RESEARCH ANALYSIS

INVEMENT OPPORTUNITIES

 EQUITY – DIRECT, MUTUAL FUNDS, ETF, SPECIAL

OPPORTUNITIES, CORPORATE ACTION.
 DEBT- CAPTURE YTM SPREADS, WELL RATED
CORPORATE BONDS
 REAL ESTATE- REIT AN OPPORTUNITY FOR THE
FUTURE
 PRECIOUS METALS- ELECTRONIC, ETF, SGB
( SOVERIGN GOLD BONDS)
 GOVT SAVINGS SCHEMES
 INTERNATIONAL INVESTMENTS- Direct or ETF
 AIF
 II. MACROECONOMIC ANALYSIS AND INDICATORS

1. EIC Framework- ECONOMY- INDUSTRY-

COMPANY
2. Economic Cycle: Influence of economic activities on
Companies Valuation
3. Economic Indicators: GDP, Inflation,
Unemployment, Industrial Production(IIP), Business
and Consumer confidence ,Fiscal and Current Account
deficit, Credit offtake,
4. ECONOMIC LEAD AND LAG INDICATORS
( lead-freight index, sale of trucks, credit offtake, capacity
expansion: Lag- GDP, Unemployment etc)
II. MACROECONOMIC ANALYSIS AND INDICATORS
TOP –DOWN & BOTTOM UP RESEARCH APPROACH
INDUSTRY ANALYSIS- PORTERS 5 FORCES MODEL
INDUSTRY ANALYSIS- Political, Economy, Social,
Technological, Environmental and Legal
INDUSTRY ANALYSIS- Political, Economy, Social,
Technological, Environmental and Legal
COMPANY : QUALITATIVE FACTORS
COMPANY:QUANTITAIVE ANALYSIS
 BASIC TERMS- TIME VALUE OF MONEY

The concept of time value of money arises from the relative

importance of an asset now vs. in future. Assets provide
returns and ownership of assets provides access to these
returns. For example, Rs. 100 of today’s money invested for
one year and earning 5% interest will be worth Rs. 105 after
one year. Hence, Rs. 100 should be worth more than Rs. 100
a year from now. Therefore, any wise person would chose to
own Rs. 100 now than Rs. 100 in future. This explains the
‘time value’ of money. Also, Rs. 100 paid now or Rs. 105 paid
exactly one year from now both have the same value to the
recipient who assumes 5% as the rate of interest.
 BASIC TERMS- TIME VALUE OF MONEY

 NPV – NET PRESENT VALUE IS ARRIVED AT WHEN

WE DISCOUNT THE FUTURE CASH FLOWS BY A
DISCOUNTING FACTOR( INTEREST RATE OR
OPPORTUNITY COST). IF NPV IS NEGATIVE THE
INVESTMENT SHOULD BE AVOIDED.
 IF NPV IS ZERO THE INVESTMENT IS NEUTRAL AND
 IF NPV IS POSITIVE THE INVESTMENT IS A GOOD
ONE TO MAKE.
BASIC TERMS- TIME VALUE OF MONEY
 BASIC TERMS: OPPORTUNITY COST

Opportunity cost is the cost of any activity measured in terms

of the value of the other alternative that is not chosen (that is
foregone). Put another way, it is the benefit you could have
received by taking an alternative action; the difference in
return between a chosen investment and one that is not
taken. Say you invest in a stock and it returns 6% over a year.
In placing your money in the stock, you gave up the
opportunity of another investment - say, a fixed deposit
yielding 8%. In this situation, your opportunity costs are 2%
(8% - 6%).
 BASIC TERMS: RISK FREE RATE OF
RETURN

The risk-free interest rate is the theoretical rate of return of

an investment with zero risk, including default risk. Default
risk is the risk that an individual or company would be unable
to pay its debt obligations. The risk-free rate represents the
interest an investor would expect from an absolutely risk-free
investment over a given period of time
Eg: G-SEC ( Govt Securities) – The interest YIELD
earned on a 10yr Gsec is the benchmark in India to calculate
Risk free rate of return
THE 10 YEAR G-SEC YIELD ON 115/05/2020 IS -
6.05%
 BASIC TERMS: EQUITY RISK PREMIUM

 Risk matters and that riskier investments should have

higher expected returns than safer investments, to be
considered good investments.
 Thus, the expected return on any investment can be
written as the sum of the risk-free rate and a risk premium
to compensate for the risk.

