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Introduction To Fundamental Analysis

Table Of Contents 1) Fundamental Analysis: Introduction 2) Fundamental Analysis: What is Fundamental Analysis? 3) Fundamental Analysis: Qualitative Factors - The Company 4) Fundamental Analysis: Qualitative Factors - The Industry 5) Fundamental Analysis: Introduction to Financial Statements 6) Fundamental Analysis: Other Important Sections Found in Financial Filings 7) Fundamental Analysis: The Income Statement 8) Fundamental Analysis: The Balance Sheet 9) Fundamental Analysis: The Cash Flow Statement 10) Fundamental Analysis: A Brief Introduction To Valuation 11) Fundamental Analysis: Conclusion

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Introduction So, you want be a stock analyst? Perhaps not, but since you're reading this we'll assume that you at least want to understand stocks. Whether it's your burning desire to be a hotshot analyst on Wall Street or you just like to be hands-on with your own portfolio, you've come to the right spot. Fundamental analysis is the cornerstone of investing. In fact, some would say that you aren't really investing if you aren't performing fundamental analysis. Because the subject is so broad, however, it's tough to know where to start. There are an endless number of investment strategies that are very different from each other, yet almost all use the fundamentals. The goal of this tutorial is to provide a foundation for understanding fundamental analysis. It's geared primarily at new investors who don't know a balance sheet from an income statement. While you may not be a "stockpicker extraordinaire" by the end of this tutorial, you will have a much more solid grasp of the language and concepts behind security analysis and be able to use this to further your knowledge in other areas without feeling totally lost. The biggest part of fundamental analysis involves delving into the financial revenue, expenses, assets, liabilities and all the other financial aspects of a company. Fundamental analysts look at this information to gain insight on a company's future performance. A good part of this tutorial will be spent learning about the
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balance sheet, income statement, cash flow statement and how they all fit together. But there is more than just number crunching when it comes to analyzing a company. This is where qualitative analysis comes in - the breakdown of all the intangible, difficult-to-measure aspects of a company. Finally, we'll wrap up the tutorial with an intro on valuation and point you in the direction of additional tutorials you might be interested in. What is Fundamental Analysis? In this section we are going to review the basics of fundamental analysis, examine how it can be broken down into quantitative and qualitative factors, introduce the subject of intrinsic value and conclude with some of the downfalls of using this technique. The Very Basics When talking about stocks, fundamental analysis is a technique that attempts to determine a securitys value by focusing on underlying factors that affect a company's actual business and its future prospects. On a broader scope, you can perform fundamental analysis on industries or the economy as a whole. The term simply refers to the 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 companys revenue growing?
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Is it actually making a profit? Is it in a strong-enough position to beat out its competitors in the Is it able to repay its debts? Is management trying to "cook the books"?

future?

Of course, these are very involved questions, and there are literally hundreds of others you might have about a company. It all really boils down to one question: Is the companys stock a good investment? Think of fundamental analysis as a toolbox to help you answer this question.

Note: The term fundamental analysis is used most often in the context of stocks, but you can perform fundamental analysis on any security, from a bond to a derivative. As long as you look at the economic fundamentals, you are doing fundamental analysis. For the purpose of this tutorial, fundamental analysis always is referred to in the context of stocks.

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Fundamentals: Quantitative and Qualitative You could define fundamental analysis as researching the fundamentals, but that doesnt tell you a whole lot unless you know what fundamentals are. As we mentioned in the introduction, the big problem with defining fundamentals is that it can include anything related to the economic well-being of a company. Obvious items include things like revenue and profit, but fundamentals also include everything from a companys market share to the quality of its management. The various fundamental factors can be grouped into two categories: quantitative and qualitative. The financial meaning of these terms isnt all that different from their regular definitions. Here is how the MSN Encarta dictionary defines the terms: Quantitative capable of being measured or expressed in numerical terms. Qualitative related to or based on the quality or character of something, often as opposed to its size or quantity. In our context, quantitative fundamentals are numeric, measurable characteristics about a business. Its easy to see how the biggest source of quantitative data is the financial statements. You can measure revenue, profit, assets and more with great precision.

