UNIT 9 FUNDAMENTAL ANALYSIS Fundamental

Analysis

The objectives of this unit are to:

• Explain the relevance of fundamental analysis for equity investment

decision
• Construct a framework of analysis for economy, industry and company
• Examine various techniques to evaluate economy and industry related
factors.
• Highlight the need for and importance of company analysis
• Discuss quantitative and qualitative methods to value equity

Structure
9.1 Introduction
9.2 Economic Analysis
9.3 Industry Analysis
9.4 Company Analysis
9.5 Ratios for Company Analysis
9.6 Summary
9.7 Self-assessment Questions/Exercises
9.8 Further Readings

9.1 INTRODUCTION
Fundamental analysis becomes important when an investor wants to invest in
a business for a long period of time. Fundamental analyst does not consider
short term noise and price deviations in the stock and prefer to focus on the
company’s performance.
Fundamental analysis is a prominent process of evaluating the intrinsic value.
Numerous variables affect an equity share's intrinsic value. To calculate the
intrinsic/fair value, company’s and economic fundamentals should be
considered which drives the prices up and down.
The share price is influenced by the company's earnings, risk exposure and
growth rate. These variables depend on a wide range of additional variables
that are found in the economic environment, which eventually determine the
performance of the individual enterprises.
If it is found that the current market price of the stock is lower than the fair or
intrinsic value of the same stock, it is believed that the company/stock is
undervalued. If it is higher than intrinsic value it is said to be overvalued.
This intrinsic value of a share is based on the present value of all expected
future cash inflows from that stock. It represents the potential price of a
company. If the current market price is lower than the intrinsic value, then the
stock may be purchased as it is undervalued. Over the long term, value
appreciation is witnessed in the stocks of a fundamentally strong company. 207
Valuation The basic advantages of fundamental analysis are that:
• It helps the investor in understanding the investment perspective for the
long term.
• Investors can understand the industry scenario for investment purposes.
• It provides a complete view of various financial aspects of a company,
while doing company analysis.
The disadvantages of fundamental analysis are that:
• To do fundamental analysis, economy, industry and company data is
required, which is difficult to analyse efficiently.
• The process is very lengthy and complex.
• Fundamental analysis uses:
• Historical data and publicly known information about the economy,
industry
dustry and company
• Private information (Internal data)

It does not consider short

short-term
term information about a company or share. Every
day information or news on particular stocks may be useful for the traders but
many individuals rely on long
long-term information as they are there for long
term investing.
The fundamental analysis determine, how much is a share's inherent value by
using
1. Economic Analysis
2. Industry Analysis
3. Company Analysis

Economic Analysis

Industry Analysis

Company Analysis

Figure 9.1: Fundamental Analysis

9.2 ECONOMIC ANALYSIS

Investor’s decision is influenced by variety of economic variables. Industry
will expand quickly if the economy expands,, and vice versa. Stock prices
also fluctuate with economic activity levels. Low economic activity keeps
stock prices low, and vice versa
versa.. When economic activity is strong, stock
prices are high, indicating the positive outlook for the companies' sales and
profits. Understanding how the macroeconomic environment affects stock
price behaviour is crucial.
The following are the most common fa
factor
ctor for macroeconomic analyses:
208
Gross Domestic Product (GDP) Fundamental
Analysis
GDP serves as a proxy for economic growth. GDP is an indicator of the total
economic output of goods and services. GDP is made up of net exports of
goods and services, gross private domestic investment, government spending
on goods and services, and personal consumption expenditure. Annually, the
GDP estimates are made accessible. In the 1990s, the GDP grew at a rate of
about 6%.

