Download - fundamental Analysys
-
8/14/2019 fundamental Analysys
1/123
Fundamental Analysis
Financial Statement Analysis
Company AnalysisIndustry Analysis
-
8/14/2019 fundamental Analysys
2/123
Financial statement analysismeans An analysis and interpretation of balance
sheet and Profit and Loss account
Also going through directors report,auditors report and chairmans speech etc.
We take into account last two years auditedbalance sheets, current years estimated andthe next years projected balance sheet.
-
8/14/2019 fundamental Analysys
3/123
Analysis means
To find out various ingredients by way of rearranging &
regrouping of various items
Calculation of various ratios
Interpretation means
To draw conclusions on the basis of analyzedstatements
To form opinion or draw inferences about
the financial health, profitability, efficiency& other aspects of the business enterprise.
-
8/14/2019 fundamental Analysys
4/123
Financial Statement Analysis
Comparison of the Financial Statements overa period of two to five years
Ratio Analysis
Inter Firm Comparison
Trend Analysis
-
8/14/2019 fundamental Analysys
5/123
Financial StatementAnalysis Balance Sheet Analysis
These data would reflect the prima facieposition of the companys operations and thefinancial results of these operations
Profit & Loss Statement Analysis Cash Flow- Funds Flow Statement Analysis
-
8/14/2019 fundamental Analysys
6/123
P & L A/c
Gross Sales
Net Sales Cost of Production Cost of Sales EBIT/Operating Profits Operating Expenses Financial Expenses Net Profit Non Operating Income
-
8/14/2019 fundamental Analysys
7/123
P & L A/c for the yearended--- Sales Net)
Other Income
Less Cost of the Goods Sold
Gross Operating Profits
Less: Operating Expenses(Administrative,selling & distribution expenses)
Net Operating Profit (EBIDT)
Minus Interest, Depreciation & Taxes
Profit After Tax (PAT) =Net Profit
-
8/14/2019 fundamental Analysys
8/123
P & L Account
Financial Expenses like interest & taxes
are deducted from gross profits to arriveat net profits.
Other non-operative income is added &non- operative expenses are deducted
out of operating profit to arrive at PBT. Non operative income arise fromsecondary activities like interest, rent ÷nd received by an enterprise whosemain business is not to deal in finance,
property & investment
-
8/14/2019 fundamental Analysys
9/123
P & L A/c
Other expenses arise from incidental
activities. Net provision for income tax is deducted
from EBT to arrive at EAT.
Profit appropriation i.e. dividend, transfer of
a part/full profit to various reserves. Balance remained after the appropriation is
carried to balance sheet
-
8/14/2019 fundamental Analysys
10/123
Balance Sheet-
LiabilitiesCurrent Liabilities
Term Liabilities
Net Worth
AssetsCurrent Assets
Fixed Assets
Intangible Assets
-
8/14/2019 fundamental Analysys
11/123
Balance Sheet as at
Sources of Funds
1. Shareholders funds
(a) Share Capital
(b) Reserves & Surplus
2. Loan Funds
(a) Secured Loans
(b) Unsecured Loans
-
8/14/2019 fundamental Analysys
12/123
Continued
Application of Funds
Fixed AssetsInvestments
Current Assets, Loans & Advances: Inventories Sundry Debtors
Cash & Bank Balances Other Current Assets Loans & Advances
Less: Current Liabilities & Provisions:
(a) Liabilities (b) Provisions
Net Current Assets
-
8/14/2019 fundamental Analysys
13/123
Statement of Changes in FinancialPosition
It measures the changes that have takenplace in the financial position of a firmbetween two balance sheet dates. Itsummarizes the sources & uses of funds
obtained. The changes in the financialposition could be related to differentconcepts of funds.
-
8/14/2019 fundamental Analysys
14/123
Importance of SCFP
What have been the factors responsible for the
difference in owners equity , assets & liabilities of thefirm at two dates of consecutive balance sheet? What have been the premier financing & investment
activities of the firm during this period? Have long term sources been adequate to finance fixed
assets purchases?
Does the firm possess adequate WC? Why did the firm not pay dividends inspite of adequate
profits? How much funds have been generated from
operations? Has the liquidity position of the firm improved?
-
8/14/2019 fundamental Analysys
15/123
Cash Flow Statement
Operating Activities Investing Activities
Financing Activities
A cash flow statement is concerned only with
cash & cash equivalents. This includes cash onhand, cash in the bank & any cash invested inshort term, highly liquid financial instruments.Accepted cash equivalents include treasury bills,commercial paper & money market funds.
-
8/14/2019 fundamental Analysys
16/123
Cash Flow from OperatingActivities
The amount of cash flow arising fromoperating activities is a key indicator of theextent to which the operations of theenterprises have generated sufficient cash
flows to maintain the operating capability ofthe enterprise , pay dividends, repay loans &make new investments without recourse tothe external sources of financing.
-
8/14/2019 fundamental Analysys
17/123
Cash Flow from OperatingActivities
Any cash transaction related to the companys on
going business, that is the business activitiesthat are responsible for most of the profits.Operating activities usually involve producing &delivering goods & providing services. Cash fromoperations will show the extent to which day-to
day operating activities have generated morecash than has been used.
Funds from operating activities can be broadlyclassified into two sections-how much dooperating profits contribute to funds generated
by the company & secondly how much doesworking capital drain away from these profits. ForEx:-If a company generates Rs 50 crores of fundsfrom operating profits & ploughs back Rs 70crores into WC, it is unlikely to be cash richdespite being profitable.
