Fundamental Analysis

Fundamental analysis Padmini Srinivasan

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Padmini Srinivasan

Types of analysis • Technical Analysis – Charting • Patterns in Price Behaviour or volume history • Predict future price movement

• Fundamental analysis – Determining value without price – Analyzing and Interpreting the fundamentals Padmini Srinivasan © iimb

Padmini Srinivasan

Research analysis • • • •

Economic Wide factors = 30 - 35 % Industry factors = 15 - 20% Company Factors = 30 - 35% Others = 15 - 20%

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Fundamental analysis • Understanding the Economic Environment • Analyzing the Industry • Assessing the projected performance of the Company

• (One must hone the skill needed for the above) Padmini Srinivasan © iimb

Economic Environment • Global economic scenario • Central Government Policy – – – – – – – –

Key Variables Growth rate of GDP Industrial Growth rate, Agriculture and Monsoon, Savings and investments, Price level and inflation, Interest rates Infrastructure facilities Padmini Srinivasan © iimb

Industry analysis • Analyze the prospects of each industry • Difficult to forecast the future • Consists of 4 parts – Sensitivity to the business cycle – Industry life cycle analysis – Structure and characteristics – Profit Potential of the industry

Padmini Srinivasan © iimb

Padmini Srinivasan

Industry analysis • Sensitivity to the business cycle – Eg: Auto industry vs Pharmaceutical

• Industry life cycle analysis – What stage of industry eg Start phase, growth phase, maturity or decline stage

• Structure and characteristics – Profit Potential of the industry

Padmini Srinivasan © iimb

Padmini Srinivasan

Industry analysis • Structure and characteristics – Nature of competition – Demand Prospects – Technology and research

• Profit Potential of the industry – Porter: Threat of new entrants, Rivalry among existent firms, substitute products , bargaining power of buyers and sellers Padmini Srinivasan © iimb

Padmini Srinivasan

Fundamental Analysis • To determine the valuation of the share, the analyst must forecast earnings, dividend and the appropriate discount rate • Earnings potential and the risk are linked to the prospects of the industry and the developments in the macro economy

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From Business Activities to Financial Statements Business Environment Labor Market Capital Market Product Market: Suppliers Customers

Accounting Environment Capital Market Structure, GAAP,Audit, &Legal system

Business Activities Operating Investment Financing Accounting System Measurement & Reporting

Financial Statements Padmini Srinivasan © iimb

Business Strategy Key factors And Risk

Accounting Strategy Choice of: Accounting Policy Reporting Format SupplementaryDisclosures

4 Step Process of analysis • • • •

Strategy analysis Accounting analysis Financial analysis Prospective Analysis (Growth etc)

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others • • • • •

Order positions Regulatory framework Technology capabilities HR Evaluation of management “mark of a good management is not how it runs its business but how it changes them” Padmini Srinivasan © iimb

Padmini Srinivasan

Company Analysis • Important parameters for analysis – EPS of the coming years – And a reasonable earnings multiple, given the growth prospects, risk exposure and other characteristics of the firm

• For this we need historical data – Of Earnings, Growth, Risk and Valuation

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Padmini Srinivasan

Earnings Level • Return of Equity – Equity Earnings

Net worth

Denoting the earnings for the shareholder

Padmini Srinivasan © iimb

Padmini Srinivasan

Earnings analysis • ROE can be decomposed into • PAT Sales • PBIT X Sales Op. eff

X Sales X Asset Assets NW(SC+RS) Sales X PBT X PAT X Asset Assets PBIT PBT Equity Asset eff, int , tax, Leverage Padmini Srinivasan © iimb

Padmini Srinivasan

Other important calculations • Book Value of the share – Paid up capital / number of shares

• Earnings per share PAT / number of Equity shares • Dividend Payout – Equity Dividend / PAT

• Dividend per share • Growth performance of sales and EPS(CAGR) • Look out for Beta Padmini Srinivasan © iimb

Padmini Srinivasan

Growth • Look at Growth : Compounded annual growth rate • Sustainable growth rate without Loans: = ROE X retention ratio where retention ratio = ( PAT – Dividend) / PAT Using this model: we can estimate the stock price as Padmini Srinivasan © iimb

Stock Price Model 1 • If Rs. 2 per share is the dividend and 15% is ROE and .6 is the retention ratio, estimate the share price ? • Price = Div per share / ROE – Growth rate • = 2 / (.15 -.06) = Rs. 22.22 • Useful for sensitivity analysis

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Intrinsic value using PE Ratio • Estimate the future EPS • Based on correct forecasting of the PAT in the future based on growth assumptions etc) • Establish a PE multiple – based on last years earnings or trailing 12 month PE or based on some expected earnings also look out for similar companies PE

• Projected EPS X Projected PE = Value Anchor • Always give a range Padmini Srinivasan © iimb

Strategy for identifying securities • Intrinsic Value > Market Value

Buy

• Intrinsic Value < Market Value

Sell

• Intrinsic Value = Market Value

Hold

Padmini Srinivasan © iimb

Padmini Srinivasan

Some keys to investing • • • • • • •

Establish Value Anchors Assess the market Price behaviour (Psychology) Combine fundamental and technical analysis Develop sound strategies for growth stocks Beware of games operators play Take Swift corrective action ie keep stop loss Have discipline – Source: Investment Analysis and Portfolio Management by Prasanna Chandra Padmini Srinivasan © iimb

Padmini Srinivasan

Thanks Any Questions

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