Table 9.1: Annual real growth in demand side of GDP

Components 2019-20 2020-21 2021-22 Recovery
(1st RE) (PE) (1st AE) over 2019-20
Total Consumption 5.9 -7.3 7.0 99.2
Government Consumption 7.9 2.9 7.6 110.7
Private Consumption 5.5 -9.1 6.9 97.1
Gross Fixed Capital Formation 5.4 -10.8 15.0 102.6
Exports -3.3 -4.7 16.5 111.1
GDP 4.0 -7.3 9.2 101.3
Source: Economic Survey 2022

The RBI data suggest that the GDP has increased to Rs 34,41,826 crores in
Q1 and Rs 35,05,599 crores in Q2 of 2022-23 respectively.
The last column in table 9.1 indicates the capacity of the Indian economy to
recover from major catastrophic or black swan events like Covid 19 leading
to major slowdown in economy due to prolonged lock downs and disruptions
in supply chains.
The economy's growth rate indicates the projections for the industry. The
stock market will benefit more from the faster growth rate.
Savings and Investment
Growth inevitably necessitates investment, which in turn necessitates
significant domestic savings. The stock market is a conduit via which
investors' savings are made available to business entities. Savings are
allocated among a variety of assets, including bullion, deposits, mutual fund
shares, and stock shares.
Figure 9.2: Gross Fixed Capital Formation

Source: Economic Survey 2022

The public's saving and investing habits have a significant impact on the
stock. 209
Valuation Inflation
If the inflation rate rises in tandem with GDP growth, the real rate of growth
will be very low. Consumer product industry demand is considerably
impacted. The government's price control approach may cause some
industries, like sugar, to lose market share. The profitability of the industry
are impacted by the government's influence over the sector.
A low level of inflation benefits market and vice versa. Inflation effect the
masses in general and therefore is very politically sensitive prompting the
governments and central banks to tighten monetary policy and raise interest
rates to control inflation. High interest rates and reduced system liquidity
generally leads to decline in equity markets.

Interest Rate
The borrowing cost for the businesses is impacted by the interest rate. A
lower interest rate indicates lower financing costs for businesses and
increased profitability. For brokers using borrowed funds, there is more
money accessible at a cheaper interest rate. The availability of inexpensive
funds promotes speculation and increases share prices. Lower interest rates
also prompts promoters to go for capacity expansion.

The Monetary System

The investors anticipate the government's moves regarding the taxes in every
budget. Investment in a specific industry is encouraged by concessions and
incentives provided to it. Tax benefits are provided to promote saving. The
stock market suffered as a result of the Minimum Alternative Tax (MAT)
imposed in 1996. The 1999 budget includes a ten-year tax break for all
industries that will be established in the northeast. The sort of tax exemption
affects how profitable an industry is.

Figure 9.3: Trends in Tax Collection

Source: Economic Survey 2022

The Balance of Payments

The record of a nation's foreign payments and receives is known as the
balance of payments. There may be a surplus or deficit when receipts and
payments differ. The rupee may lose value versus other currencies if the
imbalance widens, which would raise the price of imports. The fluctuation in
Foreign Exchange rates has a significant impact on the export and import
210
businesses. The foreign currency rate's volatility has an impact on the Fundamental
Analysis
investments made by the FIIs.

Figure 9.4: Trends in Balance of Payments

Source: Economic Survey 2022

A favourable balance of payment has a favourable impact on the stock

market.

Monsoons and Agriculture

Agriculture and industries are connected both directly and indirectly. For
instance, agriculture provides the raw materials needed for other industries.
The sector of agriculture receives inputs from the fertiliser and pesticide
businesses. A successful monsoon raises the demand for inputs and produces
a bountiful crop. The stock market would become buoyant as a result.

Figure 9.5: Real GVA of Agriculture & Allied Sectors

Source: Economic Survey 2022

Agriculture and hydropower production would suffer from poor monsoon

conditions. They had an impact on the stock market.

Infrastructure Facilities
The development of the industrial and agricultural sectors depends on the
availability of infrastructure facilities. For the economy to grow, a robust
211
Valuation communication system is essential. Regular power without any interruptions
would increase production. Additionally, the banking and financial sectors
need to be strong enough to supply enough support to business aand
agriculture.
Positive stock market effects are caused by good infrastructure facilities.
India has improved infrastructure facilities, although they are still
insufficient. The government has loosened its monopoly on the power,
transportation, and comm
communication industries and allowing participation of
both domestic and international companies in these sectors.

