Know The Market(Session-10)

Fundamental Analysis-

• Fundamental analysis is one of the most popular method of stock analysis.
• You can choose and evaluate the company through its earning and balance sheet.
• Essence of fundamental analysis is to find out as much you can about the company to decide whether it is worthwhile investment compared to other stocks. 
• It tries to estimate the value of stock through the analysis of various factors such as the management, financials,economy and industry in which the company operates etc.

Approaches to Fundamental Analysis-

There are two approaches of fundamental analysis-

1. Top Down Approach
2. Bottom Up Approach

• In top down approach we must try to understand the economy. Then we make shortlist about the industry, which industry was exactly grow. Then identify the companies based on the industry.
• In bottom up approach the fundamental analysis is based on the company specific.

Q- What is top down approach?

Ans-

• Top Down investor looks at macro economic variable like GDP, inflation, Interest rates etc.
• The investor then identifies the various sectors, that are likely to perform better than others and looks for opportunities in these sectors first.
• Lastly he picks the best performing stocks in that sector.

Q- What is bottom up approach?

Ans-

• This strategy focus more on the company.
• The stocks are chosen based on their valuations and the growth potential rather looking whether the company is in the right sector or not.
• Investment decision is based upon the factors such as market size, competitive position of the company, sales, earning expected future earnings and balance sheet.
• Financials such as debt, ratios play an important role rather than the economic or industrial factors in which the company operates.

Analysis of the Economy-

• Economic Analysis helps in understanding and interpreting the stock markets better.
• There are a few economic indicators that play a vital role.

Example-

1. GDP
2. Inflation
3. Interest Rates
4. Forex Reserves
5. International Trade
6. Crude Oil Prices
7. Credit Policies of RBI

Industry Analysis-

• Purpose of industry is to identify those industries with a potential for future growth.
• And then investing in equity shares of companies, selected from such industries.
• Provides statistics about the market potential of the business products and services in that industry.
• Gives a view about the current state of the industry and the likely future trends.

Parameters for Industry Analysis-

• Understanding the type of the industry. Ex- Manufacturing, Construction, Service, Genetic etc.
• Understanding the stage of industry life cycle, like pioneering stage, expansion stage, stagnation stage etc.
• Understanding strengths, weakness, opportunities and threats to the industry.
• Competitive forces and industry profitability: Understanding copmetitors, subtitutes, bargaining power of buyers and suppliers etc.

Company Analysis-

• Company Analysis is also referred to as Fundamental Analysis.
• It analyses all aspects of the company including finances, profit margins, organisation structure, growth opportunities, management team etc.
• There are two parts to fundamental analysis:

1. Financial Analysis
2. Non Financial Analysis

Understanding company Financials-

1. Annual report
2. Balance sheet
3. Income statement

Analysis of financial statements helps in understanding whether the financial position, operations and financial growth are satisfactory or not.

Annual Report-

• These reports are generally long and contain important financial documents
• Annual report gives below details-

1. Balance Sheet and income statement
2. Information regarding companies growth strategy
3. Marketing and advertising plans
4. Sales strategy

Directors Report - Any potential risk that could affect the company, which talks about how the company has performed, future business strategies and profitability.

Q- How to read and understand the balance sheet ?

Ans-

• Is report of the financial condition of the business
• Gives a detailed picture of the companies assets and liabilities on particular day.
• The logic behind producing a balance sheet is to ensure that all of the companies funds are accounted.
• Usually created at least once a year.
• The companies in order to get a better hold on the finances, tend to prepare it on quarterly and half yearly basis.
• Assets- Land, Machinery, Accounts, Loans and Advances.
• Liabilities- Reserves and surplus , Debt etc.
• Share Capital- Equity share capital, preference share capital.

Income Statement-

• It tell up about companies current year financials.
• It contains lot of information such as company sales, operating expenses etc.
• First line of income statement gives the companies sales or revenue referred to as top line.
• Next section in income statement gives the operating expenses, i.e. cost of doing a business like raw material cost, salaries etc.
• Third section contains income of the company after paying all the expenses referred to as bottom line.