-
8/14/2019 fundamental Analysys
18/123
Investing Activities
Investing activities are the changes to the cashposition owing to the buying & selling of non-current assets.
This includes selling & replacing equipment thatwears out or acquiring a new land or building so
that company grows. Purchase or sale of stock , bonds. Lending money& receiving payments are also consideredinvesting activities.
the cash flow from investing activities representthe extent to which expenditures have been madefor resources intended to generate future income& cash flows. This gives details of new additionsto Fixed Assets & Investments effected by thecompany
-
8/14/2019 fundamental Analysys
19/123
Financing Activities
Borrowing money
Repaying money,
Issuing stock
Paying dividends.
The cash flow arising from financing activities isuseful in predicting claims on future cash flowsby providers of funds to the enterprise. Thissection provides details of Funds raised frombanks, institutions & capital markets during the
year. Repayment of loans & buyback of sharesare also shown as applications.
-
8/14/2019 fundamental Analysys
20/123
Cash & Cash Equivalents
It consists of Cash on Hand & balances with
banks & investments in money marketinstruments.
-
8/14/2019 fundamental Analysys
21/123
Ratio Analysis
Liquidity Ratio
Solvency Ratio
Profitability Ratio
Efficiency Ratio
Valuation Ratio
-
8/14/2019 fundamental Analysys
22/123
Liquidity Ratios
The Liquidity Ratios measure the ability ofthe firm to meet its short term obligationsand reflect the short term financialstrength/solvency of a firm. Following ratiosindicate the liquidity of a firm:-
Net Working Capital Current Ratios Acid Test/Quick Ratios Turnover Ratios
-
8/14/2019 fundamental Analysys
23/123
Liquidity Ratios
Current assetsCurrent ratio =
Current liabilities
Current assets InventoriesQuick ratio =
Current liabilities
Cash + Marketable securities
Cash ratio = Current liabilities
-
8/14/2019 fundamental Analysys
24/123
Current Ratio
The higher the current ratio,the larger the amount of rupeesavailable per rupee of current liability,the more is the firms ability to meetcurrent obligations & the greater isthe safety of funds of short termcreditors.
-
8/14/2019 fundamental Analysys
25/123
Liquidity Ratios
Net Working Capital is the excess of Current
Assets over Current Liabilities. Turnover or activity ratios measure the
firms efficiency in utilizing its assets.
Cost of goods sold or net salesInventory turnober
Average (or closing) inventoryNumber of days in the year (say, 360)
of inventory holdingInventory turnover
Credit sales or net saDebtors turnover
Days
les
Average (or closing) debtors
Number of days in the year (say, 360)period
Debtors turnoverCollection
-
8/14/2019 fundamental Analysys
26/123
Liquidity Ratio
Creditors Turnover Ratio & Credit Collection
Period
Creditors Turnover Ratio= Net Credit Purchases/Average
Creditors
Net Credit Purchases= Gross Credit Purchasesless returns to suppliers Average Creditors=Average creditors outstanding
at the beginning & at the end of the year Low turnover ratio indicates liberal credit terms
granted by the suppliers while a high ratioindicates that the accounts are to be settledrapidly.
Credit Collection Period= No. of Days/Months in ayear/Creditors Turnover Ratio
L /C it l St t
-
8/14/2019 fundamental Analysys
27/123
Leverage/Capital StructureRatios measure the dependence of a firm on
borrowed funds.
DebtDebt-equity ratio
Equity (Net Worth)
Debtratio
Debt Equity employed
Earnings before interest and taxcoverage
Interest
DebtDebt
Capital
Interest
L /C it l St t
-
8/14/2019 fundamental Analysys
28/123
Leverage/Capital StructureRatios Debt to Capital ratio=Long Term
Debt/Permanent Capital Debt to Total Assets Ratio=Total Debts/Total
Assets
Total Assets= Long Term Debt+
Shareholder's Equity+ Current Liabilities Permanent Capital= Shareholders Equity +
Long Term Debt
Dividend Coverage Ratio
Debt Service Coverage Ratio
-
8/14/2019 fundamental Analysys
29/123
DSCR
Debt Service Coverage Ratio
EBDIT/Interest+Debt Repayment per annum
OR
PAT+Depreciation+Interest/Interest+DebtRepayment
In the second formula,Debt Repayment willbe grossed up for tax impact.
This ratio is useful in predicting sickness.If
DSCR is inadequate, the probability of thecompany turning sick is very high.
-
8/14/2019 fundamental Analysys
30/123
Dividend Coverage Ratio
This ratio measures the ability of the firm to
pay dividend on preference shares, whichcarry a stated rate of return
Earnings After Tax/Preference Dividend
This reveals the margin of safety available to
the preference shareholders. The higher thecoverage, the better it is from their point ofview.
-
8/14/2019 fundamental Analysys
31/123
Profitability Ratios
Profitability ratios measure a firms overallefficiency and effectiveness in generatingprofit.
before interest and tax (PBIT)Margin
Net salesafter tax (PAT)
marginNet sales
PBITreturn on investment
Net assetsProfit after tax
on equityEquity (net worth)
Profit
ProfitNet
Before tax
Return
P fit bilit R ti R l t d t
-
8/14/2019 fundamental Analysys
32/123
Profitability Ratios Related toSales These ratios consist of:-
1.Profit Margin
2.Expenses Ratios
-
8/14/2019 fundamental Analysys
33/123
Profitability Ratios
Related to Sales( Operating Margin Vs NetProfit Margin)
Related to Investments (ROCE Vs RONW)
-
8/14/2019 fundamental Analysys
34/123
Profit Margin
Gross Profit Margin=(GP/Sales) * 100
Gross Profit Margin=(Sales-Cost of the GoodsSold)/ Sales *100
Net Profit Margin
Operating Profit Ratio= EBIT/Sales
Net Profit Ratio = EAT/Sales
-
8/14/2019 fundamental Analysys
35/123
Expenses Ratio
The Term expenses includes:-
Cost of the Goods Sold
Administrative Expenses
Selling & Distribution Expenses
Exclusive of financial expenses like interest,taxes, dividends & extraordinary losses dueto theft of goods, goods destroyed by fireetc.