USUALLY 2 TIMES RISK FREE RATE IS AN

ACCEPTABLE RETURN FOR EQUITIES .
 BASIC TERMS: BETA

 Beta measures the sensitivity in the movement of the stock

against the movement of the Index ( in the stock mkt)
 Higher-beta stocks mean greater volatility and are
therefore considered to be riskier but are in turn supposed
to provide a potential for higher returns; low-beta stocks
pose less risk but also lower returns.
 Beta of 1 means that for every 1 % the index will move the
stock with 1 beta will also move 1% ( up and down)
 If Stock Beta is 2 , then for every 1% movement in Index
this stock will move 2% ( up and down)
 BASIC TERMS: VARIANCE AND STD
DEVIATION

Variance (σ2) in statistics is a measurement of the spread

between numbers in a data set. That is, it measures how far each
number in the set is from the mean and therefore from every
other number in the set.

The standard deviation is a statistic that measures the

dispersion of a dataset relative to its mean and is calculated as
the square root of the variance. It is calculated as the square
root of variance by determining the variation between each data
point relative to the mean. If the data points are further from
the mean, there is a higher deviation within the data set; thus,
the more spread out the data, the higher the standard deviation.
 BASIC TERMS: SHARPE RATIO

 Sharpe ratio is very commonly used measure of risk-adjusted returns

 This risk premium is to be compared with the risk taken. Sharpe Ratio
uses Standard Deviation as a measure of risk. It is calculated as
(Rs-Rf) ÷ Standard Deviation
 Thus, if risk free return is 5%, and a scheme with standard deviation of 0.5
earned a return of 7%, its Sharpe Ratio would be (7% - 5%) ÷ 0.5 i.e. 4%.
 Sharpe Ratio is effectively the risk premium per unit of risk. Higher the
Sharpe Ratio, better the scheme is considered to be. Care should be taken
to do Sharpe Ratio comparisons between comparable schemes. For
example, Sharpe Ratio of an equity scheme is not to be compared with the
Sharpe Ratio of a debt scheme.
.
 Profitability Ratios
Gross Profit Margin
1. This is the Gross Profit as a percentage of Sales
2. Shows production efficiency
3. Helps determine if there will be enough to cover operating
expenses
2. GPM = Gross Profit /Sales x 100
3. A GPM of 80 indicates that for every Rs.100 of sales
generated, Rs.80 goes towards your expenses and net profit

4. OPM – OPERATING PROFIT MARGIN= OPERATING PROFIT/ SALES *100

5. A fall in GPM can mean:
a. Rising Inventory Costs
b. Thefts by Staff or Customers
c. Increasing Discounts
d. Selling products with low margins

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 Net Profit Margin

1. NPM (%) = (Profit After Tax) x 100

Turnover
2. A declining NPM indicates a fall in margin due to
increased competition or rising costs
3. Indicates what percentage will remain after
accounting for all expenses
4. A fall in NPM despite an increase in Turnover and
Net Profit indicates slippage
5. In an ideal situation, Turnover, Net Profit and NPM
should be increasing

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 RETURN RATIOS ( ARE CALCULATED BASED ON
CAPITAL/ TOTAL INVESTMEMT DEPLOYED)

1. ROE- NETT PROFIT/ EQUITY

2. ROI- NETT PROFIT/ TOTAL INVESTMEMT
( EQUITY+ DEBT).
3. ROCE- ( RETURN ON CAPITAL EMPLOYED)=
NETT PROFIT/ CAPITAL EMPLOYED ( ASSETS+ WC)

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VALUATION RATIOS- EARNINGS PER SHARE (EPS)
1. Allows measurement of earnings in relation
2. To every share issued
3. EPS (Rs) = Profit After Tax
Number of Shares
4. As EPS goes up, the company will become more
Valuable
5. EPS will increase if either
a. The PAT increases or
b. The number of shares decrease
6. EPS will decrease if
a. PAT decreases or
b. The number of shares increases
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 VALUATION RATIOS

PRICE TO EARNINGS RATIO

1. Shows the number of times the share price covers
the EPS over a 12 month period
2. PE = Current Share Price
EPS
3. PE ratio not to be used as a standalone number
4. Compare with historical PE, industry or market PE

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 VALUATION- P/BV
PRICE/ BOOK VALUE
The P/B ratio compares a company's market capitalization, or market value, to
its book value. Specifically, it compares the company's stock price to its 
book value per share (BVPS). The market capitalization (company's value) is its
share price multiplied by the number of outstanding shares. The book value is
the total assets - total liabilities and can be found in a company's balance sheet.
In other words, if a company liquidated all of its assets and paid off all its debt,
the value remaining would be the company's book value.

