Dr. P.R.

K Degree College, BALLARI

Course: B.Com Sub: Investment Management Sem: VI
Unit – 2: Fundamental Analysis
CONTENT
2.1 Introduction
2.2 EIC Framework
2.2.1 Definition of Fundamental Analysis
2.2.2 Economic Analysis
2.2.3 Industry Analysis
2.2.4 Company Analysis

2.3 Valuation of Securities

2.3.1 No Growth Model (Zero Growth Model)
2.3.2 Constant Growth Model (Gordon Growth Model)
2.3.3 Super Normal Growth Model (Multistage Growth Model)

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 Dr. P.R.K Degree College, BALLARI
Course: B.Com Sub: Investment Management Sem: VI
-INTENT-
2.1 Introduction
Fundamental analysis is a cornerstone of investment strategy, providing a thorough
approach to evaluating the intrinsic value of securities. This analysis is crucial for making
informed investment decisions. This unit is organized into three main sections including this
introductory section to offer a structured and comprehensive understanding of fundamental
analysis.
The second section delves into the EIC (Economy-Industry-Company) Framework, a
systematic method for analysing investments. It begins with an examination of the global
economy, considering how international economic trends influence markets. Next, it covers
domestic economy factors and their impact on investments. This is followed by an exploration
of business cycles and their phases, which are critical for understanding economic fluctuations.
Finally, the section provides detailed insights into industry analysis and company analysis,
equipping readers with the tools to evaluate specific sectors and businesses effectively.
The third section focuses on the valuation of securities, particularly equity shares. It
explains various valuation methods under different growth scenarios: no growth rate, normal
growth rate, and supernormal growth rate. To enhance comprehension, this section includes
practical problems enabling readers to apply the concepts learned.
This structured approach ensures a thorough understanding of fundamental analysis,
from macroeconomic influences to the valuation of individual securities.

2.2 EIC Framework

The EIC (Economy-Industry-Company) Framework is a systematic approach in
fundamental analysis that examines the broader economic environment, industry trends, and
specific company performance. It helps investors understand how macroeconomic factors and
industry conditions influence individual companies, guiding more informed investment
decisions. Before delving deeper into it one has to thoroughly understand the definition of
Fundamental Analysis.
2.2.1 Definition of Fundamental Analysis
According to Michel, C.T. (1998)12, Fundamental analysis involves researching
fundamental financial data to predict profits, supply and demand dynamics, industry resilience,
management competency, and other inherent factors that influence a stock's market worth and
growth prospects.
There are three components of Fundamental Analysis. These are –

1. Economic analysis
2. Industry analysis and
3. Company analysis

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 Dr. P.R.K Degree College, BALLARI
Course: B.Com Sub: Investment Management Sem: VI
In fundamental analysis, the EIC Framework can be applied using the top-down
approach, which starts from the global economy and narrows to individual companies, or the
tottom-up approach, which begins with individual companies and expands to the broader
economy. Both methods provide valuable insights for investment decisions.
The figure 2.1 and 2.2 depicts these two approaches of Fundamental Analysis.
Figure 2.1: Top-Down Approach in Fundamental Analysis

Figure 2.2: Bottom-Up Approach in Fundamental Analysis

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 Dr. P.R.K Degree College, BALLARI
Course: B.Com Sub: Investment Management Sem: VI

The following is the detailed explanation of EIC approach in Fundamental Analysis.

2.2.2 Economic Analysis: This component involves analysing the overall economic factors
that can impact a company's performance, such as GDP growth, interest rates, inflation, and
government policies. It helps in understanding the broader economic environment in which a
company operates and how it may affect its future prospects. The economic analysis can be
classified into global economy and domestic economy. The following is the brief explanation
of these.
2.2.2.1 Global Economy

2.2.2.1.1 Definition: The global economy refers to the interconnected network of economic
activities involving countries worldwide.