Demographic Factors
Factors related to the age, sex, education, occupation, domicile, etc., are
covered in the demographic data. This is required to forecast consumer goods
demand. The age breakdown of the population shows whether there is a
skilled labour pool. Many multinational companies have launched their
businesses as a result of India's young labour market and favourable
demographic
demographics. Compared ed to the labour force in the West, Indian labour is
less expensive and much younger.. Population has an impact on business and
the stock market by supplying labour and increasing consumer demand.

9.3 INDUSTRY ANALYSIS

Industry represents a collection of bu
businesses
sinesses that use comparable production
structures and create comparable goods. Financial newspapers and
publications provide a broad classification of the industry for the investors'
convenience.
These industries can be grouped according to how they resp
respond to the various
business cycle stages. They are divided as shown in figure 9.2.

Growth Cyclical Defensive Industry with

industries Industry industry cyclical growth

Figure 9.6: Types of Industries

a) Growth Industry:
The sectors that are expanding quickly and with little regard for the
business cycle have unique characteristics. The development of
technology is the key factor influencing the industry's growth. For
instance, the information technology industry had a sursurge in growth
despite the 1997
1997–1998
1998 economic slumps in India. It continues to expand
despite the economic cycle. Similar to this, certain businesses have
experienced exceptional expansion throughout history, including the
pharmaceutical, communications, and entertainment industries.
b) Cyclical Industry:
Industries that experience cyclical growth and profitability follow the
business cycle. They experience growth during the boom and a setback
212 during the depression. For instance, goods like refrigerators, washing
 machines, kitchen ranges, etc., have a stron
strong market during a boom and Fundamental
Analysis
see a decline in demand during a recession.
c) Defensive Industry:
Defensive industry slows the cycle's progression. For instance, food and
shelter are among humanity's fundamental needs. The food industry
endures economic downturns
turns and depression. Investors have the option
of holding defensive industry stocks in order to generate income. Under
the protection of the government during the Great Depression, they grow
and make money while also being counter
counter-cyclical in time.
d) Industry
dustry with Cyclical Growth:
This industry that is growing while also being cyclical. For instance, the
automobile sector goes through phases of decline and stagnation, but
they also enjoy incredible growth. The resumption of the automobile
industry's growth
wth trajectory is made possible by advancements in
technology and the introduction of new models.

Industrial life cycle

Julius Grodensky is largely credited with developing the industry life cycle
hypothesis.
There are four clearly defined stages in the iindustry's life cycle. They are:
1. Pioneering stage
2. Rapid growth stage
3. Maturity and Stabilisation stage
4. Declining stage
Maturity and
Pioneering Stabilisation
stage stage

Rapid growth Declining stage

stage
Figure 9.7:: Stages in the Industry's Life Cycle

1. Pioneering Stage
In this stage,, both the product's technology and future demand for it look
promising. Numerous producers are drawn to make the specific product
because of the demand for it. Only the most competitive enterprises
would make it through this phase of intense rivalry. The manufacturers
work to establish a brand name, make it distinct and create an image.
Competition other than pricing would result from this. The intense
competition frequently causes changes in the firms' market share and
earnings positions. Because the survival probability is unknown in this
environment, choosingsing companies for investment is challenging.
2. Rapid Growth Stage
The rapid growth stage begins with the emergence of pioneering stage
enterprises that have survived. The market share and financial
213
Valuation performance of the enterprises that have withstood the competition
increase significantly. Advancement in Production technology results
result
in reduced production costs and high high-quality
quality goods. Companies in
this stage of development have stable growth rates and pay dividends
to shareholders. Purchasing shares of these businesses is advised.
The companies in the pharmaceutical industry, industry power, and
telecommunications sectors are some examples of industries in the
expansion stage. The above normal growth in these industries is often
due to technology advancement and corresponding decline in cost, due to
which there is market expansion. The growth rate at this level is higher
than the average growth rate for the sector.
3. Maturity and Stabilisation Stage
During the stage, the growth remain moderate and is roughly equal to
either the pace of industrial or gross domestic product growth.
Obsolescence signs could show up in the technology. Technological
advancements in the manufacturin
manufacturing g process and goods themselves must
be made in order to continue. Investors are required to keep a careful eye
on developments at the industry's mature stage.
4. Declining Stage
At this point, both the demand for the specific product and the industry's
businesses'
usinesses' profits are declining. Few customers today still prefer black
and white television. This stage is brought on by the development of new
items and modifications in consumer choices. It has unique characteristic
that, even during the boom, the indu
industry's
stry's growth would be slow and its
decline would accelerate during a recession. Even during a boom, it is
preferable to stay away from shares of lowlow-growth
growth industries. Capital is
eroded when money is invested in the shares of these companies.
Other factor
factors
The investor must also analyse several other elements besides the industry
life cycle which are :

