Fundamental Analysis

By: Prof. Kumar Dhanwani

DMS, KDKCE

Fundamental AnalysisFundamental Analysis is to evaluate a lot

information about the past performance and the expected future performance of companies, industries and the economy as a whole before taking the investment decision. Such evaluation or analysis is called fundamental analysis.

Fundamental analysis includes:

Economic analysis

Industry analysis

Company analysis

Fundamental Analysis

The Analysis of economy, industry and company constitute the main activity in the fundamental approach to security analysis. And can be viewed as different stages in investment decision making process.

Fundamental Analysis

Economy Analysis

Economic AnalysisThe performance of a company depends much on

the performance of the economy if the economy is BOOM, the industries and companies in general said to be prosperous. On the other hand, if the economy is in RECESSION, the performance of companies will be generally poor.

Investors are interested in studying those economic varieties, which affect the performance of the company in which they proposed to invest. An analyzed of those economic variable would give an idea about future corporate earnings and the payment of dividends and interest to investors.

Techniques for Economic forecasting

(1) GNP(2) SAVINGS AND INVESTMENT(3) INFLATION (4) AGRICULTURE(5) RATES OF INTEREST(6) GOVT. REVENUE, EXPENDITURE &

DEFICITS(7) INFRASTRUCTURE(8) MONSOON(9) POLITICAL STABILITY(10) NATURAL CALAMITIES

GNP/GDPGNP represents the aggregate value of goods

and services produced in the economy. It reflects the over all performance of the economy. The growth rate of GNP indicates the growth rate of the economy the higher the rate of growth of GNP, the more favorable is it for the stock market and vice versa

GDP a measure of all of the goods and services

produced in the economy during a specified time period

INFLATION Inflation prevailing significant impact on

company performance. High inflation upset company plan. Demand goes down because purchasing power fall, high inflation impact company performance adversely. Inflation is measured both in:

WPI (Wholesale price index)

CPI (Consumer price index)

INTEREST RATEInterest rates determine the cost and availability of credit for companies operating in an economy.

Low interest rate=> easily and cheaply available credit.

=> lower cost of finance => high profitability

High interest rate => higher cost of production=>lower profitability =>Lower demand

GOVERNMENT REVENUE, EXPENDITURE AND DEFICIT

Government is the largest investor in economy of any country thus revenue, expenditure and deficit have significance impact on the performance of industries and companies.

Expenditure stimulate demand and creates job.

The excess of expenditure over revenue is deficit, (budget deficit), most expenditure are spent on infrastructure, and deficit financing fuel inflation.

MONSOON/SEASONAL IMPACTThe Indian economy is essentially an agrarian

economy and agriculture forms a very important sector of the Indian economy. But the performance of agriculture to a very great extent depends upon the monsoon. The adequacy of the monsoon ensures the success of the agricultural activities in India and vice versa. Hence the progress and adequacy of the monsoon becomes a matter of great concern for an investor in India.

Weather forecasting becomes a matter of great concern for investor in the economy of agricultural country.

EXCHANGE RATE

The balance of trade in import and export determine the rate of exchange rate.

Depreciation of local currency improve the competitive position in foreign market the performance of exported product but it would also make the imported product more expensive.

A foreign Exchange reserves is needed to meet several commitments such as payment for import and servicing of foreign depts.

INFRASTRUCTUREDevelopment of a economy depends very much on the

infrastructure available. Industry needs electricity for its manufacturing activities road and railways to transport raw material and finished good.

Communication channels help supplier and customers.

Good infrastructure is symptoms of development.Bad infrastructure lead to inefficiencies, low

productivity wastages and delay.

Investors should analysis the infrastructure of any economy.

Saving & investment

Savings and investment denote that position of GNP, which is saved and invested savings increases in India since eighties now the rate of savings is 25% from 21% in 80’s, which indicates the growth of capital market. The higher the level of savings interest, the more favorable is it for the stock marketed vice versa

Industry AnalysisIndustry analysis indicates to an investor whether

the industry is a growth industry or not. It gives an investor a choice of the industry in which the investments should be made.

Industry analysis refers to an evaluation of the relative strength and weakness of particular industries which can be divided in to three parts, viz.,

1. Life cycle of an industry2. Characteristics of an industry3. Profit potential of an industry

Industry Sales

Life-Cycle Stages

Introductory

Expansion (Growth)

Mature

Industry Life Cycle

Life Cyclea) Pioneering Stage: Technology and product are newly

introduced.

(b) Expansion stage: Those companies which reached first stage grow further and becomes stronger.

(c) Stagnation Stage: In this stage the growth of the industries

Stabilizes. Sales increases at slower rate.

(d) Decay stage: The industry becomes obsolete and gradually ceases to exist.

INDUSTRY ANALYSISCyclical industries: Industries that tend to be directly related to

business cycles such that they perform best during expansions and worst during contractions.

Nature of the productProducts produced by the industries are

demanded by consumers or other industries. if industrial goods like iron, iron sheet& iron coils are produced, the demand for them depends on the construction industries.

Defensive, or countercyclical, industries:Industries that tend to perform best when the economy is in a contraction or recession, but are generally the poorest performers in expanding economies.

Industry life cycle:

The various phases of an industry with respect to its growth in sales and its competitive conditions

Competition:The investor before investing in a scrip of an company, should analyze the market share of the company's product & should compare it with the top 5 companies.

Growth of the industry : The historical performance of the industry in the terms of growth and profitability should be analysed. Industry wise growth is published periodically by the Centre for Monitoring Indian Economy.

Labour:The analysis of labour industry scenario in a particular industry is of great importance. The number of trade unions and their operating mode have impact on the labour productivity and modernization of the industry.

Company AnalysisIn the company analysis the investors assimilates the several bits of information related to the company and evaluates the present & future value of the stock.

It involves a close investigative scrutiny of the companies financial and non financial aspects with a view to identifying its strength, weaknesses and future business prospects.

Company Analysis includes financial and non financial aspects which are as follows:

The financial statement analysis is the study of a company’s financial statement from various viewpoints. The statement gives the historical and current information about the company’s operation.

Some statements & parameters used in the analysis are: Balance sheet Profit and loss account Comparative financial statements Trend analysis Common size statements Fund flow analysis Cash flow analysis Ratio analysis.

Financial analysis

Financial ParametersA.(a) Gross profit Margin

(b) Net profit Margin(c) Earning power(d) Return on equity(e) Earning per share

(f) Cash EPS

B. Financial Statement Analysis Trading, P& L A/C Analysis

Balance Sheet Analysis

C. Ratio Analysis Liquidity Ratios Leverage Ratios Profitability Ratios

Non Financial parametersBusiness of the company

The investor should know weather the company is a well established one, weather it has a good product range.

ManagementThe quality of top management team, the competence and the commitment of CEO matters a lot in shaping the destiny of the company.

Product rangeProgressive co. like ITL & HUL creates competition

for their existing products by launching new products with regular frequency. Hence investor must examine the company.

Foreign collaborationWhere a company has entered into technical

collaboration with a foreign company, the investor must find out more about the nature of the collaboration agreement.

R & D Progressive companies spent substantial

sums of money on R & D to upgrade their existing product.

Govt. regulationsThe investor must asses the implications of

governmental regulations such as licensing entry barriers, patent registrations.

Analysis is must because