2.2.2.1.2 Key Aspects:

1. International Trade: Exchange of goods, services, and capital across borders.

2. Financial Markets: Global platforms for trading currencies, stocks, bonds, etc.
3. Multinational Corporations: Companies operating in multiple countries with
global supply chains.
4. Globalization: Integration of economies through trade, investment, and
technology.
5. International Institutions: Organizations like IMF, World Bank, WTO
promoting global economic cooperation.
6. Exchange Rates: Prices at which currencies trade in global financial markets.
7. Global Economic Indicators: Metrics like GDP, inflation, and unemployment
rates that reflect worldwide economic health.

2.2.2.2 Domestic Economy:

2.2.2.2.1 Definition: The domestic economy refers to the economic activities and conditions
within a specific country’s borders.

2.2.2.2.2 Key Aspects:

1. Gross Domestic Product (GDP): Total value of goods and services produced
within the country.
2. Employment and Labor Market: Rates of employment, unemployment,
wages, and workforce dynamics.
3. Government Policies: Fiscal (taxation, spending) and monetary (interest rates,
money supply) policies.
4. Consumer Behavior: Household spending, savings, and borrowing habits.
5. Business Environment: Regulations, infrastructure, access to financing, and
entrepreneurship.
6. Economic Cycles: Phases of economic growth, recession, and recovery.
7. Sectoral Composition: Mix of industries (agriculture, manufacturing, services)
within the economy.

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 Dr. P.R.K Degree College, BALLARI
Course: B.Com Sub: Investment Management Sem: VI
2.2.2.3 Interconnection:
• Trade and Finance: Global economy involves cross-border trade and investment
flows, while domestic economy focuses on internal economic activities and policies.
• Policy and Governance: Global economic governance involves international
institutions and agreements, whereas domestic governance is managed by national
authorities.

2.2.2.3 Business Cycles

Business cycles refer to the fluctuations in economic activity that an economy

experiences over a period. These cycles consist of four main phases.

1. Peak: The point at which the economy is at its maximum output, marking the
end of the expansion phase. Growth rates slow down, and economic indicators
suggest that the economy is operating at full capacity.
2. Contraction (Recession): This phase involves a decline in economic activity,
marked by decreasing GDP, rising unemployment, reduced consumer spending,
and lower business investment. It indicates a slowdown in the economy.
3. Trough: The lowest point of the economic cycle, where economic activity
bottoms out before beginning to recover. It marks the end of the recession phase
4. Recovery: Following the trough, the economy starts to grow again, entering the
recovery phase. Economic indicators begin to improve, GDP starts to rise,
employment increases, and consumer confidence starts to return, leading back
into the expansion phase.
5. Expansion: Characterized by increasing economic activity, rising GDP, higher
employment, and improving consumer confidence. Businesses invest more, and
there is a general sense of economic well-being.

Figure 2.3 neatly depicts this.