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Turning to qualitative fundamentals, these are the less tangible factors surrounding a business - things such as the quality of a companys board members and key executives, its brand-name recognition, patents or proprietary technology. Quantitative Meets Qualitative Neither qualitative nor quantitative analysis is inherently better than the other. Instead, many analysts consider qualitative factors in conjunction with the hard, quantitative factors. Take the Coca-Cola Company, for example. When examining its stock, an analyst might look at the stocks annual dividend payout, earnings per share, P/E ratio and many other quantitative factors. However, no analysis of Coca-Cola would be complete without taking into account its brand recognition. Anybody can start a company that sells sugar and water, but few companies on earth are recognized by billions of people. Its tough to put your finger on exactly what the Coke brand is worth, but you can be sure that its an essential ingredient contributing to the companys ongoing success.

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The Concept of Intrinsic Value

Before we get any further, we have to address the subject of intrinsic value. One of the primary assumptions of fundamental analysis is that the price on the stock market does not fully reflect a stocks real value. After all, why would you be doing price analysis if the stock market were always correct? In financial jargon, this true value is known as the intrinsic value. For example, lets say that a companys stock was trading at $20. After doing extensive homework on the company, you determine that it really is worth $25. In other words, you determine the intrinsic value of the firm to be $25. This is clearly relevant because an investor wants to buy stocks that are trading at prices significantly below their estimated intrinsic value. This leads us to one of the second major assumptions of fundamental analysis: in the long run, the stock market will reflect the fundamentals. There is no point in buying a stock based on intrinsic value if the price never reflected that value. Nobody knows how long the long run really is. It could be days or years. This is what fundamental analysis is all about. By focusing on a particular business, an investor can estimate the intrinsic value of a firm and thus find opportunities where he or she can buy at a discount. If all goes well, the investment will pay off over time as the market catches up to the
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fundamentals. The big unknowns are: 1) 2) You dont know if your estimate of intrinsic value is correct; and You dont know how long it will take for the intrinsic value to be

reflected in the marketplace. Criticisms of Fundamental Analysis The biggest criticisms of fundamental analysis come primarily from two groups: proponents of technical analysis and believers of the efficient market hypothesis. Technical analysis is the other major form of security analysis. Were not going to get into too much detail on the subject. (More information is available in our Introduction to Technical Analysis tutorial.) Put simply, technical analysts base their investments (or, more precisely, their trades) solely on the price and volume movements of securities. Using charts and a number of other tools, they trade on momentum, not caring about the fundamentals. While it is possible to use both techniques in combination, one of the basic tenets of technical analysis is that the market discounts everything. Accordingly, all news about a company already is priced into a stock, and therefore a stocks price movements give
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more insight than the underlying fundamental factors of the business itself.

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Followers of the efficient market hypothesis, however, are usually in disagreement with both fundamental and technical analysts. The efficient market hypothesis contends that it is essentially impossible to produce market-beating returns in the long run, through either fundamental or technical analysis. The rationale for this argument is that, since the market efficiently prices all stocks on an ongoing basis, any opportunities for excess returns derived from fundamental (or technical) analysis would be almost immediately whittled away by the markets many participants, making it impossible for anyone to meaningfully outperform the market over the long term. Qualitative Factors - The Company

Before diving into a company's financial statements, we're going to take a look at some of the qualitative aspects of a company. Fundamental analysis seeks to determine the intrinsic value of a company's stock. But since qualitative factors, by definition, represent aspects of a company's business that are difficult or impossible to quantify, incorporating that kind of information into a pricing evaluation can be quite difficult. On the flip side, as we've demonstrated, you can't ignore the less tangible characteristics of a company. In this section we are going to highlight some of the company-specific qualitative factors that you should be aware of.
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Business Model Even before an investor looks at a company's financial statements or does any research, one of the most important questions that should be asked is: What exactly does the company do? This is referred to as a company's business model it's how a company makes money. You can get a good overview of a company's business model by checking out its website or reading the first part of its 10-K filing (Note: We'll get into more detail about the 10-K in the financial statements chapter. For now, just bear with us). Sometimes business models are easy to understand. Take McDonalds, for instance, which sells hamburgers, fries, soft drinks, salads and whatever other new special they are promoting at the time. It's a simple model, easy enough for anybody to understand. Other times, you'd be surprised how complicated it can get. Boston Chicken Inc. is a prime example of this. Back in the early '90s its stock was the darling of Wall Street. At one point the company's CEO bragged that they were the "first new fast-food restaurant to reach $1 billion in sales since 1969". The problem is they didn't make money by selling chicken. Rather, they made their money from