Industry's growth

Profitability and cost

Nature of the product

Competition

Policy related issues

Labour

Pollution

Figure 9.8: Other Factors

214
a) Industry’s growth Fundamental
Analysis
It is important to analyse the industry's past growth record. The Centre
for Monitoring Indian Economy releases periodic reports on industry-
specific growth. Future trends can be predicted by looking at how return
and growth have fluctuated in the past in response to macroeconomic
circumstances. Even if history might not repeat exactly, an analyst can
forecast the future by looking at the industry's historical progress. The
price of IT industry scrip has increased significantly over the years along
with the information technology industry.

b) Profitability and cost

The firm's cost of production and profitability is impacted by the cost
structure, which includes fixed and variable costs. If the fixed cost
component is significant and the gestation period is long as in the cases
of the oil and natural gas industry power plants, iron and steel plants,
hydro power etc., reaching the company's break-even point requires
more sales volume. Utilizing the capacity to its fullest can boost
profitability once break-even has been reached and production is on
schedule. Once the capacity has been reached, more money can be
invested in the expansion if there is persistent demand. Lower fixed costs
can better prepare companies to shifting demand, and attaining break-
even conditions.

c) Nature of the Product

Consumers and other industries demand the goods that heavy
engineering and capital goods industries make. The need for industrial
products such pig iron, iron sheet, and coils depends on the building
sector and automobile sector. Similar to the manufacturing of textiles,
the success of the textile industry determines the demand for the tools
produced by the textile machine tools sector. There are numerous
examples of this. To determine the demand for industrial goods, the
investor must examine the state of the end user industry and the
connected goods producing sector.

In the case of the consumer goods sector, demand is impacted by

changes in consumer preferences, technical advancements, and substitute
items. An easy illustration is the impact of the ballpoint pen on the
demand for ink pens when consumer preferences for ink pens shifted to
more affordable and convinent ball point pens.

d) Competition
The nature of the rivalry is a crucial variable that affects the price of the
concerned company's stock as well as the profitability and demand for
the specific product. Both domestic and foreign producers could
contribute to the supply. Detergents, for example, are made locally by
producers and sold in the area for a reasonable price. This puts the
demand for goods produced by the MNCs company at danger.
Multinational corporations are also joining the market with more
complex product processes and higher-quality goods. Today, a
215
Valuation company's capacity to resist both domestic and international competition
is crucial. In the organised sector, there would be fierce competition if
there were too many companies. The price of the product would decrease
as a result of the competition. Before purchasing shares of a firm, an
investor should research the market share of that company's product.

e) Policy Related Issues

Policies have an impact on the very core of each industry, with varying
results. Products that are intended for export are given tax breaks and
subsidies. Government may also controls the volume of production, and
export & import cost of some goods. The conflicting government
policies frequently have an impact on the sugar, fertiliser, and
pharmaceutical businesses. Sugar price regulation and decontrol have an
impact on Sugar sector profitability. Entry barriers may occasionally be
erected by the government. The government policies pertaining to the
particular industry should be carefully considered while choosing a
sector. The current domestic industries in a number of sectors are under
severe threat as a result of liberalisation and delicensing.

f) Labour
It is crucial to analyse the labour situation in a certain industry. The
number of unions and how they operate have an impact on labour
productivity and industry upgrading. A decline in production would
result from frequent strikes. The suspension of production could result in
a loss in a sector with significant fixed costs. The corporation may suffer
from high production costs when trade unions reject the modernisation.
Dysfunctional labour connection also results in a decline in customer
loyalty.
For some industries, skilled labour is required like IT. This is just one of
the many factors luring global corporations to establish operations in
India.

