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Inv. Ch-3, M.A PPM.pptx
1.
2. The fundamental school of thought appraised
the intrinsic value of shares through:
• Economic Analysis
• Industry Analysis
• Company Analysis
The analysis of economy, industry and company
fundamentals constitute the main
activity in the fundamental approach to security
analysis.
3. …
The logic of this three tier analysis is that the
company performance depends not
only on its own efforts, but also on the general
industry and economy factors.
A company belongs to an industry and the
industry operates within the economy.
As such, industry and economy factors affect the
performance of the company.
4. …
The multitude of factors affecting the performance
of a company can be broadly classified as:
1. Economy-wide factors such as growth rate of the
economy, inflation rate, foreign exchange rates, etc.
which affect all companies.
2. Industry-wide factors such as demand-supply gap
in the industry, the emergence of substitute
products, changes in government policy relating to
the industry, etc. these factors such as the age of its
plant, the quality of management.
5. …
3. Company specific factors such as the age of its
plant, the quality of management, brand image of
its products, its labor-management relations, etc.
these factors are likely to make a company’s
performance quite different from that of its
competitors in the same industry.
6. The performance of a company depends on the
performance of the economy.
If the economy is booming, incomes rise,
demand for goods increases, and hence the
industries and companies in general tend to the
prosperous.
On the other hand, if the economy is in
recession, the performance of companies will be
generally bad.
Investors are concerned with those variables in
the economy which affect the performance of
the company in which they intend to invest.
7. …
Hence, a study of these economic variables
would give an idea about future corporate
earnings and the payment of dividends and
interest part of his fundamental analysis.
8. i. Growth Rates of National Income
The rate of growth of the national economy is an
important variable to be considered by an
investor.
GNP (gross national product), NNP (net national
product) and GDP (gross domestic product) are
the different measures of the total income or
total economic output of the country as a whole.
The growth rates of these measures indicate the
growth rate of the economy.
The estimates of GNP, NNP and GDP and their
rates are made available by the government from
time to time.
9. …
The estimated growth rate of the economy
would be a pointer towards the prosperity
of the economy.
An economy typically passes through different
phases of prosperity known as the different
stages of the economic or business cycle.
The four stages of an economic cycle are
depression, recovery, boom and recession.
The stage of the economic cycle through which a
country passes has a direct impact on the
performance of industries and companies.
10. …
Depression is the worst of the four stages.
During a depression, demand is low and declining.
Inflation is often high and so are interest rates.
Companies are forced to reduce production, shut
down plant and lay off workers.
During the recovery stage, the economy begins to
revive after a depression.
Demand picks up leading to more investments in the
economy.
Production, employment and profits are on the
increase.
11. …
The boom phase of the economic cycle is
characterized by high demand.
Investments and production are maintained at a
high level to satisfy the high demand.
Companies generally post higher profits.
The boom phase gradually slows down.
The economy slowly begins to experience a
downturn in demand, production, employment,
etc.
The profits of companies also start to decline.
This is the recession stage of the business cycle.
12. …
Therefore, while analyzing the growth rate of the
economy, an investor would do well to
determine the stage of the economic cycle
through which the economy is passing and
evaluate its impact on his investment decision.
13. ii. Inflation
Inflation prevailing in the economy has considerable
impact on the performance of companies.
Higher rates of inflation upset business plans, lead to
cost escalation and result in a squeeze on profit
margins.
On the other hand, inflation leads to erosion of
purchasing power in the hands of
consumers.
This will result in lower demand for products.
Thus, high rates of inflation in an economy are likely
to affect the performance of companies adversely.
Industries and companies prosper during times of
low inflation.
14. …
• Inflation is measured both in terms of wholesale
prices through the wholesale price index (WPI)
and in terms of retail prices through the
consumer price index (CPI).
• These figures are available on weekly or monthly
basis.
• As part of the fundamental analysis, an
investor should evaluate the inflation rate
prevailing in the economy currently as also the
trend of inflation likely to prevail in the future.
15. iii. Interest Rates
Interest rates determine the cost and availability
of credit for companies operating in an economy.
A low interest rate stimulates investment by
making credit available easily and cheaply.
Moreover, it implies lower cost of finance for
companies and thereby assures higher
profitability.
On the contrary, higher interest rates result in
higher cost of production which may lead to
lower profitability and lower demand.
16. …
The interest rates in the organized financial sector
of the economy are determined by the monetary
policy of the government and the trends in
money supply.
These rates are thus controlled and vary within
certain ranges.