-
8/14/2019 fundamental Analysys
36/123
Expenses Ratio
There are different variants of expenses
ratios. They are:-Cost of the goods sold ratio
Operating Expenses Ratio
Administrative Expenses Ratio
Selling Expenses RatioOperating Ratio
Financial Expenses Ratio
-
8/14/2019 fundamental Analysys
37/123
OPM Vs NPM & ROCE VS RONW
Operating Profit Margin is a Business levelratio whereas Net Profit Margin is ownerlevel ratio.
OPM reflects business level (Marketing &
Operations) efficiency whereas NPM reflectsfinancial
Similarly, Return on Capital Employed(ROCE)is gross level OR Business level ratiowhereas Return on Net Worth is owner level
ratio.
-
8/14/2019 fundamental Analysys
38/123
ROCE Vs RONW
ROCE = PBIT/CE
CE= Net Worth + Debt ie total moneyinvested in the business.
RONW = PAT/NW= Profit after Tax/Net Worth
NW= Capital + Reserves
Profitability Ratios Related to
-
8/14/2019 fundamental Analysys
39/123
Profitability Ratios Related toInvestments
Return on Assets
Return on Capital Employed Return on Shareholders Equity
Earnings per Share
Dividends per Share
Dividend Pay-out Ratio
Earnings Yield
Dividend Yield
Price Earning Multiple
-
8/14/2019 fundamental Analysys
40/123
Valuation Ratios
Equity-related ratios measure theshareholders return and value.
Profit after taxEPS
Number of ordinary shares
DPSNumber of ordinary shares
DPSratio
EPS Pr after tax
DPSyieldMarket value per share
Dividends
DividendsPayout
ofit
Dividend
-
8/14/2019 fundamental Analysys
41/123
Valuation Ratios
EPSEarnings yield
value per share
value per shareP / E ratio =
EPS
Net worth
value per share Number of ordinary shares
value per shareM Bvalue
Book value per share
Mar'
Market
Market
Book
Market
Tobin s q
ket value of assetsEconomic value of assets
Other Important Ratios (Valuation
-
8/14/2019 fundamental Analysys
42/123
Other Important Ratios (ValuationRatios)
PEG Model Price to Cash Profit Multiple= MPS/CEPS
Cash Earning Per Share= PAT + Depreciation_____________________
No. of Shares
Enterprise Value to EBIDTA MultipleEnterprise Value= Market Capitalization of
Equity + Book Value of Debt CashEquivalents
P/E Multiple Vs Enterprise Value /EBIDTA
MultipleWealth Creation Ratio=Market to Book
Value Ratio.
-
8/14/2019 fundamental Analysys
43/123
EV/EBIDTA
Enterprise Value by EBIDTA.This ratio tells
what the market is willing to pay for everyoperating rupee earned. This brings into playthe markets perception, which would placevalue on intangibles, future potential, qualityof management amongst other factors
-
8/14/2019 fundamental Analysys
44/123
DU Pont Analysis
This analysis developed by DO Pont of the USbelieves that the company should strive toincrease its Return on Net Worth (Returns toShareholders). This analysis attempts tobreak down this return on Net Worth into
three basic components. RONW= PAT/NW. This is broken down into:- RONW=PAT/Sales *Sales/CE * CE/NW The first leg indicates Profitability The second leg indicates Efficiency The third leg indicates Solvency/Gearing
-
8/14/2019 fundamental Analysys
45/123
Utility of Ratio Analysis
Assessment of the firms financial conditions
and capabilities. Diagnosis of the firms problems, weaknesses
and strengths. Credit analysis Security analysis Comparative analysis Time series analysis
-
8/14/2019 fundamental Analysys
46/123
Shareholder Value Creation
Economic Value Added
Market Value Added
Corporates are implementing strategiesdesigned to improve EVA.
Recent rankings of the companies are basedon their market capitalisations rather thansales & assets which used to be the basessome years ago
-
8/14/2019 fundamental Analysys
47/123
EVA
EVA = Net Operating Profit AfterTaxes(NOPAT)-Cost of CapitalEmployed(COCE)
NOPAT = Profits after depreciation & taxesbut before interest costs. NOPAT thusrepresents the total pool of profits availableon an ungeared basis to provide a return tolenders & shareholders.
COCE = Weighted Average Cost of Capital(WACC) * Total Capital Employed
Weighted Average Cost of
-
8/14/2019 fundamental Analysys
48/123
Weighted Average Cost ofCapital Cost of capital includes Cost of Debt Capital,
Cost of Equity Capital & Cost of PreferenceShare Capital. WACC is worked out on posttax basis.
The mix of Debt & Equity Capital has a vitalrole in determining the cost of capital. EquityCapital is generally more costly than DebtCapital.
While liberal use of debt capital reduces thecost of capital, it increases the risk element
in the company & indirectly increases thecost of equity.Debt Equity mix should alwaysbe aimed at considering the trade-off inbetween risk & return.
-
8/14/2019 fundamental Analysys
49/123
WACC
The following steps are involved for calculatingthe firms WACC: Calculate the cost of specific sources of funds Multiply the cost of each source by its
proportion in the capital structure. Add the weighted component costs to get the
WACC
-
8/14/2019 fundamental Analysys
50/123
What does EVA Show?