Some sectors rely heavily on Research and Development activities to

develop new products and services such as pharmaceuticals, electronics
and tele-communication. Only via R&D can economies of scale and new
markets be attained. Before making an investment, it is important to
carefully research the amount of money spent on research and
development.

g) Pollution
The industrial sector has very rigorous and severe pollution
requirements. It could be heavier for some businesses than for others. For
instance, there are greater industrial effluents in the chemical,
pharmaceutical, and leather industries.
The aforementioned elements would serve as the industry's SWOT
analysis's "strengths," "weaknesses," "opportunities," and "threats."
Therefore, the investor should perform a SWOT analysis on the sector
they have selected. Consider how the presence of many companies in the
216
 market, or competition, poses a threat to a specific firm in the industry, Fundamental
Analysis
while the rise in demand
emand for the product of the industry becomes its
strength. An opportunity for that industry is the advancement of research
and development, while a threat is posed by multinational corporations
entering the market and low-cost
cost imports of the targeted prod
products. The
factors must be grouped and analysed in this manner.

9.4 COMPANY ANALYSIS

The investor analyses the present and potential values of the share by
assimilating several pieces of information about the company. To make wiser
investing decisions, the risk and return related to stock buying are analysed.
The ability of investors to infer information from the relationships and
interactions between factors relevant to the company is crucial to the
valuation process.
Company analysis broadly requires following issues in addition to many
more information:
• Reviewing qualitative aspects of the Company and the Management
• Studying financial ratios
• Analyzing the financial reports
• Identifying and comparing company's compe
competitors.
• Analyse the company’s future prospects.

A company may further be analyzed on the basis of Qualitative and

Quantitative aspects.

Basis of company analysis

Qualitative Quantitative

Figure 9.9:: Basis of company analysis

Qualitative aspectss are not directly visible and not easy to identify. Investors
can only identify these aspects only by studying annual reports, news reports
and other sources. Various Qualitative aspects for analysis are as follows:
• Related to Promoters
• Their salary and perks
• Any criminal cases against them
• Are they buying or selling shares of the group companies from
shareholders’ funds
• Giving favour to relatives, friends, etc.
• Related to Management
• Their professional education and background
217
Valuation • Merit and experience in the business
• Any criminal cases against managers, etc.
• Treatment of minority shareholders as how does their interest is taken
care by the Management.
• Significant shareholding in the company
• FIIs, DIIs, public, shareholdings
• Corporate Governance and Business Ethics
• Transparency in appointment of Directors and creating organizational
structure
• Adopting fair business practices
• Transparency in transactions etc.

Competitive advantage of the company

India's largest industries are made up of hundreds of distinct businesses. Even
though there are many businesses in the information technology sector, a
select few, like TCS, Tech Mahindra, Infosys etc., dominate. Similar to how
some businesses succeed and gain domination across all industries. Once a
company has a dominant position in the market, it is rare for them to lose it.
The company's effectiveness can be assessed with the help of:
1. Sales growth
2. Sales stability
3. The market share
4. Forecast for sales
• Sales Growth
The company may be a market leader, but if sales growth is comparably
slower than that of another company, it suggests a potential loss of market
leadership. The investors will not favour a large company with a slow rate of
sales growth. Profit growth typically occurs after a rise in sales. Investors
typically prefer scale and sales growth since larger companies may be better
able to endure business cycles than smaller companies.
Both in terms of rupees and in terms of physical units (Volumes), the
company's sales growth is analysed. Volume analysis is particularly
important since they demonstrate growth in concrete terms. The inflation has
an impact on the rupee term.
• Sales Stability
If all other factors are held constant, a company will have more steady
earnings if its sales revenue is stable. Variations in capacity utilisation,
financial planning, and dividend are caused by the fluctuation of sales. All of
the financial media occasionally publish information on the market shares of
various companies within an industry. Even though the company's revenues
are consistent in absolute terms, the decline in market share reflects the
company's deteriorating trajectory. As a result, the stability of sales should
also be compared to its market share and the market shares of its competitors.
218
• The Market Share Fundamental
Analysis
A company's relative competitive position within the industry can be
ascertained using the market share of the annual sales. The corporation would
be able to successfully compete if the market share was high. In terms of
sales.

