 15-25 %

Concept of Fundamental AnalysisIt is the examination of various factors such as earnings of the company, growth rate and risk exposure that affects the value of shares of a company. Fundamental Analysis is an attempt to analyze various fundamental or basic factors that affect the risk-return of securities.

Fundamental analysis consists of:Economic AnalysisIndustry AnalysisCompany Analysis

Economic AnalysisIt is the analysis of various macro economic factors that have a significant bearing on the stock market.The level of economic activity has a direct bearing on the investment in many ways. If the economy grows rapidly, the industries also grow and hence the investment and vice-versa.

Macro Economic FactorsThe various macro economic factors are:Gross Domestic Product (GDP)Savings and investmentInflationInterest ratesBudgetTax structure The balance of paymentMonsoon and agricultureInfrastructure facilitiesDemographic factors

Macro Economic FactorsGross Domestic Product: GDP indicates the total value of the goods and services produced in the economy. It consists of personal consumption expenditure, gross private domestic investment and government expenditure on goods and services and net export of goods and services. GDPiscommonlyused as anindicator of the economic health of a country, as well as to gauge a country's standard of living.GDP = C + G + I + NX where: "C" is equal to all private consumption, or consumer spending, in a nation's economy "G" is the sum of government spending "I" is the sum of all the country's businesses spending on capital "NX" is the nation'stotal net exports, calculated as total exports minus total imports. (NX = Exports - Imports)

Macro Economic FactorsSavings and Investments: For the growth of any economy investment is mandatory which eventually requires substantial amount of domestic savings. Stock market mobilizes the savings of the investors to make them available to the corporate bodies. These savings are invested over a plethora of assets like shares, debentures, bonds, commercial papers, real estate, bullion etc. It is important to know the level of investment in the economy to make out how much of it is directed towards the capital market.The level of investment in an economy is given by;(Domestic Savings + Inflow of Foreign Capital Investments made abroad). A higher proportion of savings and investment indicates favorable conditions for the stock market.

Macro Economic FactorsInflation: Along with the growth in GDP the inflation rate also increases, and an increase in the inflation rate corrodes both the real growth rate as well as the real returns on investments of the investors. A moderate level of inflation is always desirable for the stock market but very high level of inflation is harmful. This is because in a world where inflation is increasing, people will spend (or invest) more money because they knowthat it will be less valuable in the future, thereby giving a subsequent rise to the level of production and consumption in the economy. Thiscauses further increases inGDP in the short term, bringing about further price increases.But if the inflation rises beyond controllable levels then the interest rates have to be raised to control them which may give rise to a fall in the stock prices.

Macro Economic FactorsInterest Rates: The interest rates affect the cost of financing to the firms. A decrease in the interest rate means lower cost of financing and hence more profitability. The availability of funds at a cheap rate also encourage speculators (who generally use borrowed funds) to trade more thereby leading to arise in the share prices. If the interest rates are on a constant rise it means that the firms will have to pay more on borrowed funds and will have less distributable profits for the equity shareholders that may bring their prices down.

Macro Economic FactorsBudget: The budget provides with an elaborate account of government revenues and expenditures. A fiscal deficit (Govt. spending > Govt. Revenue) may lead to high rate of inflation and adversely affect the cost of production. A surplus budget on the other hand will result in deflation. Hence a balanced budget is more desirable for the stock market.The tax structure: Concessions and incentives given to a particular industry during the union budget promotes the investment in that industry. When the MAT was imposed by the finance ministry in the year 1996, it adversely affected the stock market. Companies in SEZ in India. The various tax exemptions impact the profitability of the industries.

Macro Economic FactorsThe balance of payment: The BoP of a country can be defined as an accounting record of all the economic transactions of the country with other countries. The difference between receipts and payments can be a BoP surplus or deficit. If there is a BoP deficit then the value of the rupee will depreciate against the foreign currency and it will affect the cost of imports. The export-import companies are heavily affected by the changes in the foreign exchange rates. The volatility of foreign exchange rates directly affect the investment of the foreign investors (mainly FIIs) in the Indian stock market.

Macro Economic FactorsMonsoon and agriculture: Despite the industrial developments and advancement made by India in the past few decades, it remains a fact that the Indian economy is still heavily dependent on agriculture for majority of revenue generation. The agricultural sector in turn is subject to the happening of monsoons. Agriculture affects other industries like sugar, textile, food processing, cotton, fertilizers, pesticides, etc. Monsoons affect the agri-based industries and hydel power production as well.

Macro Economic FactorsInfrastructural facilities: Communication, roads, power, water, banking and financial services, etc. play a major role in the development of the industries and the economy as a whole.Demographic factors: The age, gender, occupation, literacy and geographic location also affect the growth pattern of the economy depending upon their savings, consumption and investment patterns.

Economic ForecastingForecasting the future state of the economy is needed for decision making. It may be done for a short term period i.e. up to a period of 3 years or for an intermediate period of between 3 to 5 years or a long term forecasting for a period over 5 years.The factors that indicate the present status , progress or slow down of the economy are referred to as the economic indicators. These indicators can be further categorized as leading, coincidental or lagging indicators.Econometric Model Building: For econometric model building several economic factors are taken into consideration. The relationship between various independent and dependent variables are established using mathematical model. From these relationships the present state is analyzed and the future is predicted.

Economic IndicatorsLeading indicators: Indicate what is going to happen in the economy. It helps the investor to predict the path of the economy. Popular leading indicators are fiscal policy, monetary policy, rainfall, stock indices and capital investment.Coincidental indicators: Indicate what the economy is. GDP, industrial production, interest rates, reserve funds and so on. For eg: a gap between the budgeted GDP and actual GDP shows the current state of the economy. Low industrial production shows that the countrys economy is facing a slump.Lagging indicators: Lagging indicators are the consequential indicators of leading and coincidental indicators. Changes occurring in leading and coincidental indicators are reflected in lagging indicators. Unemployment rate, consumer price index and flow of foreign funds are examples of such indicators.Diffusion index: It is a composite or consensus index, which has been constructed by the National Bureau of Economic Research in USA. It consists of leading, coincidental and lagging indicators.