Figure 2.3: Business Cycles

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 Dr. P.R.K Degree College, BALLARI
Course: B.Com Sub: Investment Management Sem: VI
2.2.3 Industry Analysis
Industry analysis examines the overall industry environment to understand its structure,
competitive dynamics, and key success factors. This analysis helps investors identify attractive
industries and potential risks.
The following are the important factors in industry analysis.
2.2.3.1 Growth of the Industry: Assessing the growth prospects of an industry involves
analysing historical growth rates, projected future demand, and factors influencing market
expansion such as technological advancements or demographic shifts.
2.2.3.2 Cost Structure and Profitability: Understanding the cost structure helps determine
profitability levels within the industry. Factors include fixed and variable costs, economies of
scale, pricing power, and profitability margins relative to competitors.
2.2.3.3 Nature of the Product: Analysing the product characteristics involves studying aspects
like product differentiation, innovation cycles, life cycle stage, and consumer demand trends.
This helps gauge market acceptance and potential for product development.
2.2.3.4 Government Policy: Government policies and regulations significantly impact
industries through legislation, taxation, subsidies, trade restrictions, environmental regulations,
and industry-specific regulations. These can create barriers to entry or affect operational costs
and market dynamics.
2.2.3.5 Labor: Labor considerations encompass workforce availability, skill levels, wage
trends, unionization, and labor market conditions. These factors influence production costs,
productivity levels, and overall industry competitiveness.
2.2.3.6 Research and Development (R&D): R&D activities are critical for innovation and
competitiveness within an industry. Analyzing R&D expenditure, technological advancements,
patents, and intellectual property rights provides insights into future product offerings and
market positioning.
Each factor plays a crucial role in industry analysis, guiding stakeholders in making
informed decisions about investment, strategic planning, and risk management within specific
sectors.
2.2.3.1 Industry Life Cycle
The industry life cycle describes the stages that industries typically go through, each
characterized by distinct dynamics and challenges. The following is the detailed explanation
of these stages of industry life cycle.
2.2.3.1.1 Introduction stage: In this stage, a new industry emerges, often driven by innovation
or technological advancements. Initial demand may be limited, and companies focus on
product development and establishing market presence. The best example could be the Indian
EV industry is in its early stages. While there is a growing awareness and interest in EVs, the
market penetration is still low due to factors like high initial cost, limited charging
infrastructure, and range anxiety. Companies like Tata Motors and Mahindra & Mahindra are
some of the early players in this space, developing and launching new electric vehicle models.

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 Dr. P.R.K Degree College, BALLARI
Course: B.Com Sub: Investment Management Sem: VI
2.2.3.1.2 Growth stage: During the growth stage, industry demand expands rapidly as
awareness increases and adoption rises. Competition intensifies, attracting new entrants and
investment. The Indian e-commerce industry experienced rapid growth with players like
Flipkart and Amazon India capturing market share and expanding their operations aggressively.
2.2.3.1.3 Maturity stage: In the maturity stage, industry growth stabilizes as market saturation
approaches. Competition is fierce, leading to price competition and consolidation among
companies. The Indian FMCG market, dominated by giants like HUL and ITC, exemplifies
maturity stage. Strong brand presence, established distribution, and a saturated market define
the landscape.
2.2.3.1.4 Decline stage: The decline stage occurs when industry demand and profitability
decline due to market saturation, technological obsolescence, or changes in consumer
preferences. The rise of streaming platforms like Netflix and Amazon Prime Video has
significantly impacted the demand for renting physical video formats (DVDs, Blu-rays).
Consumers have access to a vast library of content on-demand, making physical rentals less
convenient.
Figure 2.4 depicts this.
Figure 2.4: Industry Life Cycle

Understanding the industry life cycle helps businesses, investors, and policymakers
anticipate challenges and opportunities at different stages, informing strategic decisions such
as market entry, investment allocation, and product innovation.
2.2.4 Company Analysis
Company analysis involves evaluating the financial health, management effectiveness,
competitive positioning, and growth prospects of a specific company. It includes assessing key