The size of the business should also be taken into account when analysing
market share because smaller businesses may have trouble surviving in the
future. The market's top corporations will remain at the top, at least for the
foreseeable future. The results won't be accurate if the companies in the
market aren't compared with similar product groupings. To determine which
is the finest in its field, a software firm should be compared to other software
companies only.

• Forecast for Sales

Even if the company may be in a stronger position and command greater
sales in both monetary and physical dimensions, the investor should have
some sense of whether or not this trend will continue. Sales forecasting must
be done for this reason. He is capable of making many sales projections.

1. The investor can match a trend either linearly or non-linearly, depending

on which is more appropriate.
2. A historical analysis of the proportion of business sales to industry sales
is possible.
3. The growth in sales can be compared to macroeconomic factors such the
GDP, Per Capita Income, and Population Growth.
4. Because the demand for the company's goods may come from several
sources, it is necessary to analyse the various demand components.
Demand for some products may come from both industry and
consumers. For instance, both consumers and industries need steel and
petroleum goods.
Investors may also look into the quantitative aspects of the companies, before
making the investments. These matters are related to financial ratios and
numbers and needs to be calculated sometime.

Company analysis related to quantitative aspects may include the analysis of

following factors:
1. Revenue and profit of the company
2. Matters related to expenses and taxes
3. Operating efficiency of the company
4. Type of dividends and payout
5. Cash flow from various activities
6. Short and long term liquidity and debt issues
7. Working capital management and numbers related to:
• Receivables management
219
Valuation • Cash management
• Inventory management
8. Long term Asset and liabilities
9. Financing and its sources
10. Investments made by the company
11. Calculating various ratios

9.5 RATIOS FOR COMPANY ANALYSIS

To compute value, financial ratios use data from the financial statements.
Thus, ratio analysis is a way of analysing the financial statements and helps
in interpretation of the financial results. It further lets comparison of results
with previous years for the same company and with other companies in the
same industry.
Types of ratios are:
1. Profitability ratios
2. Return ratios
3. Liquidity ratios
4. Leverage Ratios
5. Turnover ratios
6. Valuation Ratios
1. Profitability Ratios
Profitability ratio basically is a percentage measure which shows how a
company converts the profit made from sales into net income. Creditors
and investors both are interested in these figures for multiple reasons. If
the profit margin is found to be low, it indicates that the company may
increase sales or decrease expenses. Some of these ratios are:
a) Gross Profit Ratio
The gross profit ratio compares the gross margin of a company to
its revenue and indicates how much profit a company earns after
deducting its Cost of Goods Sold (COGS).
Gross Profit Ratio = (Revenue – COGS) / Sales or Revenue
b) Operating Profit Ratio
Operating profit ratio reflects the percentage of profit a company
produces from its operations before subtracting taxes and interest
charges. It is calculated by dividing the operating profit by total
revenue and expressing it as a percentage. The margin is also known
as EBIT (Earnings before Interest and Tax) Margin.
Operating profit Ratio = (Operating Profit / Sales) * 100
Where:
Operating profit = Net profit + Non-operating expenses (Interest charges
220 and Taxes) – Non-operating incomes
 Operating Profit = Gross Profit – Operating expenses Fundamental
Analysis
or
Operating profit = Sales – (Cost of goods sold + Administrative and
office expenses + Selling and distribution exp.)
c) Net Profit Ratio
The net profit margin measures net income or profit as a percentage of
revenue. It shows how much net profit is generated out of sales of the
company.
Net Profit Ratio = Net profit / Sales or Revenue
The ratios of Steel Authority of India Limited are presented as under:

