fundamental analysis intro

Fundamental Analysis –Equity Research

What,Why,Who, WhomWhat: Core analysis of each element of an entity

Why: To know the worth of the entity

Who: Research analysts

Whom: professionals in Broking,investment banking, trading,corporates, P/e Funds

There are three forms of ‘analysis’ commonly used in the Financial world for Security Analysis

Fundamental Technical Quantitative

Fundamental Analysis

Fundamental analysis tries to determine the ‘correct’ worth/value of a company by an in-depth study

Fundamental analysis is the examination of the factors underlying the stock or other instrument

In other words, It is getting to the heart of the firm, doing lots of accounting and projections to model a company and hence its stock price.

Technical AnalysisTechnical analysis is a way of predicting future price

movements based only on observing the past history of prices.

This price history may also include other quantities such as volume of trade.

Technical analysis is also called charting because the graphical representation of prices, etc. plays an important part.

Quantitative AnalysisQuantitative analysis is all about treating financial

quantities such as stock prices or interest rates as random, and then choosing the best models for that randomness.

Quantitative Analysis is used for pricing of derivatives , portfolio theory an Risk Management.

Fundamental AnalysisFundamental analysis refers to the study of the core underlying elements that influence the

economy of a particular entity.

analyzing economic indicators, government policy and societal factors (to name just a few elements) within a business cycle framework.

the process by which one can discover securities which are underpriced and take advantage

We follow the EIC approach to fundamental analysis that is Economy , Industry and Company analysis

ECONOMIC ANALYSIS

No industry or company can exist in isolation . Its sales and its costs are affected by factors, some of which

are beyond its control - the world economy, price inflation, taxes and a host of others.

Government Policy is crucial to the well being of the economy. Ideally the government should pursue a policy which ensures a favourable climate for private investments.

It is important, therefore, to have an appreciation of the politico-economic factors that affect an industry and a company.

There are three types of economic indicators which help in macroeconomic analysis

Leading Indicators: They Predict what is likely to happen to the economy .They are Rainfall, Agricultural Produce, Money Supply, Credit Position, Stock Markets, Fixed capital investment.

Coincident Indicators- They highlight the current position. They are GNP, GDP, IIP, money market rates (call, repo, CBLO), interest rates and amount of funds with the banks.

Lagging Indicators- They generally change last like unemployment rate

Economic Indicator Favourable Impact if

the Indicator is:GDP High

Unemployment Low

Fixed Capital Investment High

Interest Rates Low

Forex Reserves High

Balance of Payments Low

Fiscal Deficits Low

Inflation Low

Industrial Production High

Agricultural Production High

Freight Movement of Railways High

New House Construction High

Economic Indicators & Their Impact

II. INDUSTRY ANALYSIS

Industry Analysis is the next step in analysing a company.Every Industry has a Life-Cycle and goes through various

stages from pioneering ,expansion and declining phase.For Valuing a company it is very important to know sector

specific parameters, drivers of the sector and the stage in the life-cycle of industry

Peer comparison is also important and relative out-performance or under-performance can be mapped by comparing to peers.

Industry Analysis can be done efficiently by Michael Porter’s Five Forces Analysis

1. BARRIER TO ENTRY New entrants increase the capacity in an industry and the inflow of funds. The question that arises is

how easy is it to enter an industry? There are some barriers to entry:a) Economies of scaleb) Product differentiationc) Capital requirementd) Government policy

2. THE THREAT OF SUBSTITUTION New and better products replace existing ones. An industry that can be replaced by substitutes or is

threatened by substitutes is normally an industry one must be careful of investing in. To ward off the threat of substitution, companies often have to spend large sums of money in advertising and promotion.

3. BARGAINING POWER OF THE BUYERS In an industry where buyers have control, i.e. in a buyer's market, buyers are constantly forcing

prices down, demanding better services or higher quality and this often erodes profitability.

4. BARGAINING POWER FOR THE SUPPLIERS An industry unduly controlled by its suppliers is also under threat.

5. RIVALRY AMONG COMPETITORS Rivalry among competitors can cause an industry great harm. This occurs mainly by price cuts,

heavy advertising, additional high cost services or offers, and the like.

III. COMPANY ANALYSIS At the final stage of fundamental analysis, the investor analyzes the

company. This analysis has two thrusts:

How has the company performed vis-à-vis other similar companies and how has the company performed in comparison to earlier years.

It is imperative that one completes the politico economic analysis and the industry analysis before a company is analyzed because the company's performance at a period of time is to an extent a reflection of the economy, the political situation and the industry

Company analysis--- 1)qualitative analysis 2) quantitative analysis.

Industry Analysis

Banks

Banking Sector was opened up gradually to private sector after all major banks were nationalised in 1969.

The Indian Banking Industry is mix of Private Banks and Public Sector Banks.

The activities of Foreign Banks is somewhat restricted in India

For banks Loans( the amount it disburses to customers) are assets since banks earn interest on loans disbursed

Deposits of customers are their liabilities as have to pay interest on the deposits.

Out of the total Cash available certain amount is required for the following :

CRR (Cash Reserve Ratio) Banks need to maintain certain amounts of its cash to the Reserve Bank as a cash reserve ratio. SLR (Statutory Liquidity Ratio) Banks need to invest certain amount in Govt securities. Thus they earn interest over the G-Secs.

Key source of funds for banks are the deposits available with bank namely CASA (current account and savings account) since interest paid on CASA is very less compared to interest on term deposits

Key considerations while Analysing a Banking Stock

Income for banks primarily comes from the interest paid on the loans, other income such as fee based income is also picking up.

Fee Based income includes, MF dist, Insurance Dist, Clearing , Credit Cards, Demat accounts and advisory. (well below global average of 50% at 15%)

Key Parameters to value a bank stock (CRAMEL)Growth in CASA and assets (loans Made) Net Interest Income (NII), which basically is the difference

between interest received and interest paid. Asset Quality : Number of non- performing assets (NPAs or

bad Loans) and provisioning for the same .

Valuation

Book Value- Growth comes from Networth.Capital Adequacy Ratio- Global regulatory

requirement to cushion for provisioning of losses .Net Interest Margin= NII divided by average earning

assets.

Auto Ancillary

Considerations For Analysing Auto Ancillary Stock

Highly fragmented in nature. Different companies manufacture different products

like engine parts, transmission & steering parts, Suspension & Braking parts, Electrical, equipment , Tyres & others.

As auto ancillary cos act as vendors it is important they stay competitive both quality wise and cost wise.

Can generate revenues by two sources: (i) to supply to original equipment manufacturers (OEMs) and (ii) market sales.

Tier I players are the ones which supply to OEMs and offer value added services.

Raw materials are sourced from Tier II and Tier III for Tier I manufacturers.

Tier I command better margins but have to be quality conscious and hence have to keep high levels of inventory increasing working capital requirements.

Essential factor for success – Diversification across globe and India

Expenses:Designing and testing costsHigher raw material costs due to weakened bargaining power

of the sector. Cost rises absorbed internally through cost restructuring or lowering margins affecting profitability

Labour Intensive business mirrored by high percentage of salaries10-12% of sales Or Automation costs around 5-6 % of total sales.

Interest rate sensitive, reliant on performance of Auto Industry. Valuations:Key Ratio- P/E ratio ( higher for exporting cos)