The document discusses fundamental analysis techniques for evaluating stocks. It begins with an overview of analyzing the economy, industries, and specific companies. It then covers various financial ratios for analyzing companies' performance, valuation methods like discounted cash flow models and relative valuation. The document concludes by discussing techniques for setting price targets and projections, and notes both strengths and weaknesses of fundamental analysis.

1. Inter Connected Stock
Exchange of India
Khalsa College
18 th April 2007
By Anil Harolikar
anilharolikar@rediffmail.com

2. Structure
 Interpretation of Financial Statements
 Ratio Analysis
 Fundamental Analysis
 Valuation Ratios
 Price Target and Projections
 Summary

3. Balance sheet
Structure of Balance Sheet
Financial Statements
Ratio Analysis

4. Structure of a Balance Sheet
 Balance Sheet as at 31
st March 2006
 Profit and Loss Account
for the Year / Period
ended 31 st March 2006
 Schedules
 Cash Flow
 Ratios
 Notice of AGM
 Chairman’s Statement
 Directors Report
 Management Discussion
and Analysis
 Corporate Governance
 Auditor’s Report
 Notes on Accounts

5. Definition
Ratio is relationship between two amounts
Proportion that one amount bears to another

6. Different forms
 Pure Ratio – DER
 Related to Time period- Working capital
turnover
 Percentage – NP / Sales

7. IMPORTANCE
 Helps analyse relationships
 Helps prepare budgets and formulate
policy
 Trend analysis
 Inter company comparison
 Liquidity position

8. For whom
 Analysts
 Portfolio Managers
 Creditors / Lenders
 Suppliers
 Government
 Management
 Investors / Shareholders
 Public at large

9. Different classes of Ratios
 Based on Balance Sheet
( or Financial)
 Based on Revenue Statement
( or Operational)
 Based on Combination of both statements

10. Working capital cycle
 Current Assets =
 Cash / Bank >
 Raw materials >
 Work in process >
 Finished Goods stock >
 Receivables (if sold on credit) >
 Cash / Bank.

11. Current Liabilities
 Unpaid Expenses like
salaries / wages,
power bills,
telephone bills,
 Materials purchased on credit,
 Interest due on Working Capital and Term
loans.

12. Financial Ratios
I. Liquidity /
Solvency ratios
II. Gear ratio III. Asset cover
ratios
a. Current a.Debentures
b. Liquid b.Creditors
c. Absolute
liquidity
c. Pref.
shareholders
d. Proprietary d.Equity
e. Fixed asset e. Security cover
f. Debt Equity

13. Financial Ratios
 LIQUIDITY Ratios
 Current Ratio = Current Assets /
Current Liabilities
 Acid Test or Quick Ratio
= CA minus Inventories / short
term Liabilities

14. LEVERAGE
RATIOS
 Total DER = Total Debt / NW
 LT DER = LT Loans / NW

15. COVERAGE
Ratios
 Security Cover = Assets to TL

16. Operational Ratios
REVENUE STATEMENT RATIOS

17. Operational Ratios
I. Expense ratios II. Earnings
ratios
III. Profit cover
ratios
a. Fixed cost /
Total cost
a.GP ratio or
Turnover ratio
a. Dividend
cover
b. RM / sales b. NP ratio b. Interest cover
c. Wages / sales c. Operating
profit ratio
c. Total
coverage ratio
d. Office &
admin.exp /sales
e. Selling &

18. REVENUE STATEMENT RATIOS
 EXPENSE RATIOS
 EARNINGS RATIOS
 PROFIT COVER

19. EXPENSE RATIOS
FC to Total Cost = Power + Employee +
Others + Depreciation +
Interest charges
/ Total Cost
Wages / Sales

20. Concept of Breakeven
 Contribution =
Sale consideration − Variable cost.
 The higher the contribution, better.
 Breakeven point = the level of activity at
which revenues and costs are equal.
 The lower the fixed cost, the earlier will
the company reach breakeven.

21. EARNINGS RATIOS
GP Margin = Gross Profit / Sales
OP Margin = Operating Profit / Sales
NP Margin = Net Profit / Sales

22. Gross Profit
 Gross profit = Net Sales
minus cost of Goods sold
 Cost of goods sold = costs incurred for
manufacturing the goods sold.
 Includes Direct material cost, Direct
labour cost and factory overheads.

23. Operating profit
 Operating profit = Gross profit
minus Operating Expenses.
 Operating Expenses = General
Administrative expenses + Selling and
Distribution expenses + Depreciation.

24. EBITA margin
 Profit before Interest and taxes = EBITA
= Operating profit + Non – operating
surplus / deficit.
 Measure of profit not influenced by
Financial leverage and Tax factor.
 Considered More Suitable for inter-
company comparison.

