Fundamental Analysis
Objective of Investor
Return Maximization &
Risk Minimization
Intelligent investing requires
Scientific analysis
Rational evaluation of companies
Consider past performance
Estimate future performance
Of both Company & the Industry
What is Fundamental
Analysis?
a technique that attempts to determine a security’s value by
focusing on underlying factors that affect a
company's actual business and its future prospects.
analysis of the economic well-being of a financial entity as
opposed to only its price movements.
Fundamental analysis serves to answer questions, such as:
Is the company’s revenue growing?
Is it actually making a profit?
Is it in a strong-enough position to beat out its competitors in the
future?
Is it able to repay its debts?
Is management trying to "cook the books"?
Is the company’s stock a good investment?
The Concept of Intrinsic
Value
A primary assumptions of fundamental analysis is that the price
on the stock market does not fully reflect a stock’s “real” value.
this true value is known as the intrinsic value.
Say a stock was trading at Rs. 20. After doing extensive
homework on the company, you determine that it really is worth
Rs. 25. In other words, you determine the intrinsic value of the
firm to be Rs.25. This is clearly relevant because an investor
wants to buy stocks that are trading at prices significantly below
their estimated intrinsic value.
The second major assumption of fundamental analysis is that, in
the long run, the stock market will reflect the fundamentals.
Do’s & Don'ts of Fundamental
Analysis
Do buy shares only after detailed analysis
Do hold shares for a long term period of
atleast 1 year
Don’t buy on basis of tips and rumours
Don’t follow the crowd in buying or selling
Qualitative Factors - The
Company
Business Model
Competitive Advantage
Management
Website
Conference calls
Management Discussion & Analysis
Past performance
Corporate Governance
Structure of the Board of Directors
Qualitative Factors - The
Industry
Customers
Market Share
Industry Growth
Competition
Regulation
Industry Classification
Group of Firms
Producing reasonably similar products
Serving same needs
Common set of buyers
e.g. Cotton textile industry, cement industry, steel
industry, pharmaceutical industry
Difficult to classify diversified companies
e.g. ITC – cigarettes, edible oil, ready made
garments
Industry Life Cycle
4 stages called:
Pioneering
Expansion
Stagnation
Decay
Profitability of Company dependant on stage of
industry
Pioneering Stage
First stage of industry
New industry
Technology new, product new
Rapid growth in demand
Competition intense
Only strong companies will survive
Weak will close down
Also called “Sunrise Industries”
BPO, retail, bio-technology
Expansion Stage
Industry is established
Only survivors of Pioneering Stage
Cos. Continue to become stronger
Each Co. develops its own strategies
Improved products, lower prices
High returns, low risk as
Demand more than supply
e.g. telecom, IT, automobiles
Maturity Stage
Growth has stabilized
Sales increase at a lower rate
An industry might stagnate for a short period
Introduce improved technology
Resume growth
For e.g. Colour TVs – new innovations like plasma
TV, home theatre systems, flat screen, high
definition TV etc.
Investor to be alert
Decay Stage
Products no longer in demand
Newer Products & newer technologies
Customers lifestyle has changed
Investor should get out before decay stage
Limitations of this Approach
Not always easy to detect stage
Transition from 1 stage to another – slow
Can be exceptions to the general pattern
Many industries will never decay
e.g. basic industries like cement, pharma,
steel, textiles
Industry Structure
Demand Supply Gap
Demand changes at a steady rate
Supply or capacities at irregular intervals
At different times – undersupply or over capacity
Undersupply – higher profits
Over capacity – lower profits
e.g. automobiles – more demand – addition of new
capacities
e.g. Colour TVs – over capacity – lower prices of basic
units.
Competitive Conditions
Level of Competition – high / low
e.g. FMCG – highly competitive
Bio-technology – low competition
Entry Barriers
Difficult to establish presence
Product differentiation
Preference of buyers for established brands
e.g. colgate, pepsodent – toothpastes
Absolute cost advantage
Established players have lower costs
Economy of scale
Necessary to maintain high levels of production
e.g. PTA – a key raw material for manufacture pf polyester –
Reliance largest and now the only manufacturer
(Contd.)
Competitive Conditions
Threat of Substitution
For e.g. “Good Knight” replaced “Tortoise”
Bargaining Power
e.g. Cars
Earlier few manufacturers
Advance booking
Waiting period
Now sellers are more
More competition
Buyers are stronger
Rivalry among competitions
e.g. Coke & Pepsi
Heavy advertising expenses
Other Factors
Attitude of the Government
Govt. encourages certain industries
Discourages others
For e.g. cigarettes & liquor
Supply of raw materials
Whether freely available
Whether imported
For e.g. access to bauxite mines for aluminum
manufacturers