Investors may find the P/B ratio to be a useful metric because it can provide a
good way to compare a company's market capitalization to its book value. But
determining a standard and acceptable price-to-book ratio isn't always easy. As
mentioned above, this varies by industry. In some cases, a lower P/B ratio could
mean the stock is undervalued, but it may also point to fundamental problems
with the company.
P/BV IS USED PREDOMINANTLY TO VALUE BANKS AND
FINANCIALS
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EV - EBITA
 VALUATION-Ev - EBITDA
27


This ratio has two components: EV and EBITDA. EV, or enterprise
value, is calculated by adding the market value of equity and debt,
and subtracting the cash holding as shown in the firm’s book of
accounts. It gives the cost of acquiring business, as the buyer needs
to pay the market value of equity or market capitalisation while
purchasing the company. However, the cash with the firm acts as a
cushion for the buyer and needs to be deducted.

The value of debt must also be included while estimating the


acquisition cost since the interest cost on debt can affect the firm’s
future cash flow and the principal is repayable on maturity. 

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 EV- EBITDA
28

 The other part of the metric is the EBITDA, which is also known as the operating profit.
EBITDA is the earning before interest cost, tax, depreciation and amortisation, and appears
in the firm’s income statement. The other way of arriving at EBITDA is by adding
depreciation, interest cost and tax to the net earning. 

 The EV/EBITDA ratio is better as it values the worth of the entire company. PE ratio gives
the equity multiple, whereas EV/EBITDA gives the firm multiple. The latter is based on the
notion of most successful investors, who propose that equity investing is not just
buying/selling shares, but buying/selling the business 

 EV- EBITA IS USED MOSTLY TO VALUE STOCKS THAT HAVE A HIGH

AMOUNT OF INVESTMENT INTO CAPITAL ASSETS AND WHOSE GESTATION
PERIOD CAN BE LONG. Eg.. Infrastructure stocks, cement, steel etc.

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 WHY ARE THESE IMPORTANT?
Balance Sheet •Shows what assets the
business has
•Shows what it owes others
(liabilities)
•Difference between assets
and liabilities is NETWORTH
•More the Net-worth, more
the financial power

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 What is an Asset?
•CASH
The Resources a business has at its
•Receivables
disposal to produce and market its •Inventory
product or service. •Investments
•Land & Buildings
•Intangibles

Assets = Liabilities + CAPITAL

It must have the ability to generate cash flows!!!

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 DIFFERENT TYPES OF ASSETS
Current Assets: Those which are expected
to be converted into cash within a year
 Investment Assets: Those which are held
as Investments
Long Term Assets: Those which are held
for use over a long period of time

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IV. FINANCIAL STATEMENT ANALYSIS:
 DUPONT ANALYSIS
33

DuPont analysis is a useful technique used to decompose the

different drivers of return on equity (ROE). The decomposition of
ROE allows investors to focus on the key metrics of financial
performance individually to identify strengths and weaknesses.
There are three major financial metrics that drive return on equity
(ROE): operating efficiency, asset use efficiency and financial
leverage. Operating efficiency is represented by net profit margin
 or net income divided by total sales or revenue. Asset use
efficiency is measured by the asset turnover ratio. Leverage is
measured by the equity multiplier, which is equal to average assets
divided by average equity.

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 DUPONT ANALYSIS
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 SOTP( SUM OF THE PARTS)
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The sum-of-the-parts valuation (SOTP) is a process

of valuing a company by determining what its
aggregate divisions would be worth if they were spun
off or acquired by another company.
The valuation provides a range of values for a
company's equity by aggregating the standalone
value of each of its business units and arriving at a
single total enterprise value (TEV).

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 SOTP

 Sum-of-parts valuation, also known as breakup value

analysis, helps a company understand its true value. For
example, you might hear that a young technology company
is "worth more than the sum of its parts," meaning the value
of the company's divisions could be worth more if were sold
to other companies.
 The SOTP valuation is most commonly used to value a
company comprised of business units in different industries
since valuation methods differ across industries depending
on the nature of revenue.
 This valuation tool is used to discuss spinoff’s , sale of
divisions, M&A etc.
 SOTP

 How to Calculate Sum-of-the-Parts Valuation –

SOTP
 The value of each business unit or segment is derived
separately and can be determined by any number of
analysis methods. For example, discounted cash flow (DCF)
valuations, asset-based valuations and multiples valuations
using revenue, operating profit or profit margins are
methods utilized to value a business segment.