Margin Ratios March 2022 March 2021

Gross Profit Margin (%) 21.45 19.67

Operating Margin (%) 17.32 13.74

Net Profit Margin (%) 11.42 5.32

Source: moneycontrol.com

2. Return ratios
Return ratios measure how effectively a company is managing its debt
and equity capital. These ratios divide selected or total assets or equity
with net income. Some of these ratios are:

a) Return On Equity (ROE)

ROE calculates how efficient the company is in generating profits. The
higher ratio represents the more efficient company's management.
Return on Equity = Net Income / Average Shareholders’ Equity

b) Return On Capital Employed (ROCE)

ROCE is used to assess a company's profitability and capital efficiency.
It refers to how company is generating profits from its capital.
ROCE=EBIT / Capital Employed

c) Return on Assets (ROA)

ROA refers to a ratio which tells how profitable a company is in relation
to its total assets and determines how efficiently it uses its assets to
produce profit. It is written as a percentage of company's net income and
its average assets. Higher ROA is better as the company earns more
money with a smaller investment, it means more asset efficiency.
ROA formula is expressed as:
Return on Assets=Net Income / Total Assets

221
Valuation The ratios of Steel Authority of India Limited are presented as under:
Return Ratios MAR 2022 MAR 2021
Return on Networth / Equity (%) 22.58 9.13
ROCE (%) 22.19 13.05
Return On Assets (%) 10.19 3.47

Source: moneycontrol.com

3. Liquidity ratios
Liquidity ratios judge a debtor's ability to pay its current debt
obligations on time without raising external capital. Some of these ratios
are:
a) Current ratio
The current ratio measures company’s capability to pay short-term
obligations. A current ratio equivalent to the benchmark/industry
average or slightly higher is generally considered acceptable whereas a
lower ratio indicates higher chances of default.
Current Ratio= Current assets / Current liabilities
b) Quick ratio
The quick ratio measure a company’s short-term liquidity position to
meet its short-term obligations with its most liquid assets or near-cash
assets to pay its current liabilities.
Quick Ratio= Quick Assets / Current Liabilities
Quick Assets = Cash + CE + MS + NAR
Where, CE=Cash equivalents, MS=Marketable securities
NAR=Net Accounts Receivable
The ratios of Steel Authority of India Limited are presented as under:

Liquidity Ratios MAR 2022 MAR 2021

Current Ratio (X) 0.85 0.78

Quick Ratio (X) 0.24 0.36

Source: moneycontrol.com

4. Leverage ratios
To finance the operation, companies prefer a mix of equity and debt in
the capital structure. A leverage ratio indicates how much capital comes
as debt or loans. Various leverage ratios are discussed as under:
a) Debt to Equity Ratio
Debt-to-equity (D/E) ratio evaluates a company’s financial leverage. It
calculates the degree to which a company is financing its operations
with debt rather than its own resources.
Debt-Equity Ratios = Total Liabilities / Total Shareholders’ Equity
222
b) Interest Coverage Ratio Fundamental
Analysis
The interest coverage ratio determines how efficiently a company can
pay interest on its outstanding debt. It represents the number of times,
using its earning, a company can pay its obligations.
Interest Coverage Ratio=EBIT / Interest Expense
Where, EBIT=Earnings Before Interest and Taxes
The ratios of Steel Authority of India Limited are presented as under:
5. Turnover Ratios
The turnover ratio of a portfolio is the percentage holdings of that
portfolio or holding that is replaced in a year. Turnover ratios are:
a) Assets Turnover Ratio
Asset turnover ratio can be a basis of understanding company’s
performance. Higher ratio is better ratio. It is the ratio between a
company’s sales or revenues and its assets. The asset turnover ratio can
be calculated by dividing the net sales value by the average of total
assets.
Asset turnover ratio = Net sales value / average of total assets
b) Inventory Turnover Ratio
The inventory turnover or stock turnover ratio measures the efficiency as
how inventory is managed. It expresses how many times company’s
inventory is “turned” or sold during a period.
The formula for the ratio is:
Inventory turnover ratio= Cost of goods sold / Average inventory
The ratios of Steel Authority of India Limited are presented as under:

Turnover Ratios MAR 2022 MAR 2021

Asset Turnover Ratio (%) 0.87 57.95

Inventory Turnover Ratio (X) 1.96 3.53

Source: moneycontrol.com

6. Valuation Ratios
a) Price-to-earnings Ratio (P/E) ratio
P/E ratio determines a ratio of current share price of a company in
relation to its EPS. It is also known as price multiple or the
earnings multiple. It is calculated as follows:
P/E Ratio=Market value per share / Earnings per share
b) Price-to-Book (P/B) Ratio
Investors may also use P/B ratio to measure market's valuation of a
company in relation to its book value. It is done to identify undervalued
companies while doing fundamental analysis. It is calculated by
dividing the company's share current market price by its book value per
share.
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Valuation The formula for the price-to-book ratio:
P/B Ratio= Share Market Price per Share / Book Value per Share
c) Price-to-Sales (P/S) Ratio
One of the valuation ratios, the price-to-sales (P/S) ratio compares a
company’s stock price to its sales revenues. It indicates the value that
the market put on each unit of money for company’s sales.
P/S Ratio=MVS / SPS
where:
MVS=Market Value per Share
SPS=Sales per Share
The ratios of Steel Authority of India Limited are presented as under:
Valuation Ratios MAR 2022 MAR 2021
P/E (x) 3.32 7.85
P/B (x) 0.75 0.72
P/S (x) 0.39 0.47
Source: moneycontrol.com

9.6 SUMMARY
The study of economic, industrial, and company-related aspects is known as
fundamental analysis. The increase of the gross domestic product and
investment opportunities depend on the status of the economy.

The optimal environment for investing in common stocks is characterised by

an economy with favourable savings, investments, stable prices, balance of
payments, and infrastructure facilities. To predict economic growth, leading,
coincidental, and trailing indicators are used. A growing stock market is one
of the indicators that predicts and robust future for the economy and pattern
of industrial expansion. The best course of action for investors is to buy
shares after the IPO stage and sell them before the stagnation period. The cost
structure, R&D, and government policies addressing the sectors have an
impact on the industries' growth and profitability. The results of a SWOT
analysis show the industry's true state.

The market share of the business, as well as the growth and stability of its
annual sales, can be used to assess its competitive advantage. The company's
financial statements provide the investor with the necessary details to make
an investment choice. The fund flow and cash flow figures could be used to
analyse the company's financial standing. An investor can evaluate specific
criteria including profitability, liquidity, leverage, and stock value with the
aid of ratio analysis.

9.7 SELF ASSESSMENT QUESTIONS/EXERCISES

1. What is `Fundamental Analysis'? Discuss the advantages and
224 disadvantages of fundamental analysis?
2. What is ‘Industry Analysis’? Explain the concept of industry life cycle? Fundamental
Analysis
3. Write short notes on the following:
a. Economy Analysis
b. Industry Analysis
4. What are different methods of quantitative analysis used for equity
investment decision? How do they differ from qualitative analysis?
5. What is ratio analysis? Discuss various types of ratio analysis?

9.8 FURTHER READINGS

1. Fischer, D. E., Jordan, R. J., and Pradhan, Ashwini K. (2018) Security
Analysis and Portfolio Management, Pearson.
2. Rustagi. R. P., (2022) Investment Analysis and Portfolio Management,
Sultan Chand & Sons
3. Bhalla, V K., (2008) Investment Management: Security Analysis and
Portfolio Management, S. Chand.

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