Industry AnalysisAn industry is a group of firms that have similar technological structure of production and produce similar products. In simpler words, an industry is a group of firms that are engaged in the production of similar goods and services.Industry analysis is used to analyze the performance of the industries over the years.An investor must analyze the following factors in industry analysis:Type of industryGrowth of the industryIndustry Life CycleCost structure and profitabilityNature of the productNature of the competitionGovernment policy

Type of IndustriesIndustries can be classified into various categories depending upon their reaction to the different phases of the business cycle.

Growth industry: Has high rate of earnings and expansion and growth is independent of business cycle. Like the infrastructure and real estate industry grew despite the economic slowdown in India during 2008 2009.Cyclical industry: Growth and profitability of the industry move along with the business cycle. For eg: Electronics, home appliances, etc. Defensive industry: It is an industry which defies the business cycle. For eg.: basic necessities like food, shelter. These industries manage to grow even in slump periods. Cyclical growth industry: It is an industry that is cyclical and at the same time growing. It has its own growth - maturity - stagnation - decline pattern. Eg: Scooters, automobile etc.

Industry Life CycleUnder the pioneering (introduction) phases, revenues and earnings are likely to be very low, which makes investments during these phases more speculative in nature. Revenues and earnings are likely to be low because there is little demand for the product, or the product is not completed. Expenses are likely to be very large during these phases as a company or industry spends a lot on marketing and research.Through the growth phase, revenues and margins are likely to be on the rise due to an increase in demand for a product and the pricing power the firm has due to a small number of competitors. Stock prices are likely to rise during this phase.During the maturity and stability phase, revenues and margins are likely to decline due to lower sales demand and more competition. Stock prices are likely to decline during these phases. For example, the video cassette recording (VCR) industry was performing well for approximately 20 years. However, the introduction of DVDs, which are more efficient and of higher quality, turned the VCR industry into a declining industry.

Industry AnalysisCost Structure and Profitability: The proportion of fixed and variable cost components in the cost of production of a company has a significant bearing on the profitability of the firm. For eg.: In oil and natural gas industry and iron and steel industry the investment in the fixed costs are comparatively high and so their gestation period is also lengthy. So, the sales volume required to break even is also high. So, these things are to be borne in mind that at which stage of the gestation period the company is in.Nature of the product: Depending upon the nature of the product, an analysis needs to be made about the condition of the related goods producing / consuming industries. In case of consumer goods the change in consumers preference, technological innovations and substitute products affect the demand.

Industry AnalysisNature of Competition: The nature of competition that exists in a particular industry affects greatly the demand for a particular product, its price, profitability and hence the market value of the scrip of the company.Government Policy: Tax subsidies and tax holidays are provided for export oriented products. Government policies are particularly stringent for some industries and are favorable for some other and this has a considerable effect on their profitabilities. For eg.: SEZ, EPZ etc

Company AnalysisIn company analysis, the growth of the company is analyzed by the investor so that the present and future value of the shares can be known.The present and future value of shares is affected by a following number of factors such as:Competitive edge of the companyMarket shareGrowth of salesStability of the sales

Financial AnalysisIt involves analyzing the financial statements of the company.The financial statements of the company include:Balance sheet: It shows the status of a companys financial position at the end of the year. Profit and loss account: It shows the profit and loss made by the company during a period.

P/ E Ratio

N/AA company with no earnings has an undefined P/E ratio. By convention, companies with losses (negative earnings) are usually treated as having an undefined P/E ratio, even though a negative P/E ratio can be mathematically determined.010Either the stock is undervalued or the company's earnings are thought to be in decline. Alternatively, the company may have profited from selling assets.1017For many companies a P/E ratio in this range may be considered fair value.1725Either the stock is overvalued or the company's earnings have increased since the last earnings figure was published. The stock may also be a growth stock with earnings expected to increase substantially in future.25+A company whose shares have a very high P/E may have high expected future growth in earnings, or this year's earnings may be considered to be exceptionally low, or the stock may be the subject of a speculative bubble.

Growth PerformanceCAGR

Sustainable growth rate Sustainable growth rate = Retention rate X Return on equity This can be written as follows:

Analysis of Financial StatementsIt helps the investor in determining the financial position and progress of the company.The various simple analyses that are performed to ascertain the financial position of the company are:Comparative financial statement: In this , data from the current years balance sheet is compared with similar data from the previous years balance sheet.Trend analysis: It shows the growth and decline of sale and profit over the years.Common size income statement: It shows each item of expense as a percentage of net sales.Fund flow analysis: It is a statement of the sources and application of funds.Cash flow analysis: It shows cash inflow and outflow of a company during the year.Ratio analysis: It is the numerical relationship between the two items.

Qualitative Analysis of companiesStrategy Analysis Competitive Strategies (Differentiation, cost leadership & Focus)Evaluation of managementMarket position, technology, HR & personnel relations

Family ManagementProfessional ManagementIntegrity of ManagementPast record of managementHow highly is the management rated by its peers in the same industryHow the management fares in adversityThe depth of knowledge of the managementThe management must be open, innovative and must also have a strategyAvoid investing in family controlled companies

Strength of F.ALong-term trendsValue-spottingBusiness acumen- familiar with business revenue, risk factor, competitors, opportunities etc.,

Weakness of F.ATime constraintsIndustry/company specificSubjectivityAnalyst bias