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royalty fees and high-interest loans to franchisees. Boston Chicken was really nothing more than a big franchisor. On top of this, management was aggressive with how it recognized its revenue. As soon as it was revealed that all the franchisees were losing money, the house of cards collapsed and the company went bankrupt. At the very least, you should understand the business model of any company you invest in. The "Oracle of Omaha", Warren Buffett, rarely invests in tech stocks because most of the time he doesn't understand them. This is not to say the technology sector is bad, but it's not Buffett's area of expertise; he doesn't feel comfortable investing in this area. Similarly, unless you understand a company's business model, you don't know what the drivers are for future growth, and you leave yourself vulnerable to being blindsided like shareholders of Boston Chicken were. Competitive Advantage Another business consideration for investors is competitive advantage. A company's long-term success is driven largely by its ability to maintain a competitive advantage - and keep it. Powerful competitive advantages, such as Coca Cola's brand name and Microsoft's domination of the personal computer operating system, create a moat around a business allowing it to keep competitors at bay and enjoy growth and profits. When a company can achieve competitive advantage, its shareholders can be well rewarded for decades.

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Harvard

Business

School

professor

Michael

Porter

distinguishes between strategic positioning and operational effectiveness. Operational effectiveness means a company is better than rivals at similar activities while competitive advantage means a company is performing better than rivals by doing different activities or performing similar activities in different ways. Investors should know that few companies are able to compete successfully for long if they are doing the same things as their competitors. Professor Porter argues that, in general, sustainable competitive advantage gained by: A unique competitive position Clear tradeoffs and choices vis--vis competitors Activities tailored to the company's strategy A high degree of fit across activities (it is the activity system, not the parts, that ensure sustainability) A high degree of operational effectiveness

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Management Just as an army needs a general to lead it to victory, a company relies upon management to steer it towards financial success. Some believe that management is the most important aspect for investing in a company. It makes sense - even the best business model is doomed if the leaders of the company fail to properly execute the plan. So how does an average investor go about evaluating the management of a company? This is one of the areas in which individuals are truly at a disadvantage compared to professional investors. You can't set up a meeting with management if you want to invest a few thousand dollars. On the other hand, if you are a fund manager interested in investing millions of dollars, there is a good chance you can schedule a face-to-face meeting with the upper brass of the firm. Every public company has a corporate information section on its website. Usually there will be a quick biography on each executive with their employment history, educational background and any applicable achievements. Don't expect to find anything useful here. Let's be honest: We're looking for dirt, and no company is going to put negative information on its corporate website. Instead, here are a few ways for you to get a feel for management:
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1. Conference Calls The Chief Executive Officer (CEO) and Chief Financial Officer (CFO) host quarterly conference calls. (Sometimes you'll get other executives as well.) The first portion of the call is management basically reading off the financial results. What is really interesting is the question-and-answer portion of the call. This is when the line is open for analysts to call in and ask management direct questions. Answers here can be revealing about the company, but more importantly, listen for candor. Do they avoid questions, like politicians, or do they provide forthright answers? 2. Management Discussion and Analysis (MD&A) The Management Discussion and Analysis is found at the beginning of the annual report (discussed in more detail later in this tutorial). In theory, the MD&A is supposed to be frank commentary on the management's outlook. Sometimes the content is worthwhile, other times it's boilerplate. One tip is to compare what management said in past years with what they are saying now. Is it the same material rehashed? Have strategies actually been implemented? If possible, sit down and read the last five years of MD&As; it can be illuminating.

