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Fundamental analysis hard copy


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Fundamental analysis hard copy

  2. 2. Class: S.Y.B.F.M. Semester: 4 th PRESENTATION ON: Fundamental analysis Submitted to: Prof. priya shroff Academic year: 2011-12
  4. 4. Introduction Fundamental analysis of a business involves analyzing its Financial statement and health, Its management and competitive advantage, and its competitors and markets. When applied to futures and forex, it focuses on the overall state of the economy, interested, production, earning and management. When analyzing a stock, future contracts, or currency using fundamental analysis there are two basic approaches one can use; bottom up analysis and top down analysis. The term is used to distinguish such analysis from other types of investment analysis, such as quantitative analysis and technical analysis. As the market relentlessly calls into question virtually every portion of your stock portfolio, even the most independent-minded investor can start doubting himself. You wonder did I make the right decisions when I bought these stocks? To answer yourself in any rational fashion, you need to be able to judge whether circumstances, not just psychology, have changed for your holdings. Fundamental analysis is performed on historical and present data, but with the goal of making financial forecasts. There are some objectives: 1) To conduct a company stock valuation and predict its probable price evolution 2) To make a projection on its business performance, to evaluate its management and make internal business decisions, to calculate its credit risk.
  5. 5. Meaning of Fundamental analysis  Fundamental analysis is a method used to determine the value of a stock by analyzing the financial data that is 'fundamental' to the company. That means that fundamental analysis takes into consideration only those variables that are directly related to the company itself, such as its earnings, its dividends, and its sales. Fundamental analysis does not look at the overall state of the market nor does it include behavioral variables in its methodology. It focuses exclusively on the company's business in order to determine whether or not the stock should be bought or sold.  Fundamental analysis is a stock valuation method that uses financial and economic analysis to predict the movement of stock prices.  Fundamental analysis is the study of economic, industry, and company conditions in an effort to determine the value of a company's stock. Fundamental analysis typically focuses on key statistics in a company's financial statements to determine if the stock price is correctly valued.
  6. 6. overview Fundamental analysis is the study of economic, industry, and company conditions in an effort to determine the value of a company's stock. Fundamental analysis typically focuses on key statistics in a company's financial statements to determine if the stock price is correctly valued. They realize that some people will find a discussion on fundamental analysis within a book on technical analysis peculiar, but the two theories are not as different as many people believe. It is quite popular to apply technical analysis to charts of fundamental data, for example, to compare trends in interest rates with changes in security prices. It is also popular to use fundamental analysis to select securities and then use technical analysis to time individual trades. Even diehard technicians can benefit from an understanding of fundamental analysis (and vice versa). Interpretation Most fundamental information focuses on economic, industry, and company statistics. The typical approach to analyzing a company involves four basic steps: 1) Determine the condition of the general economy. 2) Determine the condition of the industry. 3) Determine the condition of the company.
  7. 7. Economic Analysis The economy is studied to determine if overall conditions are good for the stock market. Is inflation a concern? Are interest rates likely to rise or fall? Are consumers spending? Is the trade balance favorable? Is the money supply expanding or contracting? These are just some of the questions that the fundamental analyst would ask to determine if economic conditions are right for the stock market. Industry Analysis The company's industry obviously influences the outlook for the company. Even the best stocks can post mediocre returns if they are in an industry that is struggling. It is often said that a weak stock in a strong industry is preferable to a strong stock in a weak industry. Company Analysis After determining the economic and industry conditions, the company itself is analyzed to determine its financial health. This is usually done by studying the company's financial statements. From these statements a number of useful ratios can be calculated. The ratios fall under five main categories: profitability, price, liquidity, leverage, and efficiency. When performing ratio analysis on a company, the ratios should be compared to other companies within the same or similar industry to get a feel for what is considered "normal." At least one popular ratio from each category is shown below.