But the interest rates in the unorganized financial
sector are not controlled and may fluctuate
widely depending upon the demand and supply
of funds in the market.
Further, long-term interest rates differ from
short-term interest rates.
17. …
An investor has to consider the interest rates
prevailing in the different segments of the
economy and evaluate their impact on the
performance and profitability of companies.
18. iv. Government Revenue, Expenditure and
Deficits
As the government is the largest investor and
spender of money, the trends in government
revenue, expenditure and deficits have a significant
impact on the performance of industries and
companies.
Expenditure by the government stimulates the
economy by creating jobs and generating demand.
Since a major portion of demand in the economy is
generated by government spending, the nature of
government spending is of great importance in
determining the fortunes of many an industry.
19. …
However, when government expenditure exceeds
its revenue, there occurs a deficit.
This deficit is known as budget deficit.
All developing countries suffer from budget
deficits as government spend large amount of
money to build up infrastructure.
But budget deficit is an important determinant of
inflation, as it leads to deficit financing which
fuels inflation.
20. v. Exchange Rates
The performance and profitability of industries
and companies that are major importers or
exporters are considerably affected by the
exchange rates of the ETB against major
currencies of the world.
A depreciation of the ETB improves the
competitive position of Ethiopian products in
foreign markets, thereby stimulating exports.
But it would also make imports more expensive.
A company depending heavily on imports may
find devaluation of the ETB affecting its
profitability adversely.
21. …
The exchange rates of the ETB are influenced by
the balance of trade deficit, the balance of
payments deficit and also the foreign exchange
reserves of the country.
The excess of imports over exports is called
balance of trade deficit.
The balance of payments deficit represents the
net difference payable on account of all
transactions such as trade, services and capital
transaction.
If these deficits increase, there is a possibility that
the ETB may depreciate in value.
22. …
• The exchange rates of the ETB against the major
currencies of the world are published daily in the
financial press.
An investor has to keep track of the trend in
exchange rates of rupee.
An analysis of the balance of trade deficit,
balance of payments deficit and the foreign
exchange reserves will help to project the future
trends in exchange rates.
23. vi. Infrastructure
The development of an economy depends very
much on the infrastructure available.
Industry needs electricity for its manufacturing
activities, roads and railways to transport
raw materials and finished goods, communication
channels to keep in touch with suppliers
and customers.
The availability of infrastructural facilities such as
power, transportation and communication
systems affects the performance of companies.
24. …
Bad infrastructure leads to inefficiencies, lower
productivity, wastage and delays.
An investor should assess the status of the
infrastructural facilities available in the economy
before finalizing has investment plans.
25. vii. Monsoon/Environmental or climate change
The Ethiopian economy is essentially an agrarian
economy and agriculture forms a very important
sector of the Indian economy.
Because of the strong forward and back-ward
linkages between agriculture and industry,
performance of several industries and companies
are dependent on the performance of
agriculture.
Moreover, as agricultural incomes rise, the
demand for industrial products and services will
be good and industry will prosper.
26. …
But the performance of agriculture to a very
great extent depends on the monsoon/climate
change.
The adequacy of the monsoon/climate change
determines the success or failure of the
agricultural activities in Ethiopia.
Hence, the progress and adequacy of the
monsoon/Climate becomes a matter of great
concern for an investor in the Ethiopian context.
27. viii. Economic and Political Stability
A stable political environment is necessary for
steady and balanced growth.
No industry or company can grow and prosper in
the midst of political turmoil.
Stable long-term economic policies are what are
needed for industrial growth.
Such stable policies can emanate only from stable
political systems as economic and political factors
are inter-linked.
A stable government with clear cut long-term
economic policies will be conducive to good
performance of the economy.
28. Investment is a future-oriented activity, so the
investor is more interested in the expected
future performance of the overall economy
and its various segments.
For this reason, forecasting the future direction
of the economy becomes necessary.
Economic forecasting thus becomes a key activity
in economy analysis.
The central theme in economic forecasting is to
forecast the national income with its
various components.
29. …
Gross national product (GNP) is a measure of the
national income.
It is the total value of the final output of goods and
services produced in the economy.
It is a measure of the total economic activities over a
specified period of time and is an indicator of the
level and rate of growth of economic activities.
An investor would be particularly interested in
forecasting the various components of the national
income, especially those components that have a
bearing on the particular industries and companies
that he is analyzing.
30. Forecasting Techniques
Economic forecasting may be carried out for
short-term periods (up to three years),
intermediate term periods (three to five years)
and long-term periods (more than five years).