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3. Ownership and Insider Sales Just about any large company will compensate executives with a combination of cash, restricted stock and options. While there are problems with stock options (See Putting Management Under the Microscope), it is a positive sign that members of management are also shareholders. The ideal situation is when the founder of the company is still in charge. Examples include Bill Gates (in the '80s and '90s), Michael Dell and Warren Buffett. When you know that a majority of management's wealth is in the stock, you can have confidence that they will do the right thing. As well, it's worth checking out if management has been selling its stock. This has to be filed with the Securities and Exchange Commission (SEC), so it's publicly available information. Talk is cheap - think twice if you see management unloading all of its shares while saying something else in the media. 4. Past Performance Another good way to get a feel for management capability is to check and see how executives have done at other companies in the past. You can normally find biographies of top executives on company web sites. Identify the companies they worked at in the past and do a search on those companies and their performance.

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Corporate Governance Corporate governance describes the policies in place within an organization denoting the relationships and responsibilities between management, directors and stakeholders. These policies are defined and determined in the company charter and its bylaws, along with corporate laws and regulations. The purpose of corporate governance policies is to ensure that proper checks and balances are in place, making it more difficult for anyone to conduct unethical and illegal activities. Good corporate governance is a situation in which a company complies with all of its governance policies and applicable government regulations (such as the Sarbanes-Oxley Act of 2002) in order to look out for the interests of the company's investors and other stakeholders. Although, there are companies and organizations (such as Standard & Poor's) that attempt to quantitatively assess companies on how well their corporate governance policies serve stakeholders, most of these reports are quite expensive for the average investor to purchase. Fortunately, corporate governance policies typically cover a few general areas: structure of the board of directors, stakeholder rights and financial and information transparency. With a little research and the right questions in mind, investors can get a good idea about a company's corporate governance.
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Financial and Information Transparency This aspect of governance relates to the quality and timeliness of a company's financial disclosures and operational happenings. Sufficient transparency implies that a company's financial releases are written in a manner that stakeholders can follow what management is doing and therefore have a clear understanding of the company's current financial situation. Stakeholder Rights This aspect of corporate governance examines the extent that a company's policies are benefiting stakeholder interests, notably shareholder interests. Ultimately, as owners of the company, shareholders should have some access to the board of directors if they have concerns or want something addressed. Therefore companies with good governance give shareholders a certain amount of ownership voting rights to call meetings to discuss pressing issues with the board. Another relevant area for good governance, in terms of ownership rights, is whether or not a company possesses large amounts of takeover defenses (such as the Macaroni Defense or the Poison Pill) or other measures that make it difficult for changes in management, directors and ownership to occur.

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Structure of the Board of Directors The board of directors is composed of representatives from the company and representatives from outside of the company. The combination of inside and outside directors attempts to provide an independent assessment of management's performance, making sure that the interests of shareholders are represented. The key word when looking at the board of directors is independence. The board of directors is responsible for protecting shareholder interests and ensuring that the upper management of the company is doing the same. The board possesses the right to hire and fire members of the board on behalf of the shareholders. A board filled with insiders will often not serve as objective critics of management and will defend their actions as good and beneficial, regardless of the circumstances. Information on the board of directors of a publicly traded company (such as biographies of individual board members and compensation-related info) can be found in the DEF 14A proxy statement. We've now gone over the business model, management and corporate governance. These three areas are all important to consider when analyzing any