 PL REFER ITC SOTP EXCEL SHEET******

 HOLDING COMPANY-GODREJ INDUSTRIES LTD
38
(in crores)

Holding Company Market capitalisation

Godrej Industries Limited 16,599

Market capitalisation Shareholding

Subsidiaries (in crores) (%) Value
Godrej Consumer Products
Limited 70,991 23.80% 16895.86
Godrej Properties Limited 36,888 49.40% 18222.67
Godrej Agrovet Limited 9,430 59.30% 5591.99
    TOTAL 40710.52

DISCOUNT TO MARKET CAPITALISATION IS 60%

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 SOTP-GRASIM INDUSTRIES
LTD
39 (in crores)
Holding Company Market capitalisation
GRASIM INDUSTRIES LIMITED 90,547

Market capitalisation Shareholding

Subsidiaries Value
(in crores) (%)

UltraTech Cement Ltd. 190,607 57.28% 109179.69

Aditya Birla Capital Ltd. 30,611 54.24% 16603.406
Samruddhi Swastik Trading and Investments
Limited 7 100.00% 6.5
Grasim Premium Fabric Private Limited 103 100.00% 102.65
Aditya Birla Solar Limited 67 100.00% 66.58
Aditya Birla Renewables Limited 246 100.00% 245.93
ABNL Investment Limited 28 100.00% 28.14
Birla Power Solutions Ltd 21 51.00% 10.71
Aditya Birla Science & Technology Company Private
Ltd 10 49.50% 4.89555
    TOTAL 126248.5

DISCOUNT TO MARKET CAPITALISATION IS 30%

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 DCF
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 Discounted cash flow (DCF) is a valuation method used to estimate the value

of an investment based on its future cash flows. DCF analysis finds the 
present value of expected future cash flows using a discount rate. A present
value estimate is then used to evaluate a potential investment. If the value
calculated through DCF is higher than the current cost of the Investment, the
opportunity should be considered.
 The purpose of DCF analysis is to estimate the money an investor
would receive from an investment, adjusted for the 
time value of money. The time value of money assumes that a
dollar today is worth more than a dollar tomorrow. For example,
assuming 5% annual interest, $1.00 in a savings account will be
worth $1.05 in a year. Similarly, if a $1 payment is delayed for a
year, its present value is $.95 because it cannot be put in your
savings account.

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 DCF FORMULA
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CF = Cash Flow

r = discount rate (WACC)

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 DISCOUNT RATE- WACC
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 Weighted Average Cost of Capital (WACC)

 If a firm is evaluating a potential project, they may use the 
weighted average cost of capital (WACC) as a discount rate
for estimated future cash flows. The WACC is the average
cost the company pays for capital from borrowing or selling
equity.

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 Valuation – Methodology & Enterprise Value

EXAMPLE OF DCF Method: This is based on the assumption that the value of
the business is a function of the present value of future cash flows to the equity
holders
The projected free cash flow to equity of the next five years is given below

PARTICULARS 2017-18 2018-19 2019-20 2020-21 2021-22

Profit after Tax & Pref. Dividend 14.00 39.30 59.87 89.47 121.42

Add : Depreciation 13.00 13.00 13.00 13.00 13.00

Less : CAPEX (Net of fresh equity) 0.00 0.00 0.00 0.00 0.00

Less : Redemption of Pref. Capital 0.00 0.00 0.00 -25.00 0.00

Changes in Working Capital -4.00 -10.00 -10.00 -10.00 -10.00

Free Cash Flow to Equity 23.00 42.30 62.87 92.47 124.42

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The above projected cash flows have been discounted using a 12% discount factor to
arrive at the following values :

Discounted Cash Flow 20.54 33.72 44.75 58.77 70.60

To the sum of the above, a terminal value is added. As the growth rate of
20% is
more than the discount rate of 12%, Terminal Value is arrived at by dividing the
fifth year’s discounted value with 12%.

44
The Enterprise Value is the total of the discounted cash flows of the
five years
and the terminal value.

R.Lacs

Sum of the above Cash Flows 228.37

Terminal value (70.60/12%) 588.33

Total 816.68

Accordingly, we have arrived at an Enterprise Value of 816 LACS .