EVA is residual income after charging thecompany for the cost of capital provided bylenders & shareholders. It represents thevalue added to the shareholders bygenerating operating profits in excess of thecost of capital employed in the business.
-
8/14/2019 fundamental Analysys
51/123
When will EVA Increase?
EVA will increase if:
a Operating profits can be made to growwithout employing more capital i.e greater
efficiency.b. Additional Capital is invested in projectsthat return more than the cost of obtainingnew capital i.e profitable growth.
C. Capital is curtailed in activities that do
not cover the cost of capital.
k l dd d( )
-
8/14/2019 fundamental Analysys
52/123
Market Value Added(MVA)
MVA is determinant of the premium the
market is willing to place on the companysvalue in recognition of its earnings potential.
MVA of a company depends upon its past,present & future performance
MVA= Current Market Value of Debt & Equity Economic Book Value
Economic Book Value= Share Capital+FreeReserves+Debts
k l dd d
-
8/14/2019 fundamental Analysys
53/123
Market Value Added
MVA is the definitive measure of wealth
creation because it captures the marketsassessment of the effectiveness with which acompanys managers have used the scarceresources under their control.
It also reflects how well management haspositioned the company for longterm,because market value incorporates thepresent value of the expected long run netcash flows/outflows
C f C i l
-
8/14/2019 fundamental Analysys
54/123
Cost of Capital
The Cost of Capital is the minimum required
rate of return expected by the providers offunds.
Cannot be calculated with precision.
C t f C it l
-
8/14/2019 fundamental Analysys
55/123
Cost of Capital
Concept
Cost of Equity(Dividend Discount &CAPMModel)
Cost of Debt
Cost of Preference Capital
Weighted Average Cost of Capital
Significance of the Cost of
-
8/14/2019 fundamental Analysys
56/123
Significanceof the Cost ofCapital
Evaluating investment decisions,
Designing a firms debt policy, and
Appraising the financial performance of topmanagement.
W i ht
-
8/14/2019 fundamental Analysys
57/123
Weights
Book Value Reported Value in Books ofAccounts.
Market Value--- Market Capitalization Valueof each source of Finance
Those sources of Finance which are notquoted, Book Value is used.
Why would you use Market Value? Book Value is historical in nature & hence not
relevant
Market Value captures expectations of theproviders of funds.
C t f E it C it l
-
8/14/2019 fundamental Analysys
58/123
Cost of Equity Capital
Is Equity Capital Free of Cost? No, it has an opportunitycost.
Cost of Internal Equity: The DividendGrowth Model
Normal growth
Supernormal growth
Zero-growth
C t f E it C it l
-
8/14/2019 fundamental Analysys
59/123
Cost of Equity Capital
It is the return expected by shareholders who
choose to invest in a particular companysequity. Equity Capital & accumulatedreserves & surpluses which are free to equityshareholders carry the same cost becausethe reserves & surplus are created out of the
appropriation of profit, that is, by retentionof profit attributable to equity shareholders.
It is important to understand the concept ofBeta, for calculating the Cost of Equity
Capital
B t
-
8/14/2019 fundamental Analysys
60/123
Beta
Beta is a relative measure of volatility that is
determined by comparing the return on ashare to the return on the stock market as awhole.
In simple terms, the greater the volatility,the more risky the share & the higher thebeta.
If a company is affected by themacroeconomic factors in the same way asthe market, then the company is likely to
have a beta of one & will be expected togenerate returns equal to the market.
B t
-
8/14/2019 fundamental Analysys
61/123
Beta
A company having a beta of 1.3 implies that
if stock market increases by 10 %, thecompanys share price will increase by 13 %& if stock market decreases by 10 %, thecompanys share price will decrease by 13%
Cost of Equity Capital
-
8/14/2019 fundamental Analysys
62/123
Cost of Equity Capital
Cost of External Equity: The DividendGrowthModel
EarningsPrice Ratio and the Cost of Equity
The Capital Asset Pricing Model(CAPM)
-
8/14/2019 fundamental Analysys
63/123
(CAPM)
As per the CAPM, the required rate of return onequity is given by the following relationship:
Equation requires the following three parametersto estimate a firms cost of equity:
The risk-free rate (Rf)
The market risk premium (Rm Rf)The beta of the firms share ()
Limitations of CAPM
-
8/14/2019 fundamental Analysys
64/123
It is based on unrealistic assumptions
It is difficult to test the validity of CAPM Betas do not remain stable over time.
It is very difficult to find a risk free security.
It is unlikely that the Govt. will default, butinflation causes uncertainty about the realrate of return.Further, investors might nothold well diversified portfolios or the marketindices may not be well diversified.
Beta Estimation
-
8/14/2019 fundamental Analysys
65/123
Beta Estimation
The ratio of covariance between marketreturn and the securitys return to themarket return variance:
2
Covar=
Cor = = Cor
j, m
jm
j m j, m j
j, m
m m m
Beta Estimation
-
8/14/2019 fundamental Analysys
66/123
Beta Estimation
The Market ModelIn the market model, we
regress returns on a security against returnsof the market index.
Security Market Line
-
8/14/2019 fundamental Analysys
67/123
Security Market Line
For a given amount of systematic risk Beta,SML
shows the required rate of return. A securitysbeta of 1 indicates systematic risk equal to theaggregate market risk & the required rate on thesecurity will be equal to the market rate ofreturn.
If the securitys beta is greater than 1, then itssystematic risk is greater than the aggregatemarket.This implies that the securitys returnsfluctuate more than the market returns.
