The document discusses fundamental analysis techniques for evaluating stocks. It begins with an overview of analyzing the economy, industries, and specific companies. It then covers various financial ratios for analyzing companies' performance, valuation methods like discounted cash flow models and relative valuation. The document concludes by discussing techniques for setting price targets and projections, and notes both strengths and weaknesses of fundamental analysis.
4. Structure of a Balance Sheet
Balance Sheet as at 31
st March 2006
Profit and Loss Account
for the Year / Period
ended 31 st March 2006
Schedules
Cash Flow
Ratios
Notice of AGM
Chairman’s Statement
Directors Report
Management Discussion
and Analysis
Corporate Governance
Auditor’s Report
Notes on Accounts
5. Definition
Ratio is relationship between two amounts
Proportion that one amount bears to another
6. Different forms
Pure Ratio – DER
Related to Time period- Working capital
turnover
Percentage – NP / Sales
7. IMPORTANCE
Helps analyse relationships
Helps prepare budgets and formulate
policy
Trend analysis
Inter company comparison
Liquidity position
8. For whom
Analysts
Portfolio Managers
Creditors / Lenders
Suppliers
Government
Management
Investors / Shareholders
Public at large
9. Different classes of Ratios
Based on Balance Sheet
( or Financial)
Based on Revenue Statement
( or Operational)
Based on Combination of both statements
10. Working capital cycle
Current Assets =
Cash / Bank >
Raw materials >
Work in process >
Finished Goods stock >
Receivables (if sold on credit) >
Cash / Bank.
11. Current Liabilities
Unpaid Expenses like
salaries / wages,
power bills,
telephone bills,
Materials purchased on credit,
Interest due on Working Capital and Term
loans.
12. Financial Ratios
I. Liquidity /
Solvency ratios
II. Gear ratio III. Asset cover
ratios
a. Current a.Debentures
b. Liquid b.Creditors
c. Absolute
liquidity
c. Pref.
shareholders
d. Proprietary d.Equity
e. Fixed asset e. Security cover
f. Debt Equity
13. Financial Ratios
LIQUIDITY Ratios
Current Ratio = Current Assets /
Current Liabilities
Acid Test or Quick Ratio
= CA minus Inventories / short
term Liabilities
17. Operational Ratios
I. Expense ratios II. Earnings
ratios
III. Profit cover
ratios
a. Fixed cost /
Total cost
a.GP ratio or
Turnover ratio
a. Dividend
cover
b. RM / sales b. NP ratio b. Interest cover
c. Wages / sales c. Operating
profit ratio
c. Total
coverage ratio
d. Office &
admin.exp /sales
e. Selling &
19. EXPENSE RATIOS
FC to Total Cost = Power + Employee +
Others + Depreciation +
Interest charges
/ Total Cost
Wages / Sales
20. Concept of Breakeven
Contribution =
Sale consideration − Variable cost.
The higher the contribution, better.
Breakeven point = the level of activity at
which revenues and costs are equal.
The lower the fixed cost, the earlier will
the company reach breakeven.
21. EARNINGS RATIOS
GP Margin = Gross Profit / Sales
OP Margin = Operating Profit / Sales
NP Margin = Net Profit / Sales
22. Gross Profit
Gross profit = Net Sales
minus cost of Goods sold
Cost of goods sold = costs incurred for
manufacturing the goods sold.
Includes Direct material cost, Direct
labour cost and factory overheads.
23. Operating profit
Operating profit = Gross profit
minus Operating Expenses.
Operating Expenses = General
Administrative expenses + Selling and
Distribution expenses + Depreciation.
24. EBITA margin
Profit before Interest and taxes = EBITA
= Operating profit + Non – operating
surplus / deficit.
Measure of profit not influenced by
Financial leverage and Tax factor.
Considered More Suitable for inter-
company comparison.
25. Net Profit
Net profit = OP (+/– non-OP) - financial
expenses ( interest on borrowed funds).
PBT = NP
PAT = PBT- tax
Retained earnings = PAT - dividends
26. PROFIT COVER
Dividend Cover Ratio
= NP / Dividend amount
Dividend pay out ratio
What is the reasonable ratio
Growing company
Mature company
Cash strapped company
Cash rich company
27. PROFIT COVER
Interest Cover
= NP+ Interest added back / Interest
Manufacturing company
Banking / Finance company
28. Combined Ratios
I. Turnover ratios
Inventory turnover
Debtors turnover
Creditors turnover
Turnover to assets and
liabilities
II. Profitability ratio
ROCE/RONW/ROE
NP to Fixed assets
/NP to Total assets
EPS / PE ratio / Div
Yield ratio / DPS / Div
payout ratio
30. PROFITABILITY RATIOS
ROCE = NP / Total Capital
RONW = NP / NW
EPS = NP / No. of Shares
DPS = Dividend amount / No. of shares
31. OTHER RATIOS
SPS = Sales / No. of Shares
Book Value = NW (less revaluation reserves)
per share
32. Limitations
Basis of valuation of stock
Depreciation methods
Authenticity of data
More meaningful if trend analysis
Past results may not help predict
future
Varies for Industry / Company /
Season
34. Definition
Fundamental analysis is the examination of the
underlying forces that affect the well being of the
Economy, Industry groups and Companies
Fundamental Analysis determines the worth of a
business by its future expected earning potential
which in turn depends on quality of company’s
management, business outlook for the company,
outlook for the industry in which the company
operates and the overall economic backdrop.