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company. We will now move on to looking at qualitative factors in the environment in which the company operates. Qualitative Factors - The Industry Each industry has differences in terms of its customer base, market share among firms, industry-wide growth, competition, regulation and business cycles. Learning about how the industry works will give an investor a deeper understanding of a company's financial health. Customers Some companies serve only a handful of customers, while others serve millions. In general, it's a red flag (a negative) if a business relies on a small number of customers for a large portion of its sales because the loss of each customer could dramatically affect revenues. For example, think of a military supplier who has 100% of its sales with the U.S. government. One change in government policy could potentially wipe out all of its sales. For this reason, companies will always disclose in their 10-K if any one customer accounts for a majority of revenues. Market Share Understanding a company's present market share can tell volumes about the company's business. The fact that a company possesses an 85% market share tells you that it is the largest player in its market by far. Furthermore,
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this could also suggest that the company possesses some sort of "economic moat," in other words, a competitive barrier serving to protect its current and future earnings, along with its market share. Market share is important because of economies of scale. When the firm is bigger than the rest of its rivals, it is in a better position to absorb the high fixed costs of a capitalintensive industry. Industry Growth One way of examining a company's growth potential is to first examine whether the amount of customers in the overall market will grow. This is crucial because without new customers, a company has to steal market share in order to grow. In some markets, there is zero or negative growth, a factor demanding careful consideration. For example, a manufacturing company dedicated solely to creating audio compact cassettes might have been very successful in the '70s, '80s and early '90s. However, that same company would probably have a rough time now due to the advent of newer technologies, such as CDs and MP3s. The current market for audio compact cassettes is only a fraction of what it was during the peak of its popularity. Competition Simply looking at the number of competitors goes a long way in understanding

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the competitive landscape for a company. Industries that have limited barriers to entry and a large number of competing firms create a difficult operating environment for firms. One of the biggest risks within a highly competitive industry is pricing power. This refers to the ability of a supplier to increase prices and pass those costs on to customers. Companies operating in industries with few alternatives have the ability to pass on costs to their customers. A great example of this is Wal-Mart. They are so dominant in the retailing business, that Wal-Mart practically sets the price for any of the suppliers wanting to do business with them. If you want to sell to Wal-Mart, you have little, if any, pricing power. Regulation Certain industries are heavily regulated due to the importance or severity of the industry's products and/or services. As important as some of these regulations are to the public, they can drastically affect the attractiveness of a company for investment purposes. In industries where one or two companies represent the entire industry for a region (such as utility companies), governments usually specify how much profit each company can make. In these instances, while there is the potential for sizable profits, they are limited due to regulation. In other industries, regulation can play a less direct role in affecting industry pricing. For example, the drug industry is one of most regulated
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industries. And for good reason - no one wants an ineffective drug that causes deaths to reach the market. As a result, the U.S. Food and Drug Administration (FDA) requires that new drugs must pass a series of clinical trials before they can be sold and distributed to the general public. However, the consequence of all this testing is that it usually takes several years and millions of dollars before a drug is approved. Keep in mind that all these costs are above and beyond the millions that the drug company has spent on research and development. All in all, investors should always be on the lookout for regulations that could potentially have a material impact upon a business' bottom line. Investors should keep these regulatory costs in mind as they assess the potential risks and rewards of investing. Introduction to Financial Statements

The massive amount of numbers in a company's financial statements can be bewildering and intimidating to many investors. On the other hand, if you know how to analyze them, the financial statements are a gold mine of information. Financial statements are the medium by which a company discloses information

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concerning its financial performance. Followers of fundamental analysis use the quantitative information gleaned from financial statements to make investment decisions. Before we jump into the specifics of the three most important financial statements - income statements, balance sheets and cash flow statements - we will briefly introduce each financial statement's specific function, along with where they can be found. The Major Statements The Balance Sheet The balance sheet represents a record of a company's assets, liabilities and equity at a particular point in time. The balance sheet is named by the fact that a business's financial structure balances in the following manner:

Assets = Liabilities + Shareholders' Equity

Assets represent the resources that the business owns or controls at a given point in time. This includes items such as cash, inventory, machinery and buildings. The other side of the equation represents the total value of the financing the company has used to acquire those assets. Financing comes as a result of liabilities or equity. Liabilities represent debt (which of course must be paid back), while equity represents the total value of money that the owners have contributed to the business - including retained earnings, which is the profit made in previous years.