  8. 8. Fundamental analysis of stocks in india The process of fundamental analysis involves examining the economic, financial & other qualitative as well as quantitative factors related to a security so as to determine its intrinsic value. While usually this method is used to evaluate the value of a company’s stock, it can also be used for any kind of security, like bonds or currency. Fundamental analysis is also known as quantitative analysis and involves delving into a company’s financial statements (such as profit and loss account and balance sheet) in order to study the various financial indicators (such as earnings, liabilities, revenues, expenses and assets). Such an analysis is usually carried out by brokers, analysts, and savvy investors. Two approaches in fundamental analysis While carrying out fundamental analysis, investors can use any of the following approaches: Top-down approach: in this approach, an analyst investigates both national and international economic indicators, like energy prices, gdp growth rates, inflation and interest rates. The analysis of total sales, price levels and foreign competition in a sector is also done in order to identify the best business in the sector. Bottom-up approach: In this method, an analyst starts the search with specific businesses, irrespective of the industry or region.the analysis of a business health starts with financial statement analysis that includes ratios. It looks at dividends paid,operating cash flow,new equity issues and financing.
  9. 9. Fundamental analysis tool These are the most popular tools of fundamental analysis. They focus on earnings, growth, and value in the market. For convenience, I have broken them into separate articles. Each article discusses related ratios. There are links in each article to the other articles and back to this article. Earning per share: The overall earnings of a company are not in itself a useful indicator of a particular stock's worth. Low earnings and low outstanding shares could be more valuable than high earnings along with a high number of outstanding shares. The Earnings per share is much more practical information than earnings by itself. Earnings per share (EPS) is arrived at by dividing the net earnings by number of outstanding shares. EPS = (NPAT- PD)/ NO.OF EQUITY SHARE Price earnings ratio (P/E ratio): The Price to Earnings Ratio (P/E) indicates the relationship between stock prices and company earnings. It is computed by dividing the share price by the Earnings per Share. The P/E indicates how much investors are willing to pay for a particular company's earnings. A high P/E can mean that the company is overpriced or it could also mean that investors are expecting the company to continue growing and generate profits. P/E ratio = MPS/EPS
  10. 10. Dividend payout ratio: is calculated to find the extent to which earnings per share have been used for paying dividend and to know what portion of earnings has been retained in the business. It is an important ratio because ploughing back of profits enables a company to grow and pay more dividends in future. Dividend payout ratio= Dividend per share / EPS Dividend yield ratio: It is the relationship between dividends per share and the market value of the shares. This measurement tells you what percentage return a company pays out to shareholders in the form of dividends. Older, well-established companies tend to payout a higher percentage then do younger companies and their dividend history can be more consistent. Dividend yield ratio = DPS/MPS Price to book ratio: The P/B ratio is the value that the market places on book value of the company and is calculated by dividing current price per share by book value per share (i.e. book value / number of outstanding shares). Companies having a low P/B are good and often chosen by long term investors who see the company’s potential. P/B = Share Price / Book Value Per Share
  11. 11. Book value: A company's book value is a price ratio calculated by dividing total net assets (assets minus liabilities) by total shares outstanding. Depending on the accounting methods used and the age of the assets, book value can be helpful in determining if a security is overpriced or under-priced. If a security is selling at a price far below book value, it may be an indication that the security is under-priced.. book value = assets – liability price to sale: One ratio you can use is Price to Sales or P/S ratio. This metric looks at the current stock price relative to the total sales per share. You calculate the P/S by dividing the market cap of the stock by the total revenues of the can also calculate the P/S by dividing the current stock price by the sales per share. P/S = Market Cap / Revenues or P/S = Stock Price / Sales Price Per Share
  12. 12. Fundamental Analysis :Qualitative factor- The company Business Model Even before an investor looks at a company's financial statements or does any research, one of the most important questions that should be asked is: What exactly does the company do? This is referred to as a company's business model – it's how a company makes money Sometimes business models are easy to understand. Take McDonalds, for instance, which sells hamburgers, fries, soft drinks, salads and whatever other new special they are promoting at the time. It's a simple model, easy enough for anybody to understand. Competitive Advantage Another business consideration for investors is competitive advantage. A company's long-term success is driven largely by its ability to maintain a competitive advantage - and keep it.. When a company can achieve competitive advantage, its shareholders can be well rewarded for decades. Management Just as an army needs a general to lead it to victory, a company relies upon management to steer it towards financial success. Some believe that management is the most important aspect for investing in a company. This is one of the areas in which individuals are truly at a disadvantage compared to professional investors. On the other hand, if you are a fund manager interested in investing millions of dollars, there is a good chance you can schedule a face-to-face meeting with the upper brass of the firm.