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 Dr. P.R.K Degree College, BALLARI
Course: B.Com Sub: Investment Management Sem: VI
financial ratios, analysing corporate strategy, scrutinizing operational efficiency, and
considering industry dynamics to make informed investment decisions.
The following are the important factors of company analysis.
2.2.4.1 Competitive Edge of the Company: Evaluating a company's competitive edge
involves assessing its unique strengths, such as proprietary technology, brand reputation,
patents, or cost leadership. Understanding these advantages helps determine the company's
ability to withstand competition and sustain profitability.
2.2.4.2 Market Share: Market share indicates the portion of total market sales or revenue a
company controls. Analysing market share trends over time provides insights into a company's
competitive position within its industry and its ability to expand or maintain market presence.
2.2.4.3 Growth of Sales: Monitoring the growth of sales reveals a company's ability to increase
revenue over time. Factors influencing sales growth include market demand, pricing strategies,
product innovation, and expansion into new markets or customer segments.
2.2.4.4 Earnings of the Company: Earnings, including profitability metrics like net income,
operating income, and earnings per share (EPS), reflect a company's financial performance.
Analysing earnings helps assess profitability, efficiency in cost management, and overall
financial health.
2.2.4.5 Capital Structure: Examining a company's capital structure involves analysing its mix
of debt and equity financing. Factors such as debt levels, interest coverage ratio, and leverage
ratios (like debt-to-equity ratio) impact financial risk, cost of capital, and shareholder returns.
2.2.4.6 Management: Assessing management quality and effectiveness involves evaluating
leadership capabilities, strategic decision-making, corporate governance practices, and
alignment with shareholder interests. Strong management can drive operational efficiency and
long-term value creation.
2.2.4.7 Operating Efficiency: Operating efficiency measures how well a company utilizes its
resources to generate profit. Key indicators include profitability ratios (like gross margin and
operating margin), asset turnover ratios, inventory turnover, and return on assets (ROA).
Improving operational efficiency enhances profitability and competitiveness.
These factors collectively provide a comprehensive view of a company's financial
performance, competitive position, growth prospects, and risk profile, guiding investment
decisions and strategic planning.

2.3 Valuation of Securities

Valuation of securities is a part of company analysis but it is classified as a separate
section for ease of understanding. Valuation of securities is the process of determining the fair
or intrinsic value of financial assets such as stocks and bonds. This section covers the no
growth, normal growth and super normal growth models which are based on dividends as
dividends play a crucial role as they are the primary source of returns for investors in this model
2.3.1 No Growth Model (Zero Growth Model): In the no growth model, dividends are
assumed to remain constant indefinitely. This assumption reflects mature companies or
industries where earnings are stable, and there are limited growth opportunities.
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 Dr. P.R.K Degree College, BALLARI
Course: B.Com Sub: Investment Management Sem: VI
2.3.2 Constant Growth Model (Gordon Growth Model): The constant growth model
assumes that dividends will grow at a stable rate indefinitely into the future. This model is
suitable for companies with predictable and sustainable growth patterns.
2.3.3 Super Normal Growth Model (Multistage Growth Model): The supernormal growth
model accommodates periods of rapid growth followed by a transition to stable growth. It is
used for companies experiencing high growth rates early on, which are expected to slow down
over time. The super normal growth model consists of two stage and three stage model.
2.3.3.1 Two Stage Model
➢ Stage 1 - High Growth Phase: In the first stage, the company is expected to grow
dividends at a higher-than-normal rate for a limited period. This growth phase is
typically driven by factors like new product launches, market expansion, or other
strategic initiatives.
➢ Stage 2 - Stable Growth Phase: After the initial high growth phase, the company
transitions into a stable growth phase where dividends grow at a constant rate
indefinitely. This phase represents the long-term sustainable growth rate of the
company.
2.3.3.2 Three Stage Model
➢ Stage 1 – High Growth Phase: Similar to the two-stage model, the company
experiences a period of high dividend growth due to specific factors.
➢ Stage 2 – Transition Phase: After the initial high growth phase, the company enters a
transition phase where dividend growth gradually slows down as the company matures
or faces competitive pressures.
➢ Stage 3 – Stable Growth Phase: In the final stage, the company reaches a stable
growth phase where dividends grow at a constant rate indefinitely.
Note: The numerical problems are solved in the class.

SUMMARY
Fundamental analysis is pivotal in investment strategy, assessing the intrinsic value of
securities. This unit is structured into three main sections including the introductory section
highlighted its importance, a detailed exploration of EIC framework covering global and
domestic economic impacts, business cycles is provided in second section, and a focused study
on equity valuation methods under various growth scenarios is explained in third section. This
structured approach ensures a comprehensive understanding of this unit and enables the
students effectively evaluating investment opportunities in financial markets.

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