A security of Beta less than 1means that the
securitys risk is lower than the aggregate marketrisk. This implies that the securitys returns areless sensitive to the changes in the marketreturns.
Beta Estimation in Practice
-
8/14/2019 fundamental Analysys
68/123
Beta Estimation in Practice
In practice, the market portfolio is
approximated by a well-diversified shareprice index. We have several price indicesavailable in India.
There is no theoretically determined timeperiod and time intervals for calculatingbeta. The time period and the time intervalmay vary.
The returns may be measured on a daily,weekly or monthly basis. One should have
sufficient number of observations over areasonable length of time.
Beta Estimation in Practice
-
8/14/2019 fundamental Analysys
69/123
Beta Estimation in Practice
The return on a share and market index may
be calculated as total return; that is, dividendyield plus capital gain.
One may calculate the compounded rate ofreturn as shown below:
rj = log[Pt Pt -1] = log[Pt /Pt -1
Summaries of Regression Parameters
-
8/14/2019 fundamental Analysys
70/123
for Company X Vs. Market Returns
Alpha (intercept) 0.0061
Standard error of alpha 0.0038
Beta 0.7479
Standard error of beta 0.1107
Correlation 0.6635Coefficient of determination 0.4402
F-statistic 45.6143
Significance 0.0000Market HLL
Average return0.00046 0.00647
Variance of returns 0.00115 0.00149
Variance 0.00086
Does Beta Remain Stable Over
-
8/14/2019 fundamental Analysys
71/123
Time? Betas may not remain stable for a company
over time even if a company stays in thesame industry. There could be severalreasons for this. Over time, a company maywitness changes in its product mix,technology, competition or market share.
Risk
-
8/14/2019 fundamental Analysys
72/123
Risk
Company Specific Risk
Market Risk Co. specific Risk will include all those risk factors
which would affect one company or set ofcompanies in an industry. Govt. Policy, ExciseDuty Change, Technology
Valuation Models
-
8/14/2019 fundamental Analysys
73/123
Valuation Models
Dividend Discount Model
Free Cash Flow Approach Contemporary Concepts & their Application
Enterprise Value & Earnings
Industry Analysis
-
8/14/2019 fundamental Analysys
74/123
Industry Analysis
Industry Characteristics Importance to the Economy Criticality for Customers Nature of Producers
Cyclicality in Supplier & User Industries
Govt. Policies Regulation Subsidies Export Incentives Customs & Excise Duties
Demand/Supply Dynamics
Competitive Forces
-
8/14/2019 fundamental Analysys
75/123
Competitive Forces
Competition Among Domestic Players
- Number of Players- Relative Market Shares
- Demand-Supply
- Cartelisation & threats therein
- Unorganized Sector Competition
Threats of Imports/Substitutes
-
8/14/2019 fundamental Analysys
76/123
Threats of Imports/Substitutes
Global Demand Supply Dynamics
Relative Cost Structure;International &Domestic
Availability of Substitutes
Economic Feasibility of Substitutes
Entry Barriers
-
8/14/2019 fundamental Analysys
77/123
Entry Barriers
Capital Intensity
Technology Availability Regulatory Issues
Demand & Supply
Existence of strong players
Industry Financials
-
8/14/2019 fundamental Analysys
78/123
Industry Financials
In Industry Analysis, other key factors to be looked intoby the analyst are:-
Past sales & earnings performance Industry Share Prices Relative Earnings per Share Operating Margins Return on Capital Employed
Earnings Growth Analysis of Fixed Costs Industry Peculiarities-seasonality, stocking
requirements, debtors etc. P/E Ratio Trends
Industry Indices
Company Analysis
-
8/14/2019 fundamental Analysys
79/123
Company Analysis
Annual Reports
Chairmans Speech to its investorsThe Managements views on the current
performance of the company
Performance after the year end
The backdrop of the economy & industry in which
the company operatesFuture Plans
Difficulties faced by the company along withmeasures to tackle them
Future Prospects
Directors Report
-
8/14/2019 fundamental Analysys
80/123
Directors Report
The State of the Companys Affairs
The amounts which it proposes to Carry tothe Reserves
The amount which should be paid by way ofDividend
Material Changes & commitments, if any,affecting the financial position of thecompany which have occurred in between
The conservation of energy, technologyabsorption, foreign exchange earnings &
outgo.
Auditors Report
-
8/14/2019 fundamental Analysys
81/123
Auditors Report
This is a statutory report testifying the
correctness of the accounts & giving theircomments on the accounting practices &procedures of the company. The real position ofthe companys operations is known from thefootnotes to the accounts & the comments of theAuditors.
Analysts should examine carefully thesenotes & the Auditors Report to make anycorrect assessment of the valuation of ashare
Why Study Economics?
-
8/14/2019 fundamental Analysys
82/123
Why Study Economics?
Harry S. Truman (33rd President of the UnitedStates) once asked his advisors to find him aone-armed economist. When asked, Why?,
Truman replied, So he cant say, On the onehand and on the other....
What can Economics help us
-
8/14/2019 fundamental Analysys
83/123
understand?
Macro questions How are interest rate and exchange rates determined? What determines national income? How do we measure productivity? What determines the wealth of nations?
Micro questions How are markets organized? How are prices determined?
How do we measure inflation? How do demand and supply operate in product,
financial and labor markets?
Why do we care?
-
8/14/2019 fundamental Analysys
84/123
Why do we care?