Q- What are the key ratio's to analyze a company?

Ans-

• Operating and Net profit margin Ratios- Measure the % of profits earned per rupee of sales made by the company.
• Operating Profit Margin- Measures the revenue generated from operations.
• Net profit Margin- Reflects the income that is left for the investors after the deduction of costs such as depreciation, tax, interest etc.
• Higher the profit margins indicate a company to be more profitable having better control over its costs.

EPS- Earning Per Share

• It measures the profit available to equity share holders on a per share basis.
• This ratio is considered important in estimation the market price of the share.
• Low EPS = Lower possible dividends and so lower market value.
• High EPS has a favourable effect on the market.
• However, EPS alone does not reflect the effect of various operations of the business.

Return on Equity(ROE)-

• It is a tool that helps measure how effectively a company has been managed.
• It measures efficiency of the firm in generating profits for each unit of share holders equity utilized.
• % of return each share holder is likely to get for the money invested.
• In general higher the ROE more  effective with a rising ROE and growing earnings.

Return on Capital Employed-

• Efficiency of the in generating profits for each unit capital invested in the firm.
• The capital may be a combination of funds raised through equity as well as debt.

Current Ratio-

• It measures the  companies ability to pay short-term obligations.
• It indicates the liquidity position of the firm, the ease with which the firm is able to manage its working capital requirements.
• A ratio greater than 1 indicates the company is more capable in paying off its obligations provided the current assets are majorly composed of liquid assets.

Debt to Equity Ratio-

• Relation between the borrowed funds and the owner's capital of the firm.
• It is also know as external -  internal equity ratio.
• It is used to ascertain the soundness of the long term financial policies of the business.
• It shows the choice of financial channels of a company. whether the company is dependent more on debt or on equity for raising of funds.
• Debt refers to long term loans such as long term debentures, loans from financial institutions etc.
• Equity refers to the share holders funds such as equity share capital, preference share capital, reserves and surplus etc.
• A higher debt equity ratio compared to the industry may be dangerous, as its indicates higher debt leading to majority of earnings routed for the payment of interest.

Interest Coverage Ratio-

• Efficiency of the companies EBIT to cover the interest expenses.
• A higher interest coverage ratio indicates that the company can easily meet the interest expense.
• An interest ratio less than 2 indicates that more than 50% of the companies EBIT is routed for interest payments.

Price/Book Value Ratio(P/B ratio)-

• It used to compare the market price of the share to its book value.
• P/B is commonly used in industries with more liquid assets such as banks and financial institutions.
• A higher P/B is a better condition for a running company a P/B should never be low.
• If a good company has a P/B , it may be a buy signal.

Price Earning Ratio(P/E ratio)-

• This ratio establishes a relationship between the market price of the shares of a company and its earning per share.
• This ratio helps in predicting the future market value of the shares within reasonable limits.
• P/E ratio is the most commonly used method of valuing companies.

A high P/E ratio indicates two things-

1. the investors are expecting the earnings to grow at a faster pace.
2. the company is fundamentally strong compared to its peers in the industry.

Non Financial Analysis of a company-

• It is the practice of analysing something based on subjective method, apart form any factual or statistical data.

Limitations of Fundamental Analysis-

• It is extremely time consuming process.
• Even though company fundamentals are good, stock price can still go down for a variety of reasons like, supply and demand, fear and hope, price and volume.
• You need skill and knowledge to do fundamental analysis.
• It is based on certain assumptions about a companies future prospects, in reality assumptions may not come true.
• Almost all companies tend to highlight the positive aspects of the business while underplaying the negatives.

---Thank You---

1. Know The Market- Session-1

2. Know The Market- Session-2

3. Know The Market- Session-3

4. Know The Market- Session-4

5. Know The Market- Session-5

6. Know The Market- Session-6

7. Know The Market- Session-7

8. Know The Market- Session-8

9. Know The Market- Session-9