FROM 816 LACS WE NEED TO ADD THE CASH BALANCE AND
MINUS DEBT TO ARRIVE AT EQUITY VALUE. IN THIS CASE
THE CASH WAS 35 LACS AND DEBT ZERO, HENCE THE EQUITY
VALUE WOULD BE 816+35 = 851 LACS

If the mkt cap of this company is less than 851 lacs it means the
stock is undervalued and can be bought and if it is more than 851
lacs means the company is over valued and can be sold.
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 FCFF VS FCFE
46

FCFF vs. FCFE

Free cash flow to firm (FCFF) is the cash flow available to
all the firm's providers of capital once the firm pays all
operating expenses (including taxes) and expenditures
needed to support the firm's productive capacity. The
providers of capital include common stockholders,
bondholders, preferred stockholders, and other
claimholders.
Free cash flow to equity (FCFE) is the cash flow available to
the firm’s common stockholders only.
If the firm is all-equity financed, its FCFF is equal to FCFE.
 IPO VALUATION
47

 Some of the factors that play a large role in an IPO valuation are not
based on numbers or financial projections. Qualitative elements that
make up a company's story can be as powerful – or even more powerful
– as the revenue projections and financials. A company may have a new
product or service that will change the way we do things, or it may be
on the cutting edge of a whole new business model. 
 Another aspect of IPO valuation is industry comparables. If the IPO
candidate is in a field that already has comparable publicly traded
companies, the IPO valuation may be linked to the valuation multiples
 being assigned to competitors. The rationale is that investors will be
willing to pay a similar amount for a new company in the industry as
they are currently paying for existing companies.

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 IPO VALUATION
48

The main methods bankers use to value the company

before it goes public are:
Financial modeling (discounted cash flow analysis /
DCF analysis)
Comparable company analysis
Precedent transaction analysis
By combining these three methods, bankers are able to
triangulate on what they think is a reasonable value an
investor would be willing to pay for the business.
 
 WRITING A RESEARCH REPORT- STOCK
RECOMENDATION
49

 BASIC INFORMATION The research report should begin

with some basic information about the firm, including the
company’s ticker symbol, the primary exchange upon which
its shares are traded, the primary sector and industry in which
it operates, the investment recommendation, the current stock
price and market capitalization, and the target stock price.
 INVESTMENT SUMMARY This section should include a
brief description of the company, significant recent
developments, an earnings forecast, a valuation summary and
the recommended investment action. If the purchase or sale of
a security is being advised, there should be a clear and concise
explanation as to why the security is deemed to be mispriced
 RESEARCH REPORT
50

 BUSINESS DESCRIPTION This section should include a detailed

description of the company and its products and services. It should also
convey a clear understanding of the company’s economics, including a
discussion of the key drivers of revenues and expenses. Much of this
information can be sourced from the company itself and via its regulatory
filings, as well as industry publications.
 INDUSTRY OVERVIEW AND COMPETITIVE POSITIONING This
section should include an overview of the industry dynamics, including a
competitive analysis of the industry. Most firms’ annual reports include
some discussion of the competitive environment. A group of peer companies
should be developed for purposes of a competitive analysis. The “Porter’s
Five Forces” framework for industry analysis is an effective tool for
examining the health and competitive intensity and of an industry.
Additionally, production capacity levels and pricing are important
considerations, as are the distribution and stability of market share
 RESEARCH REPORT
51

 VALUATION This section should include a thorough

valuation analysis of the company using conventional
valuation metrics and formulas. Equity valuation models
can derive either absolute or relative values. Absolute
valuation models derive an asset’s intrinsic value, and
generally take the form of discounted cash flow models.
Relative equity valuation models estimate a stock’s value
relative to another stock, and can be based on a number of
different metrics, including price/sales, price/earnings,
price/cash flow, and price/book value. Because model
outputs can vary, as a check, more than one valuation
model should be used.
 RESEARCH REPORT
52

FINANCIALS OF THE COMPANY- LAST TWO YEARS

PERFORMANCE AND ONE YEAR FORWARD
PROJECTION SHOULD BE MADE AVAILABLE, QNQ
PERFORMANCE FOR 2 YEARS ALSO IS A MUST. ( this
can be in a tabular form)
INVESTMENT RISKS This section should address
potentially negative industry and company developments
that could pose a risk to the investment thesis. Risks can be
operational or financial in nature, or related to regulatory
issues or legal proceedings. ANY CORPORATE
GOVERNANCE CONCERNS SHOULD BE MENTIONED
HERE.