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The Income Statement While the balance sheet takes a snapshot approach in examining a business, the income statement measures a company's performance over a specific time frame. Technically, you could have a balance sheet for a month or even a day, but you'll only see public companies report quarterly and annually. The income statement presents information about revenues, expenses and profit that was generated as a result of the business' operations for that period. Statement of Cash Flows The statement of cash flows represents a record of a business' cash inflows and outflows over a period of time. Typically, a statement of cash flows focuses on the following cash-related activities: Operating Cash Flow (OCF): Cash generated from day-to-day business operations Cash from investing (CFI): Cash used for investing in assets, as well as the proceeds from the sale of other businesses, equipment or long-term assets

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Cash from financing (CFF): Cash paid or received from the issuing

and borrowing of funds The cash flow statement is important because it's very difficult for a business to manipulate its cash situation. There is plenty that aggressive accountants can do to manipulate earnings, but it's tough to fake cash in the bank. For this reason some investors use the cash flow statement as a more conservative measure of a company's performance. 10-K and 10-Q Now that you have an understanding of what the three financial statements represent, let's discuss where an investor can go about finding them. In the United States, the Securities And Exchange Commission (SEC) requires all companies that are publicly traded on a major exchange to submit periodic filings detailing their financial activities, including the financial statements mentioned above. Some other pieces of information that are also required are an auditor's report, management discussion and analysis (MD&A) and a relatively detailed description of the company's operations and prospects for the upcoming year. All of this information can be found in the business' annual 10-K and quarterly 10- Q filings, which are released by the company's management and can be found
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on the internet or in physical form. (For more information, see Where can I find a company's annual report and its SEC filings?) The 10-K is an annual filing that discloses a business's performance over the course of the fiscal year. In addition to finding a business's financial statements for the most recent year, investors also have access to the business's historical financial measures, along with information detailing the operations of the business. This includes a lot of information, such as the number of employees, biographies of upper management, risks, future plans for growth, etc. Businesses also release an annual report, which some people also refer to as the 10-K. The annual report is essentially the 10-K released in a fancier marketing format. It will include much of the same information, but not all, that you can find in the 10-K. The 10-K really is boring - it's just pages and pages of numbers, text and legalese. But just because it's boring doesn't mean it isn't useful. There is a lot of good information in a 10-K, and it's required reading for any serious investor. You can think of the 10-Q filing as a smaller version of a 10-K. It reports the company's performance after each fiscal quarter. Each year three 10Q filings are released - one for each of the first three quarters. (Note: There is no 10Q for the fourth quarter, because the 10-K filing is released during that time). Unlike

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the 10-K filing, 10-Q filings are not required to be audited. Here's a tip if you have trouble remembering which is which: think "Q" for quarter. Other Important Sections Found in Financial Filings

The financial statements are not the only parts found in a business's annual and quarterly SEC filings. Here are some other noteworthy sections: Management Discussion and Analysis (MD&A) As a preface to the financial statements, a company's management will typically spend a few pages talking about the recent year (or quarter) and provide background on the company. This is referred to as the management discussion and analysis (MD&A). In addition to providing investors a clearer picture of what the company does, the MD&A also points out some key areas in which the company has performed well. Don't expect the letter from management to delve into all the juicy details affecting the company's performance. The management's analysis is at their discretion, so understand they probably aren't going to be disclosing any negatives. Here are some things to look out for: How candid and accurate are management's comments? Does management discuss significant financial trends over the past
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couple years? (As we've already mentioned, it can be interesting to compare the MD&As over the last few years to see how the message has changed and whether management actually followed through with its plan.) How clear are management's comments? If executives try to confuse you with big words and jargon, perhaps they have something to hide. Do they mention potential risks or uncertainties moving forward? Disclosure is the name of the game. If a company gives a decent amount of information in the MD&A, it's likely that management is being upfront and honest. It should raise a red flag if the MD&A ignores serious problems that the company has been facing. The Auditor's Report The auditors' job is to express an opinion on whether the financial statements are reasonably accurate and provide adequate disclosure. This is the purpose behind the auditor's report, which is sometimes called the "report of independent accountants".

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By law, every public company that trades stocks or bonds on an exchange must have its annual reports audited by a certified public accountants firm. An auditor's report is meant to scrutinize the company and identify anything that might undermine the integrity of the financial statements. The typical auditor's report is almost always broken into three paragraphs and written in the following fashion:

The Notes to the Financial Statements Just as the MD&A serves an introduction to the financial statements, the notes to the financial statements (sometimes called footnotes) tie up any loose ends and complete the overall picture. If the income statement, balance sheet and statement of cash flows are the heart of the financial statements, then the footnotes are the arteries that keep everything connected. Therefore, if you aren't reading the footnotes, you're missing out on a lot of information. The footnotes list important information that could not be included in the actual ledgers. For example, they list relevant things like outstanding leases, the maturity dates of outstanding debt and details on compensation plans, such as stock options, etc.

