UNIT- III FUNDAMENTAL ANALYSIS
Economic Analysis – Economic forecasting and stock
Investment Decisions – Forecasting techniques.
Industry Analysis : Industry classification, Industry
life cycle – Company Analysis Measuring Earnings
– Forecasting Earnings – Applied Valuation
Techniques – Graham and Dodd's investor ratios.
Concept
Fundamental analysis is the process of looking at
a business at the basic or fundamental financial
level
Micro level analysis-if only one scrip is analyzed
Macro level-Whole market securities are
analyzed
Objectives
To make a projection on its business performance
To evaluate its management
To calculate its credit risk
To conduct a company stock valuation
Approaches to the security analysis
Economic analysis
Fundamental analysis
Approaches to
the security Industry analysis
analysis
Technical analysis
Company analysis
Fundamental analysis
This is based on the assumption that a share
price is determined by fundamental factors
related to economy, industry and company
It includes economic analysis, industry
analysis and company analysis
1.Economic analysis
• The share price is determined based on the
performance of industry and economy
• Economy is booming, the company will be
prosperous
• Economy is recession, the company will be far
from satisfactory
2.Industry analysis
The investor will wish to invest in the
securities of specific companies belonging to a
particular industry that is doing well
3.Company Analysis
It concentrates various aspects of company
such as financial and non-financial aspects
Economic forecasting and stock
Investment Decisions
I. Agriculture
II. Gross domestic product
III. Savings and investment
IV. Inflation
V. Rates of interest
VI. Research and technological developments
VII.Infrastructural facilities
VIII.Political stability
Economic Analysis
Economic analysis is process whereby strengths and
weakness of an economy are analyzed
Economic Forecasting
Economic forecasting is a term used to apply to any
methods that are utilized to predict the future movements
of an economy
Types of economic Forecasting
1.Short Term Forecasting
Period of 3 years or less
2.Medium Term Forecasting
3 to 5 years period
3.Long Term Forecasting
More than 5 years
Forecasting Techniques
Economic Model Building Trend Analysis Method
Anticipatory Surveys Monetary Indicators
Diffusion Indexes Opportunistic Model Building
1.Anticipatory Surveys
The method in this category is those on opinions and
attitudes of forecasting or experts involved
a)Expert Opinion
b)Cross – Impact Analysis
Researchers identify a set of key trends in term of high
importance and high probability
2.Trend Analysis Method
Based on the time series data of different economic
indicators these method held forecast economic changes
a)Trend Extrapolation
b)Trend Correlation
3.Diffusion Indexes
A diffusion index is an indicator of the
extensiveness or spread of an expansion or
construction
a)Composite Index
b)Component Evaluation Index
4.Monetay Indicators
In recent years the significance of monetary
indicators of the economy growth
5.Econometric Model Building
Econometric explains past economic activity
by deriving mathematical equation that will
express the most probable interrelationship
between a set of economic variables
6.Opportunistic Model Building
a)Hypothesis of Total Demand
b)Test of Consistency and Comparison
Factors affecting Economic Forecasting
1.Gross Domestic Product
GDP represents the aggregate value of the
goods and services produced in the economy
2.Savings and Investments
Savings are distributed over various assets
like equity , deposits , mutual fund , real
estate and bullion
3.Inflation
The demand in the consumer product
industry is significantly affected
4.Interest Rates
A decrease in interest rate implies lower cost
of finance for firm and more profitability
5.Moonsoon and Agriculture
Agriculture is directly and indirectly linked
with the industries
6.Infrastructure Facility
Infrastructure facilities are essential for the
growth of industrial and agricultural sectors
7.Demographic Factors
The demographic data provides details about
population by age , occupation , literacy and
geographic location
8.Fiscal Policy
Fiscal policy is concerned with the spending
and tax initiatives of the government
9.Monetary Policy
Monetary Policy is concerned with the
manipulation of money supply in the
economy
Stock Investment Decision
1.Look for a Stable Company
Investors always wants to invest in a company that
on good financial ground and that has a good future
forecast
2.Look for a company that can Grow and Prosper
Always wants continue to improve their profit and
success
3.Look for a company that has Good management and
corporate structure
Investors need to know that the right people are
leading the company in the right direction
2.Industry Analysis
Industry analysis involves reviewing the
economic, political and market factors
that influence the way the industry develops
Characteristics of Industry Analysis
1.Past sales and Earnings performance
It is a crucial input in forecasting future trends
2.Permanence
Technology developments and government
rule play an important role
3.Attitude of Government towards Industry
Should be aware of various government
policies and regulations
4.Labour Conditions
Should examine labor laws
5.Competitive Conditions
a)Existence of Product Differentiations
b)Absolute Cost Advantages