Maybe we wont be better at prediction but we
will understand the dynamics of the market andhow we can read Expectations
Understanding how and why nations succeed orfail will help us understand their real andfinancial interactions
Markets have undergone major transformationsin recent years, we may be able to anticipatefuture developments
It will be easier to analyze companies,governments and financial institutions if we
understand the dynamics of supply and demandand the structure of the markets in which theyoperate
A look @ the Indian Economy
-
8/14/2019 fundamental Analysys
85/123
A look @ the Indian Economy
Trends in GOI Yield Curve
Trends in Exchange Rate Trends in 6 M Premiums(%)
Monthly Increase in Forex Reserves
Likely Trends in Inflation
Trends in FII Flows Trends in Commodities(Oil Prices, Gold &
Silver)
Equity Classes
-
8/14/2019 fundamental Analysys
86/123
Equity Classes
Growth and value
Active and passive Large and small cap
Cyclical vs defensive stock
Stock selection
- P/E ratio- Dividend yield
Fundamental analysis
Technical analysis
Equity Markets and MutualF d
-
8/14/2019 fundamental Analysys
87/123
Funds Equity stocks can be classified as large cap, mid cap
and small cap
Market cap = Market Price per share X No of sharesoutstanding
Large cap stocks are traded everyday in large volumes;hence highly liquid but these are establishedcompanies offering normal profit potential
Small cap stocks provide higher return potential butare generally not very liquid
Cyclical stocks are those whose performance is closelylinked to macro economic factors; eg. cement stockswhich are linked to infrastructure development in thecountry
The P/E ratio (Market Price Per Share / Earnings PerShare) indicates the price the market is willing to payper rupee of companys earnings (or potentialearnings)
Higher P/E ratio indicates growth stock; value stockshave generally lower P/E ratios
Equity Markets and MutualF d
-
8/14/2019 fundamental Analysys
88/123
Funds The investment pattern of a fund is primarily dictated
by the fund objectives
Growth investing is a style which is aggressive and thefund manager is willing to invest in companies whichmay be expensive but have high future profit potentialas well; fund manager focuses on sectors which are
expected to do well in future, and even be willing tobuy them at higher prices
Value Investing is a style where the fund managerprefers investing in companies which are undervalued
today; he will buy only if the price is right; his focus ison companies which have a value proposition that isyet to be recognized by the market
Equity Markets and MutualF d
-
8/14/2019 fundamental Analysys
89/123
Funds So, by definition
P/E Ratio is Market Price Per Share / Earnings perShare, and;
Dividend Yield is defined as Dividend Per Share /Market Price Per Share
If market price moves up, P/E ratios are higher
and Dividend Yield is lower If market prices move up, P/E ratios are lower and
dividend yield is higher
-
8/14/2019 fundamental Analysys
90/123
Fundamental Analysis is the analysis of the profit
potential of a company, based on numbersrelating to its products, sales, costs, profits andmanagement of the company
Technical Analysis is the analysis of the marketprices and trading volumes data to identify clues
to market assessment of a stock A fund manager focuses on asset allocation, asecurities dealer buys and sells shares and ananalyst researches and recommends them forbuying and selling
-
8/14/2019 fundamental Analysys
91/123
An active fund manager hopes to do better than
the market by selecting companies which hebelieves will outperform the market
A passive fund manager simply replicates theindex, and hopes to do as well as the index
A passive fund manager tries to keep costs down
and has to rebalance his portfolio if thecomposition of the index changes
Types of Equity Instruments
-
8/14/2019 fundamental Analysys
92/123
yp q y
Ordinary Shares
Preference Shares Equity Warrants
Convertible Debentures
pproac es o or o oManagement & Role of
-
8/14/2019 fundamental Analysys
93/123
gSecurities Research Passive Fund Management: Index Funds
Active Fund Management
Fundamental Analysis
Technical Analysis
Quantitative Analysis
Successful Equity PortfolioManagement
-
8/14/2019 fundamental Analysys
94/123
Management Set realistic target returns based on appropriate
benchmarks Be aware of the level of flexibility available while
managing the portfolio
Decide on an appropriate investment philosophy,I.e whether to capitalize on economic cycles, or to
focus on growth sectors or on finding valuestocks
Develop an investment strategy based on theinvestment objective, the time frame forinvestment & economic expectations over this
span Avoid over-diversification to maintain focus &
facilitate sound tracking
Develop a flexible approach to investing
Fund Selection
-
8/14/2019 fundamental Analysys
95/123
Equity funds: Characteristics
- Fund category Suitability to investor objective
- Investment style
Growth vs Value
- Age of the fund
Experience preferred to new fund- Fund management experience
- Size of the fund
Larger funds have lower costs
- Performance and risk
Equity Funds Selection Style
-
8/14/2019 fundamental Analysys
96/123
q y y
Percentage holding in cash.
Concentration in portfolio. Market capitalisation of the fund.
Portfolio turnover.
Risk Statistics
- Beta
- Ex-Marks
- Gross dividend yield
- Funds with low beta, high ex-marks and high gross
dividend yield is preferable
Equity Price Risks
-
8/14/2019 fundamental Analysys
97/123
q y
Company Specific
Sector Specific Market Level
Company specific risks have to be researched& assessed by the funds analysts & portfolio
managers. Holding a large, say 15/20 shareportfolio generally balances out & diversifiescompany specific risks.
Specific sector funds have more risks. Fundsresearch & track the sectors with good
potential. The more the number of sectors ina portfolio, the less is the portfolios sectorrisk
Market Risk
-
8/14/2019 fundamental Analysys
98/123
Market Risk is not diversifiable as it arises
from broad economic & other factors.Managers try to anticipate bear or bullphases & try to adjust their portfolio assetallocation. If equity index futures & optionsare available, managers try to hedge their
portfolios with these instruments.