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Generally speaking there are two types of footnotes: Accounting Methods - This type of footnote identifies and explains the major accounting policies of the business that the company feels that you should be aware of. This is especially important if a company has changed accounting policies. It may be that a firm is practicing "cookie jar accounting" and is changing policies only to take advantage of current conditions in order to hide poor performance.

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Disclosure - The second type of footnote provides additional disclosure that simply could not be put in the financial statements. The financial statements in an annual report are supposed to be clean and easy to follow. To maintain this cleanliness, other calculations are left for the footnotes. For example, details of long-term debt - such as maturity dates and the interest rates at which debt was issued - can give you a better idea of how borrowing costs are laid out. Other areas of disclosure include everything from pension plan liabilities for existing employees to details about ominous legal proceedings involving the company. The majority of investors and analysts read the balance sheet, income statement and cash flow statement but, for whatever reason, the footnotes are often ignored. What sets informed investors apart is digging deeper and looking for information that others typically wouldn't. No matter how boring it might be, read the fine print - it will make you a better investor. The Income Statement

The income statement is basically the first financial statement you will come across in an annual report or quarterly Securities And Exchange Commission (SEC) filing. It also contains the numbers most often discussed when a company announces its results -numbers such as revenue, earnings and earnings per share. Basically, the income statement shows how much money the
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company generated (revenue), how much it spent (expenses) and the difference between the two (profit) over a certain time period. When it comes to analyzing fundamentals, the income statement lets investors know how well the companys business is performing - or, basically, whether or not the company is making money. Generally speaking, companies ought to be able to bring in more money than they spend or they dont stay in business for long. Those companies with low expenses relative to revenue - or high profits relative to revenue - signal strong fundamentals to investors. Revenue as a investor signal Revenue, also commonly known as sales, is generally the most straightforward part of the income statement. Often, there is just a single number that represents all the money a company brought in during a specific time period, although big companies sometimes break down revenue by business segment or geography.

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The best way for a company to improve profitability is by increasing sales revenue. For instance, Starbucks Coffee has aggressive long-term sales growth goals that include a distribution system of 20,000 stores worldwide. Consistent sales growth has been a strong driver of Starbucks profitability. The best revenue are those that continue year in and year out. Temporary increases, such as those that might result from a short-term promotion, are less valuable and should garner a lower price-to-earnings multiple for a company. What are the Expenses? There are many kinds of expenses, but the two most common are the cost of goods sold (COGS) and selling, general and administrative expenses (SG&A). Cost of goods sold is the expense most directly involved in creating revenue. It represents the costs of producing or purchasing the goods or services sold by the company. For example, if Wal-Mart pays a supplier $4 for a box of soap, which it sells to customers for $5. When it is sold, Wal-Marts cost of good sold for the box of soap would be $4. Next, costs involved in operating the business are SG&A. This category includes marketing, salaries, utility bills, technology expenses and other general costs associated with running a business. SG&A also includes depreciation and amortization. Companies must include the cost of replacing worn out assets. Remember, some corporate expenses, such as research and development (R&D) at technology companies, are crucial to
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future growth and should not be cut, even though doing so may make for a better-looking earnings report. Finally, there are financial costs, notably taxes and interest payments, which need to be considered. Profits = Revenue - Expenses Profit, most simply put, is equal to total revenue minus total expenses. However, there are several commonly used profit subcategories that tell investors how the company is performing. Gross profit is calculated as revenue minus cost of goods sold. Returning to Wal-Mart again, the gross profit from the sale of the soap would have been $1 ($5 sales price less $4 cost of goods sold = $1 gross profit). Companies with high gross margins will have a lot of money left over to spend on other business operations, such as R&D or marketing. So be on the lookout for downward trends in the gross margin rate over time. This is a telltale sign of future problems facing the bottom line. When cost of goods sold rises rapidly, they are likely to lower gross profit margins - unless, of course, the company can pass these costs onto customers in the form of higher prices. Operating profit is equal to revenues minus the cost of sales and SG&A. This number represents the profit a company made from its actual operations, and excludes certain expenses and revenues that may not be related to its central