35. How does it differ from
Technical analysis
Technical
“Future price is based on past price trend and
current price”
Efficient market
Price discounts every thing.
Fundamental
Future price can not be determined using past /
current price
Current price does not reflect fair value
It is only reflection of the past
Weak form of market efficiency
36. What is the Goal or Objective
Derive a forecast for the future
Profit from future price
movements
37. How do we achieve this
Value
What is value
The intrinsic value of a company
depends on the underlying business
strength of the company
Price
What is price
38. General Steps
“TOP DOWN” Approach
Economy
Industry groups
Specific Company
39. INDICATORS
GDP growth rate
Index of Industrial Production ( IIP )
Inflation indices –WPI / CPI.
Growth rate of Money supply
Growth rate of Population
Growth rate of Agriculture
40. Indicators -- contd
Growth rate of per capita income
Growth rate of Imports and Exports
Interest rates.
Stock Market Indices
Foreign Exchange Reserves
41. The Political Equation
The political stability of the country is of
paramount importance. No industry or
company can grow and prosper in the
midst of political turmoil.
42. Contribution of different
Sectors to Economy
Last Year Expected in
Future
Agriculture 54 ?
Industry 24 ?
Services 22 ?
Total 100 100
46. Michael Porter’s Analysis
Threat of
New
Entrants
Bargaining
Power
of
Suppliers
Rivalry
among
Existing
Competitor
s
Bargaining
Power
of Buyers
Threat of
Substitute
Products or
47. Right Industry or Right Company
Stocks move in groups
More important to be in right industry than
in right stock
51. “Discounted cash flow “
valuation model
Dividend discount model
Free cash flow to company model
Free cash flow to equity model
52. DIVIDEND DISCOUNT
MODEL
• John Burr Williams
The present worth of a share is the
present value of future dividends (
rather than the Earnings).
53. “ Relative” Valuation Models
Assumption
Company will sell at a specific multiple of
earnings, revenue or growth.
54. PRICE EARNING RATIO
P/ E = MP * EPS
What is the right PE ? – Industry -
Expectations
-- Future earning potential
Commodity stock EPS rises faster
when market is recovering and drops
faster during decline
56. PE ratio-continued
Siemens India – FY 06
Net profit (consolidated) – Rs.39169 Lacs.
No. of equity shares - 1685.8 Lacs
Current market price – Rs.1150
EPS = 39169/1685.8 = 23.23
PE Multiple = 1150/23.23 = 49.5
Earnings yield = 1*100/49.5 = 2.02%
Relatively simple to calculate and use
57. Industry composite P/E=8.5
Name EPS Price P/E ratio
Essar 4.7 38.5 8.3
JSW 55.1 338 6.1
SAIL 9.7 87.4 9.0
Tata steel 60.4 506 8.4
58. PRICE EARNINGS GROWTH
RATIO
P / E = G
The P/E ratio of any Company that is
fairly priced will equal the Growth rate.
P/E is past and does not include effect
of
Brand, Human capital, Expectations,
Barriers to entry- factors which affect
growth rate
60. PRICE TO SALES per SHARE
RATIO
Earnings-complicated, some times
reflect non-recurring amounts
PSR = Share Price / Annual sale per
share
Simple
But carries no information about Debt or
Profitability
61. PRICE / BOOK VALUE
Book value = Net worth / Number of
shares
Sectoral view-Old Economy- Good
Indicator
Services sector-Low tangible assets
Services, Software, FMCG-High
Auto, Engineering, Steel-Low
64. Price Target and Projection
The value of a share ( Say Allahabad
Bank) by looking at the pricing of a
comparable company ( say Andhra
Bank)
Relative to a common variable
Earnings, Book value, Sales (say BV)
Two stage process
65. Components of forecasting
1. Determine the length of the extraordinary
growth period,
2. Select appropriate variable,
3. Estimate earnings ( or whatever variable)
during this high growth period,
4. Stable growth period
5. Estimate earnings (variable) during this
period
66. Components of forecasting
1. Projected value of variable after desired
period say 3 years
2. Select an appropriate company for
comparison
3. BV of Allahabad Bank as on 31-03-2010
4. Projected target price of Allahabad
bank=BV* Multiple
5. Say 1.65 to 1.76----
67. WARREN BUFFET VALUE
FORMULA
Intrinsic value = Estimated future
earnings * Confidence Margin
Confidence margin –Zero to 100 %
100 = risk free return – Yield on
Government securities
69. STRENGTHS
Good for understanding long term
trends
Value spotting – Warren Buffet
Thorough understanding of the
business
70. Weaknesses
Time constraint
Industry and Company specific
Subscription based - ISP
Refining margin – Oil Company
Subjective
Bias
Definition of Fair value
71. Winston Churchill
No two on earth in all things can
agree.
All things have some darling
singularity.
73. George Bernard Shaw
The Reasonable Man adapts himself
to the world.
The Unreasonable One persists in
trying to adapt the World to himself.
Therefore all progress depends on
the unreasonable man.