Market Cycles
-
8/14/2019 fundamental Analysys
99/123
These are extensively researched & analysed
in the U.S by agencies such as Lipper. In India, independent agencies, brokers &
newspapers are doing some of this analysis.It is important to see how a portfolio or ashare performs over a well defined cycle than
over some arbitrary calender period. Equity investments are basically more
rewarding in the long term.Any equity fundcan be more risky as a short term
investment. Sticking to a good fund helps.
Risk Measures
-
8/14/2019 fundamental Analysys
100/123
Risk defined as volatility, is measurable by
the statistical concept of StandardDeviation(SD)
SD measures the fluctuations of a fundsreturns around a mean level.Use monthlyresults of an equity fund. Tabulate returns.
Calculate mean returns. Calculate variancesof each months returns from the mean.Square these numbers. Sum up. Divide by theno. of periods of observations. Computeoverall variance or the standard deviation.SDgives an idea of how volatile the earningsare.
Standard Deviation
-
8/14/2019 fundamental Analysys
101/123
SD can be computed for both equity & debt
funds.SDs of different funds can becompared with each other, or with SD of amarket index or even that of anothercategory.
SD is the best measure of risk, though it is
based on past returns.It is broader conceptthan beta. It measures total risk & not justmarket risk.It is an independent number.
Risks of both specialized & diversified funds
& both equity & debt funds are measurablewith SD
Standard Deviation
-
8/14/2019 fundamental Analysys
102/123
Measures the absolute risk of a portfolio byexplaining the dispersion of return around themean
It explains the extent of deviation from the meanreturn of a portfolio
It is the preferred measure of risk in a portfolio
Higher SD implies higher portfolio risk.
Beta Coefficient:
-
8/14/2019 fundamental Analysys
103/123
this measures the extent to which fund returnsare impacted by market factors;
Higher beta means higher impact of marketreturns hence more risky
Lower beta means less risk.
Beta Coefficient
-
8/14/2019 fundamental Analysys
104/123
Beta relates a funds return with a market index& measures the sensitivity of the funds return tochanges in the market index.
A beta of 1 means the fund moves with themarket. A beta of less than 1 means the fund willbe less volatile than the market,typically in caseof conservative portfolios
Higher Beta portfolios give greater returns inrising markets & are riskier in falling markets.It isa good measure of fund risk level
Beta is based on past performance, so it does notnecessarily indicate future performance
Funds with specialized portfolios cannot beassessed by betas based on overall market index
Bogles Ex-marks or R-Squared:
-
8/14/2019 fundamental Analysys
105/123
measures return from a fund and the returnsfrom a market index and measures the extentof correlation in their movement;
R-squared of an index fund would be 1 or ex-marks would be 100%;
lower ex-marks means lower correlation orsympathy with market returns;
a fund's risk can be gauged by its ex-marks incomparison with the market index
Quality of beta depends on ex-marks.
ExMarks or R-Squared
-
8/14/2019 fundamental Analysys
106/123
This is used to help spot questionable betas.
R-squared measures how much of a fundsfluctuations is attributable to movements inthe overall markets from 0 to 100 %
An Index Fund will have ExMarks of nearly100 %.Non-Diversified funds will have lower
ExMarks To be meaningful,the fund being evaluated
should have some correlation with themarket. A low beta fund with very low R-
squared/ExMarks is least risky;but not so ifthe fund is a Gold Fund, with little relation tostock markets
Risk Adjusted Return
-
8/14/2019 fundamental Analysys
107/123
The differential return earned by the fund
manager may be due to difference in theexposure to risk. Hence it is imperative toadjust the return for the risk. There areessentially two major methods of assessingrisk-adjusted performance:
Return per unit of risk Differential Return(Alpha)
Risk Adjusted Return
-
8/14/2019 fundamental Analysys
108/123
Returns must be evaluated on a risk-adjustedbasis
Higher return may be accompanied by higherrisk
Compute return and risk for both for fundand benchmark and find out return per unit
of risk, earned by each of them Eg. benchmark return (12%) and S.D. (9%) Fund return (16%) and risk i.e. SD (11%) Then the benchmark has return per unit of
risk of (12/9)1.33 and the fund has return per
unit of risk of (16/11) 1.45 Hence, on a risk adjusted basis, the fund has
performed better than the benchmark
SHARPE & TREYNOR RATIO
-
8/14/2019 fundamental Analysys
109/123
Sharpe Ratio is a measure of risk-adjustedperformance of a fund by measuring the returnper unit of Standard Deviation
Sharpe Ratio = (R-Rf)/SD
Treynor ratio is a measure of risk-adjusted returnby measuring the return per unit of beta (market
risk) Treynor Ratio = (R-Rf)/b
Sharpe Ratio is useful to understand a singlefunds performance
Treynor ratio is useful for comparison of multiple
funds
Portfolio Turnover
-
8/14/2019 fundamental Analysys
110/123
Portfolio turnover refers to churn
Portfolio turnover is the ratio of amount of salesor purchases (whichever is lesser) / net assets ofthe fund
Higher the portfolio turnover, greater the amountof churning of assets done by fund manager
If portfolio turnover is 200%, it means that on anaverage every investment is held for a period of 6months
Higher turnover rate also means highertransaction costs. This ratio is relevant for
actively managed equity portfolios
-
8/14/2019 fundamental Analysys
111/123
Comparisons are usually done
With a market index With funds from peer group
With similar products in which investors puttheir funds
When comparing fund performance with peer
group, size and composition of the portfoliosmust be comparable
Tracking Error
-
8/14/2019 fundamental Analysys
112/123
In order to obtain the same returns as the
index, an Index Fund invests in all of thestocks included in the index calculation, inthe same proportion as the stocksweightage in the index.