  13. 13. Corporate Governance Corporate governance describes the policies in place within an organization denoting the relationships and responsibilities between management, directors and stakeholders. These policies are defined and determined in the company charter and its bylaws, along with corporate laws and regulations. The purpose of corporate governance policies is to ensure that proper checks and balances are in place, making it more difficult for anyone to conduct unethical and illegal activities. a) Financial and Information Transparency This aspect of governance relates to the quality and timeliness of a company's financial disclosures and operational happenings. Sufficient transparency implies that a company's financial releases are written in a manner that stakeholders can follow what management is doing and therefore have a clear understanding of the company's current financial situation. b) Stakeholder Rights This aspect of corporate governance examines the extent that a company's policies are benefiting stakeholder interests, notably shareholder interests. Therefore companies with good governance give shareholders a certain amount of ownership voting rights to call meetings to discuss pressing issues with the board.
  14. 14. Fundamental Analysis: Qualitative Factors - The Industry Customers Some companies serve only a handful of customers, while others serve millions. In general, it's a red flag (a negative) if a business relies on a small number of customers for a large portion of its sales because the loss of each customer could dramatically affect revenues. For example, think of a military supplier who has 100% of its sales with the U.S. government. One change in government policy could potentially wipe out all of its sales. For this reason, companies will always disclose in their 10-K if any one customer accounts for a majority of revenues. Market Share Understanding a company's present market share can tell volumes about the company's business. The fact that a company possesses an 85% market share tells you that it is the largest player in its market by far. Furthermore, this could also suggest that the company possesses some sort of "economic moat," in other words, a competitive barrier serving to protect its current and future earnings, along with its market share. Market share is important because of economies of scale. When the firm is bigger than the rest of its rivals, it is in a better position to absorb the high fixed costs of a capital-intensive industry.
  15. 15. Industry Growth One way of examining a company's growth potential is to first examine whether the amount of customers in the overall market will grow. This is crucial because without new customers, a company has to steal market share in order to grow. In some markets, there is zero or negative growth, a factor demanding careful consideration. For example, a manufacturing company dedicated solely to creating audio compact cassettes might have been very successful in the '70s, '80s and early '90s. However, that same company would probably have a rough time now due to the advent of newer technologies, such as CDs and MP3s. The current market for audio compact cassettes is only a fraction of what it was during the peak of its popularity. Competition Simply looking at the number of competitors goes a long way in understanding the competitive landscape for a company. Industries that have limited barriers to entry and a large number of competing firms create a difficult operating environment for firms. One of the biggest risks within a highly competitive industry is pricing power. This refers to the ability of a supplier to increase prices and pass those costs on to customers. Companies operating in industries with few alternatives have the ability to pass on costs to their customers. A great example of this is Wal-Mart. They are so dominant in the retailing business, that Wal-Mart practically sets the price for any of the suppliers wanting to do business with them. If you want to sell to Wal-Mart, you have little, if any, pricing power.
