Fundamental Analysis

A 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 Decisions
Investment 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 Value
The 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 Value
It 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:
1. If IV > MV, security is underpriced, buy the security
2. If IV < MV, it is overpriced, sell the security
3. If 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
Analysis

It 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 Analysis
Industry Analysis
Company Analysis

Economic
Analysis
It 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 Factors

The various macro economic factors are:
Gross Domestic Product (GDP)
Savings and investment
Inflation
Interest rates
Budget
Tax structure
The balance of payment
Monsoon and agriculture
Infrastructure facilities
Demographic factors

Macro Economic Factors

Gross 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
Factors
Savings 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 Factors

Inflation: 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 Factors

Interest 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 Factors

Budget: 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 Factors

The 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 Factors

Monsoon 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 Factors

Infrastructural
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 Forecasting
Forecasting 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 Indicators
Leading 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 Analysis
An 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 industry
Growth of the industry
Industry Life Cycle
Cost structure and profitability
Nature of the product
Nature of the competition
Government policy

Type of Industries
Industries 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 Cycle

Under 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 Analysis
Cost 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 Analysis
Nature 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 Analysis
In 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 company
Market share
Growth of sales
Stability of the sales

Financial Analysis
It 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/A

A 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.

010

Either the stock is undervalued or the company's earnings

are thought to be in decline. Alternatively, the company may
have profited from selling assets.

1017

For many companies a P/E ratio in this range may be

considered fair value.

1725

Either 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 Performance
CAGR

Sustainable growth rate

Sustainable growth rate = Retention rate X Return on equity

Analysis of Financial
Statements
helps the investor in determining the

It
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
companies
Strategy Analysis
Competitive Strategies (Differentiation,
cost leadership & Focus)

Evaluation of management
Market position, technology, HR &
personnel relations

Family Management
Professional Management
Integrity of Management
Past record of management
How highly is the management rated by its
peers in the same industry
How the management fares in adversity
The depth of knowledge of the
management
The management must be open,
innovative and must also have a strategy
Avoid investing in family controlled
companies

Strength of F.A
Long-term trends
Value-spotting
Business acumen- familiar with
business revenue, risk factor,
competitors, opportunities etc.,

Weakness of F.A

Time constraints
Industry/company specific
Subjectivity
Analyst bias