25. Net Profit
 Net profit = OP (+/– non-OP) - financial
expenses ( interest on borrowed funds).
 PBT = NP
 PAT = PBT- tax
 Retained earnings = PAT - dividends

26. PROFIT COVER
 Dividend Cover Ratio
= NP / Dividend amount
 Dividend pay out ratio
 What is the reasonable ratio
Growing company
Mature company
Cash strapped company
Cash rich company

27. PROFIT COVER
 Interest Cover
= NP+ Interest added back / Interest
 Manufacturing company
 Banking / Finance company

28. Combined Ratios
 I. Turnover ratios
 Inventory turnover
 Debtors turnover
 Creditors turnover
 Turnover to assets and
liabilities
 II. Profitability ratio
 ROCE/RONW/ROE
 NP to Fixed assets
/NP to Total assets
 EPS / PE ratio / Div
Yield ratio / DPS / Div
payout ratio

29. Combined Ratios
 TURNOVER or VELOCITY RATIOS
 Inventory Turnover = Sales / Inventory
 Debtors Turnover = Credit Sales /
Debtors
 Turnover to Assets = Sales / Total
Assets

30. PROFITABILITY RATIOS
 ROCE = NP / Total Capital
 RONW = NP / NW
 EPS = NP / No. of Shares
 DPS = Dividend amount / No. of shares

31. OTHER RATIOS
 SPS = Sales / No. of Shares
 Book Value = NW (less revaluation reserves)
per share

32. Limitations
 Basis of valuation of stock
 Depreciation methods
 Authenticity of data
 More meaningful if trend analysis
 Past results may not help predict
future
 Varies for Industry / Company /
Season

33. Fundamental Analysis
What we mean by FA

34. Definition
 Fundamental analysis is the examination of the
underlying forces that affect the well being of the
Economy, Industry groups and Companies
 Fundamental Analysis determines the worth of a
business by its future expected earning potential
which in turn depends on quality of company’s
management, business outlook for the company,
outlook for the industry in which the company
operates and the overall economic backdrop.

35. How does it differ from
Technical analysis
Technical
 “Future price is based on past price trend and
current price”
 Efficient market
 Price discounts every thing.
Fundamental
 Future price can not be determined using past /
current price
 Current price does not reflect fair value
 It is only reflection of the past
 Weak form of market efficiency

36. What is the Goal or Objective
 Derive a forecast for the future
 Profit from future price
movements

37. How do we achieve this
 Value
 What is value
The intrinsic value of a company
depends on the underlying business
strength of the company
 Price
 What is price

38. General Steps
 “TOP DOWN” Approach
 Economy
 Industry groups
 Specific Company

39. INDICATORS
GDP growth rate
Index of Industrial Production ( IIP )
Inflation indices –WPI / CPI.
Growth rate of Money supply
Growth rate of Population
Growth rate of Agriculture

40. Indicators -- contd
 Growth rate of per capita income
 Growth rate of Imports and Exports
 Interest rates.
 Stock Market Indices
 Foreign Exchange Reserves

41. The Political Equation
 The political stability of the country is of
paramount importance. No industry or
company can grow and prosper in the
midst of political turmoil.

42. Contribution of different
Sectors to Economy
Last Year Expected in
Future
Agriculture 54 ?
Industry 24 ?
Services 22 ?
Total 100 100

43. INDUSTRY
Overall growth rate
Market size
Importance to economy

44. Industry Analysis
Industry Life Cycle Product Demand Profitability
Embryonic phase Low- Educating
Buyers
Low-High Fixed
cost, Low capacity
Growth phase Approaching
Saturation level
Good, decreasing
Shake out phase Approaching
Saturation level
Good, decreasing
Maturity phase Stagnant,
Replacement
Low, steady
Decline phase Declining Declining, Rivalry

45. Steps
1. Demand Supply Analysis
2. Profitability Analysis
3. Level of Competition

46. Michael Porter’s Analysis
Threat of
New
Entrants
Bargaining
Power
of
Suppliers
Rivalry
among
Existing
Competitor
s
Bargaining
Power
of Buyers
Threat of
Substitute
Products or

47. Right Industry or Right Company
 Stocks move in groups
 More important to be in right industry than
in right stock

48. Company selection
 Leader
 Innovator
 Edge – Market / Technology /
Market share /
Product positioning /
Innovations
 Barriers to entry

49. Company Analysis
 Sensible business plan
 Solid Management – track record,
talent, team
 Financial analysis

50. Valuation models
which one to adopt
 Discounting Models
 Relative Valuation Models

51. “Discounted cash flow “
valuation model
 Dividend discount model
 Free cash flow to company model
 Free cash flow to equity model

52. DIVIDEND DISCOUNT
MODEL
• John Burr Williams
The present worth of a share is the
present value of future dividends (
rather than the Earnings).