c)Advantages rising from Economics of Scale
6.Industry Share Prices Relative to its Earnings
Industry Classification
Reporting Business Industry Input
Agencies Cycle Groups Based
Cyclical Defensive Cyclical
Industries Industries Growth
Industries
Small Medium Large
Scale Scale Scale
Units Industries Industries
1.Classification by Reporting Agencies
RBI classified industries into 32 groups
Stock Exchange classified into 10 groups
Economic times classified into 10 groups
Financial express classified into 19 groups
2.Business Cycle
a)Cyclical Industries
Purchasing Power
b)Defensive Industries
Inelastic Demand
c)Cyclical Growth Industries
Technical and Economic changes
3.Industry Growth
a)Small Scale Units
Listed should be having a capital of 30 lacs
Listed in OTCEI
b)Medium Scale Industries
Capital 5 Crores
Regional Stock Exchanges like Coimbatore , cochin
c)Large Scale Industries
Paid up 10 Croes
Listed in BSE and NSE
4.Input Scale Classifications
Agro-Based
Forest Based
Metal Based
Marine Based
Chemical Based
Factors Influencing Industry Analysis
1.Product Line
2.Raw Materials
3.Capacity Utilized
4.Industry Characteristics
5.Government Policy
6.Management
7.Future Prospects
8.Economic Factors
Frameworks of Industry Analysis
1.Industry Life Cycle
2. SWOT Analysis
1.Pioneering / Introduction Stage
New Product Introductions
Demand Keep growing
2.Expansion / Growth Stage
Firm continue to improve financially and
competitively
3.Stagnation / Maturity Stage
Slow progress
Social habits , high labor costs , technology changes
4.Decay / Decline Stage
Result to lead in decline in profit , dividend and
share price
Concentrate Here Keep The Good Work
Take enough Care Diversion
Marketing Finance
Popularity Cost Of Capital
Relative Market Share Funds availability
Quality Image Financial Stability
Service reputation Profitability
Distribution Cost
Sales force
Market Location
Manufacturers Human Resources
Facilities Leadership
Economic scale Management capabilities
Capacity Utilization Worker attitudes
Labor Productivity Skill Development
Manufacturing Cost Adaptation
Raw Material availability Industrial Relations
Technology
3.Company Analysis
It consists of measuring its performance and
ascertaining the cause of this performance
Quantitative - Financial and Operational
indicators
Qualitative – name of the company ,
operational plans for future
Nature and Style of Management
Good management depends on qualities of
managers
1.Ability to get along with people
2.Leadership
3.Analytical competence
4.Industry
5.Judgment
6.Ability to get the things done
Analysis can be carried out on the following ways
1.Background of Managerial Personnel
Manager age , educational background , levels of
responsibilities and activities
2.Past Year Records
Past records has to be reviewed
3.Management Skill
4.company’s strength to expand
5.Porper utilization of plant and machinery
6.Management capacity to finance
7.Relationship with employees
Financial Indicators
Financial indicators are those which can be
used to analysis the financial position of the
company
Tools
1.Income Statement
2.Balance Sheet
3.Statement of cash flow
4.Ratio Analysis
Statement should be accurate , complete ,
consistent and comparable
1.Income Statement
It is not only to assess current management
performance but also assess the company’s future
profitability
Inventory cost method
Depreciation
After tax net income
EPS
2.Balance Sheet
Asset side- Dividend in current assets , investments ,
long term assets and intangible assets
Liability side – Long term debt , other liabilities
income tax and shareholders equity
3.Statement of Cash flows
The statement of cash flows shows how a
company’s cash balance changed from one year
to next
1.Cash flow from Operating activities
2.Cash flow from Investing activities
3.Cash flow from Financing activities
4.Ratio Analysis
Widely used tools of financial analysis
1.Profitablity Ratio
2.Leverage Ratio
3.ROE Ratio
1.Profitablity Ratio
a)Return on Investment = EBIT / Total Asset
b)Net Profit Margin = PAT / Net Sales
c)Return on Equity = PAT- PD / Equity capital +
Reserves
d)EPS = PAT – PD / Out standing Shares
e)Dividend Payout Ratio = EPS / Dividend per
share
2.Leverage Rations
a)Debt Equity Ration = Total Debt / Equity
b) Interest Coverage Ratio = EBIT / Int
3.ROE Analysis ( Return On Equity)
PBT PAT NS TA
ROE = ----- * ----- * ----- * -----
NS PBT TA NW
PAT = Profit After Tax
PBT = Profit Before Tax
NS = Net Sales
TA = Total Asset
NW = Net Worth
Non Financial Indicators
1.Business of the Company
2.Top Management
3.Product Range
4.Diversification
5.Foreign Collaboration
6.R&D
7.Government Regulations
8.Pattern of Shareholding and Listing
Applied Valuation Techniques
Regression analysis Correlation analysis
Trend analysis Decision Trees
1.Regression Analysis
1.Dependant Variable - single variable
2.Independent Variable – explanatory variable
Regression is the measure of the average
relationship between two or more variables
in terms of the original units of data
2.Correlation Analysis
Correlation is the study of the linear
relationship between two variables
Eg: Relationship between heights and weights ,
demand prices of commodities
3.Trend Analysis
Trend analysis of often used to predict future
events
Trend analysis is a time series analysis
4.Decision Trees
Decision tress can be used to forecast
earnings and security values