An index funds actual return may, however
be better or worse by the tracking error. The tracking error arises from the practical
difficulties faced by the fund manager intrying to always buy or sell stocks to remainin line with the weightage that the stocksenjoy in the index.
Active Equity Funds
-
8/14/2019 fundamental Analysys
113/123
Selection of appropriate benchmark is
required to compare the returns of an equityfund to the returns on benchmark, usingappropriate market index.
The appropriate index to be used to evaluatea broad based equity fund should be decided
on the basis of the size & composition of thefunds portfolio
If the fund has a large portfolio, a broadermarket index like BSE 100 or 200 or NSE 100may have to be used as the benchmarkrather than S & P CNX Nifty or BSE 30
as s o oos ng anAppropriate PerformanceB h k
-
8/14/2019 fundamental Analysys
114/123
Benchmark 1. The Asset Class it invests in: An equity
fund has to be judged by an appropriatebenchmark from the equity markets, a debtfund performance against a debt marketbenchmark & so on. And
2 The funds stated Investment Objective: If a
fund invests in long term growth stocks, itsperformance ought to be evaluated against abenchmark that captures growth stocksperformance.
Choosing Market Benchmarksin Practice
-
8/14/2019 fundamental Analysys
115/123
in Practice Agencies such as Credence prefer the BSE
200 because of its broad-based nature. For sector funds, the S & P CNX Sectoral
Indices have been preferred
India Index Services Ltd, Index ServicesDivision of BSE or other exchange
Debt Funds
-
8/14/2019 fundamental Analysys
116/123
1. I-SEC : Its I-Bex index is often used bysome analysts as a benchmark to trackgovernment securities performance. Thereare 4 indices- Li-bex that tracks thesecurities with long maturities over 7 years,Mi-Bex tracking maturities between 3 & 7years, Si-Bex tracking short maturities of 1-3
years & a Composite Index that is theaverage of all three maturities.
2. CRISIL: has 8 debt indices,4 primaryindices that track the prices of underlyingsecurities & 4 derived indices based on the
primary indices. Primary indices cover AAA &AA rated securities, and Call Market &Commercial Paper
Derived Indices
-
8/14/2019 fundamental Analysys
117/123
Liquid Funds Index : This tracks the returns
on Call Market & Commercial Paper; Balanced Fund Index: This tracks the returns
on Nifty Index for equity & CRISIL CompositeBond Fund Index for debt. The CBFI in turntracks returns on Call,Govt.Securities, AAA &
AA securities & CP.
Debt Funds
-
8/14/2019 fundamental Analysys
118/123
3. NSE : has designed a Government
Securities Index & a Treasury Bills Index.These indices track either
a. Market price movements( capital gains orlosses) that are a mirror image of yieldmovements,and are called Principal Return
Index; or b. Both interest accruals and capital gains
or losses, the so called Total Return Index
In any case, any benchmark for a debt fund
must have the same portfolio composition &the same maturity profile as the fund itself,to be comparable
Money Market/Liquid Funds
-
8/14/2019 fundamental Analysys
119/123
Liquid Funds have portfolios of short term
instruments.Hence performance is usuallybenchmarked against the governmentsecurities of appropriate maturities. In India,besides NSE, J.P Morgan has also developed aTreasury Bill Index.I-BEX, being a composite
index is not suitable for liquid funds. A better benchmark for MM funds in India is
either the Liquid Fund Index of CRISIL orNSEs G-Sec & T-Bills indices
Criteria for Peer GroupComparisons
-
8/14/2019 fundamental Analysys
120/123
p The investment objectives & risk profiles
Portfolio Composition Credit Quality & Average Maturity
Fund Size
Expenses Ratios
Advance/Decline Issues Ratio (A/DIssues Ratio)
-
8/14/2019 fundamental Analysys
121/123
the advance/decline issues ratio (AD issues ratio)is one of the most widely followed measures of
market breadth; it can also be used as a measureof market strength (market momentum).
The formula for calculating the A/D issues ratio issimple:
A/D Ratio (Issues)=Advancing Issues/Declining
Issues The AD issues ratio is applied as follows: 1. Values higher than 1 show that more issues
are presently advancing than declining; 2. Values between 0 and 1 indicate that more
issues are currently declining in price.
Advance/Decline Issues Ratio (A/DIssues Ratio)
-
8/14/2019 fundamental Analysys
122/123
The A/D ratio has an absolute value that does notvary in function of the number of components
being analyzed it remains constant, regardlessof the number of stocks under consideration. Thisis a big advantage, especially when analyzingentire stock exchanges, where the number oftraded issues changes constantly. The other keyadvantage of using the A/D ratio is that it easily
allows comparisons among different indexes orstock exchanges. For instance, comparing the A/Dratios of the DJI and the NYSE is much easier thanevaluating the A-D lines for the NYSE (which canrange from 0 to over 3.600) and the DJI (it has amuch smaller range: from 0 to 30).
What is put call ratio (PCR)?
-
8/14/2019 fundamental Analysys
123/123
Put call ratio (PCR) can be judged for aparticular stock or index or all the availableoption stocks. In the Indian stock marketcontext investors generally talk more about
the PCR of nifty which can be found by thetotal number of nifty puts divided by totalnumbers of nifty calls (Nifty Puts/ NiftyCalls). The data can be available from theNse site. PCR ratio has not been able to give
clear guidance of the trend of Indian stockmarket.