An investor is more concerned about short-term
economic forecasts for periods ranging from a
quarter to three years.
• Some of the techniques of short-term economic
forecasting are discussed below:
31. i. Anticipatory Surveys
Anticipatory surveys are the surveys of intentions of
people in government, business, trade and industry
regarding their construction activities, plant and
machinery expenditures, level of inventory, etc.
Much of the activities in government, business,
trade and industry are planned in advance and
stated in the form of budgets.
Consumers also plan for their major spending
in advance.
To the extent that institutions and people plan and
budget for expenditures in advance, surveys of their
intentions can provide valuable input to short-term
economic forecasting.
32. …
Based on the results of these surveys, the analyst
can form his own forecast of the future state of
the economy.
The greatest shortcoming of the anticipatory
surveys is that there is no guarantee that the
intentions surveyed will certainly materialize.
The forecast based on anticipatory surveys or
surveys of intentions will be valid only to the
extent that the intentions are translated into
action.
Hence, the analyst may not rely solely on these
surveys.
33. ii. Barometric or Indicator Approach
• In this approach to economic forecasting, various
types of indicators are studied to find out how
the economy is likely to perform in the future.
• These indicators are time series data of certain
economic variables.
• The indicators are classified into leading,
coincidental and lagging indicators.
The leading indicators are those time series data
that reach their high points (peaks) or their low
points (troughs) in advance of the high points
and low points of total economic activity.
34. …
The coincidental indicators reach their peaks and
troughs at approximately the same time as the
economy, while the lagging indicators reach their
turning points after the economy has already
reached its own turning points.
In this method, the indicators act as barometers
to indicate the future level of economic activity.
However, careful examination of historical data of
economic series is necessary to ascertain which
economic variables have led, lagged behind or
moved together with the economy.
35. …
• Of the three types of indicators, leading indicators
are more useful for economic forecasting because
they measure something that foreshadows a
change in economic activity.
36. iii. Econometric Model Building
This is the most precise and scientific of the
different forecasting techniques which applies
mathematical and statistical techniques to
economic theory.
In the economic field we find complex
interrelationships between the different
economic variables. The precise relationships
between the dependent and independent
variables are specified in a formal mathematical
manner in the form of equations. The
system of equations is then solved to yield a
forecast that is quite precise.
37. …
• The accuracy of the forecast derived from this
technique would depend on the validity of the
assumptions made by the analyst regarding
economic interrelationships and the quality of his
input data.
38. iv. Opportunistic Model Building
• This is one of the most widely used forecasting
techniques also known as GNP model building or
sectoral analysis.
• Initially, an analyst estimates the total demand in
the economy, and based on this he estimates the
total income or GNP for the forecast period.
• This initial estimate takes into consideration the
prevailing economic environment such as the
existing tax rates, interest rates, rate of inflation
and other economic and fiscal policies of the
government.
39. …
• After this initial forecast is arrived at, the analyst
now begins building up a forecast of the GNP
figure by estimating the levels of various
components of GNP.
• For this, he collects the figures of consumption
expenditure, gross private domestic investment,
government purchase of goods and services and
net exports.
• He adds these figures together to arrive at the
GNP forecast.
40. …
• Hence, economic forecasting is an extremely
complex and difficult process.
• The investor must evaluate all economic forecasts
critically before making his investment decision.
• It gives the investor an overall picture of the
expected performance of the economy in the near
future. Therefore, it is a valuable input to
investment decision-making.
41. • Security analysis calls for collection of vast
information relating to industry, company and
market.
• The market for securities can be regarded as
perfect when demand and supply forces
determine the prices of securities.
42. Sources and Types of Information Needed for
Security Analysis
Availability of money and flow of information into
market largely affect the demand and supply
forces.
Besides the market price, the investors are
interested in knowing the intrinsic value of shares.
Intrinsic value of shares means the value of net
assets available per equity share of the company.
43. …
Intrinsic value always revolves around the market
price. When the intrinsic value is less than the
market price, it is advisable to sell the shares.
On the other hand, investors intend to buy
securities when the intrinsic value of shares held
is more than the market price.
Thus, the market analysis and estimate of
intrinsic value require collection of information
from the appropriate sources.
44. …
The sources of such information and the types of
information needed for security analysis are briefly
explained as follows.
The sources and types of information are—
1. World affairs
2. Domestic economic and political factors
3. Industry information
4. Company information
5. Security market information
6. Security price quotations
7. Data on related markets
8. Data on mutual funds
9. Data on New Issue market
10. Financial information.