  16. 16. Regulation Certain industries are heavily regulated due to the importance or severity of the industry's products and/or services. As important as some of these regulations are to the public, they can drastically affect the attractiveness of a company for investment purposes. In industries where one or two companies represent the entire industry for a region (such as utility companies), governments usually specify how much profit each company can make. In these instances, while there is the potential for sizable profits, they are limited due to regulation. In other industries, regulation can play a less direct role in affecting industry pricing. For example, the drug industry is one of most regulated industries. And for good reason - no one wants an ineffective drug that causes deaths to reach the market. As a result, the U.S. Food and Drug Administration (FDA) requires that new drugs must pass a series of clinical trials before they can be sold and distributed to the general public. However, the consequence of all this testing is that it usually takes several years and millions of dollars before a drug is approved. Keep in mind that all these costs are above and beyond the millions that the drug company has spent on research and development.
  17. 17. Fundamental Analysis: Introduction to Financial Statements Financial statements are the medium by which a company discloses information concerning its financial performance. Followers of fundamental analysis use the quantitative information gleaned from financial statements to make investment decisions. Before we jump into the specifics of the three most important financial statements - income statements, balance sheets and cash flow statements - we will briefly introduce each financial statement's specific function, along with where they can be found. The Major Statements The Balance Sheet The balance sheet represents a record of a company's assets, liabilities and equity at a particular point in time. The balance sheet is named by the fact that a business's financial structure balances in the following manner: Assets = liability + shareholder’s equity Assets represent the resources that the business owns or controls at a given point in time. This includes items such as cash, inventory, machinery and buildings. The other side of the equation represents the total value of the financing the company has used to acquire those assets. Financing comes as a result of liabilities or equity. Liabilities represent debt (which of course must be paid back), while equity represents the total value of money that the owners have contributed to the business including retained earnings, which is the profit made in previous years.
  18. 18. The Income Statement The income statement measures a company's performance over a specific time frame. The income statement presents information about revenues, expenses and profit that was generated as a result of the business' operations for that period. Statement of Cash Flows The statement of cash flows represents a record of a business' cash inflows and outflows over a period of time. Typically, a statement of cash flows focuses on the following cash-related activities: Operating Cash Flow (OCF): Cash generated from day-today business operations. Cash from investing (CFI): Cash used for investing in assets, as well as the proceeds from the sale of other businesses, equipment or long-term assets. Cash from financing (CFF): Cash paid or received from the issuing and borrowing of funds. The cash flow statement is important because it's very difficult for a business to manipulate its cash situation. There is plenty that aggressive accountants can do to manipulate earnings, but it's tough to fake cash in the bank. For this reason some investors use the cash flow statement as a more conservative measure of a company's performance.
  19. 19. 10-K and 10-Q Some other pieces of information that are also required are an auditor's report, management discussion and analysis (MD&A) and a relatively detailed description of the company's operations and prospects for the upcoming year. All of this information can be found in the business' annual 10K and quarterly 10-Q filings, which are released by the company's management and can be found on the internet or in physical form. The 10-K is an annual filing that discloses a business's performance over the course of the fiscal year. In addition to finding a business's financial statements for the most recent year, investors also have access to the business's historical financial measures, along with information detailing the operations of the business. This includes a lot of information, such as the number of employees, biographies of upper management, risks, future plans for growth, etc. Businesses also release an annual report, which some people also refer to as the 10-K. The annual report is essentially the 10-K released in a fancier marketing format. It will include much of the same information, but not all, that you can find in the 10-K. The 10-K really is boring - it's just pages and pages of numbers, text and legalese. But just because it's boring doesn't mean it isn't useful. There is a lot of good information in a 10-K, and it's required reading for any serious investor. You can think of the 10-Q filing as a smaller version of a 10-K. It reports the company's performance after each fiscal quarter. Each year three 10-Q filings are released - one for each of the first three quarters. Unlike the 10-K filing, 10-Q filings are not required to be audited
  20. 20. conclusion Whenever you’re thinking of investing in a company it is vital that you understand what it does, its market and the industry in which it operates. You should never blindly invest in a company. One of the most important areas for any investor to look at when researching a company is the financial statements. It is essential to understand the purpose of each part of these statements and how to interpret them.