53. “ Relative” Valuation Models
 Assumption
 Company will sell at a specific multiple of
earnings, revenue or growth.

54. PRICE EARNING RATIO
 P/ E = MP * EPS
 What is the right PE ? – Industry -
 Expectations
 -- Future earning potential
 Commodity stock EPS rises faster
when market is recovering and drops
faster during decline

55. PE ratio-continued
 TISCO-1994 to 2004 CAGR 17%
2001 to 2004 CAGR 193%
 FY 2002 EPS P / E = 20.5
 FY 2005 EPS P / E = 5

56. PE ratio-continued
 Siemens India – FY 06
Net profit (consolidated) – Rs.39169 Lacs.
No. of equity shares - 1685.8 Lacs
Current market price – Rs.1150
EPS = 39169/1685.8 = 23.23
PE Multiple = 1150/23.23 = 49.5
Earnings yield = 1*100/49.5 = 2.02%
 Relatively simple to calculate and use

57. Industry composite P/E=8.5
Name EPS Price P/E ratio
Essar 4.7 38.5 8.3
JSW 55.1 338 6.1
SAIL 9.7 87.4 9.0
Tata steel 60.4 506 8.4

58. PRICE EARNINGS GROWTH
RATIO
 P / E = G
 The P/E ratio of any Company that is
fairly priced will equal the Growth rate.
 P/E is past and does not include effect
of
Brand, Human capital, Expectations,
Barriers to entry- factors which affect
growth rate

59. PEG Ratio
Name Price EPS P/E Growth%
YoY %
Blue star info 107 5.5 19.7 11.81
Geometric 118 2.9 40.8 107.82
HCL 19.7 611 31.0 101.65
Iflex 1576 29.7 53.0 109.76
Infosys 43.5 2071 47.6 52.44
Mastek 338 17.5 19.4 42.16
Satyam 422 18.9 22.3 49.40
TCS 1059 27.8 38.2 44.10

60. PRICE TO SALES per SHARE
RATIO
 Earnings-complicated, some times
reflect non-recurring amounts
 PSR = Share Price / Annual sale per
share
 Simple
 But carries no information about Debt or
Profitability

61. PRICE / BOOK VALUE
 Book value = Net worth / Number of
shares
 Sectoral view-Old Economy- Good
Indicator
 Services sector-Low tangible assets
 Services, Software, FMCG-High
 Auto, Engineering, Steel-Low

62. P / BV Ratio
Bank Price BV P/BV
Allahabad 89 54 1.65
Andhra 95 54 1.76
Canara 290 171 1.70
SBI 1109 525 2.11
Syndicate 79 39 2.03
Centurion 26 2 13.0
Federal 219 86 2.55
ICICI 998 149 6.70
HDFC 768 142 5.41

63. Market capitalisation
 Market cap = MP * Number of shares
 Capacity
 Commodity companies
 Barrier to entry

64. Price Target and Projection
 The value of a share ( Say Allahabad
Bank) by looking at the pricing of a
comparable company ( say Andhra
Bank)
 Relative to a common variable
 Earnings, Book value, Sales (say BV)
 Two stage process

65. Components of forecasting
1. Determine the length of the extraordinary
growth period,
2. Select appropriate variable,
3. Estimate earnings ( or whatever variable)
during this high growth period,
4. Stable growth period
5. Estimate earnings (variable) during this
period

66. Components of forecasting
1. Projected value of variable after desired
period say 3 years
2. Select an appropriate company for
comparison
3. BV of Allahabad Bank as on 31-03-2010
4. Projected target price of Allahabad
bank=BV* Multiple
5. Say 1.65 to 1.76----

67. WARREN BUFFET VALUE
FORMULA
 Intrinsic value = Estimated future
earnings * Confidence Margin
 Confidence margin –Zero to 100 %
 100 = risk free return – Yield on
Government securities

68. Summary
 Strengths
 Weaknesses

69. STRENGTHS
 Good for understanding long term
trends
 Value spotting – Warren Buffet
 Thorough understanding of the
business

70. Weaknesses
 Time constraint
 Industry and Company specific
 Subscription based - ISP
 Refining margin – Oil Company
 Subjective
 Bias
 Definition of Fair value

71. Winston Churchill
No two on earth in all things can
agree.
All things have some darling
singularity.

72. Behavioral Finance
 Overconfidence
 Overreaction
 Loss aversion
 Risk tolerance
 Attachment

73. George Bernard Shaw
The Reasonable Man adapts himself
to the world.
The Unreasonable One persists in
trying to adapt the World to himself.
Therefore all progress depends on
the unreasonable man.

74. Any Questions??
THANK YOU
anilharolikar@rediffmail.com