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operations. High operating margins can mean the company has effective control of costs, or that sales are increasing faster than operating costs. Operating profit also gives investors an opportunity to do profit-margin comparisons between companies that do not issue a separate disclosure of their cost of goods sold figures (which are needed to do gross margin analysis). Operating profit measures how much cash the business throws off, and some consider it a more reliable measure of profitability since it is harder to manipulate with accounting tricks than net earnings. Net income generally represents the company's profit after all expenses, including financial expenses, have been paid. This number is often called the "bottom line" and is generally the figure people refer to when they use the word "profit" or "earnings". When a company has a high profit margin, it usually means that it also has one or more advantages over its competition. Companies with high net profit margins have a bigger cushion to protect themselves during the hard times. Companies with low profit margins can get wiped out in a downturn. And companies with profit margins reflecting a competitive advantage are able to improve their market share during the hard times - leaving them even better positioned when things improve again. Conclusion You can gain valuable insights about a company by examining its income statement. Increasing sales offers the first sign of strong fundamentals.
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Rising margins indicate increasing efficiency and profitability. Its also a good idea to determine whether the company is performing in line with industry peers and competitors. Look for significant changes in revenues, costs of goods sold and SG&A to get a sense of the companys profit fundamentals. To learn more about reading financial statements, see Understanding The Income Statement or Advanced Financial Statement Analysis. The Balance Sheet

Investors often overlook the balance sheet. Assets and liabilities aren't nearly as sexy as revenue and earnings. While earnings are important, they don't tell the whole story. The balance sheet highlights the financial condition of a company and is an integral part of the financial statements. (To read more on financial statement basics, see What You Need To Know About Financial Statements and Advanced Financial Statement Analysis.)

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The Snapshot of Health The balance sheet, also known as the statement of financial condition, offers a snapshot of a company's health. It tells you how much a company owns (its assets), and how much it owes (its liabilities). The difference between what it owns and what it owes is its equity, also commonly called "net assets" or "shareholders equity". The balance sheet tells investors a lot about a company's fundamentals: how much debt the company has, how much it needs to collect from customers (and how fast it does so), how much cash and equivalents it possesses and what kinds of funds the company has generated over time. The Balance Sheet's Main Three Assets, liability and equity are the three main components of the balance sheet. Carefully analyzed, they can tell investors a lot about a company's fundamentals. Assets There are two main types of assets: current assets and non-current assets. Current assets are likely to be used up or converted into cash within one business cycle - usually treated as twelve months. Three very important current asset items found on the balance sheet are: cash, inventories and accounts receivables.

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Investors normally are attracted to companies with plenty of cash on their balance sheets. After all, cash offers protection against tough times, and it also gives companies more options for future growth. Growing cash reserves often signal strong company performance. Indeed, it shows that cash is accumulating so quickly that management doesn't have time to figure out how to make use of it. A dwindling cash pile could be a sign of trouble. That said, if loads of cash are more or less a permanent feature of the company's balance sheet, investors need to ask why the money is not being put to use. Cash could be there because management has run out of investment opportunities or is too shortsighted to know what to do with the money. Inventories are finished products that haven't yet sold. As an investor, you want to know if a company has too much money tied up in its inventory. Companies have limited funds available to invest in inventory. To generate the cash to pay bills and return a profit, they must sell the merchandise they have purchased from suppliers. Inventory turnover (cost of goods sold divided by average inventory) measures how quickly the company is moving merchandise through the warehouse to customers. If inventory grows faster than sales, it is almost always a sign of deteriorating fundamentals. Receivables are outstanding (uncollected bills). Analyzing the speed at which a company collects what it's owed can tell you a lot about its financial efficiency. If a company's collection period is growing longer, it could mean problems ahead.
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The company may be letting customers stretch their credit in order to recognize greater top-line sales and that can spell trouble later on, especially if customers face a cash crunch. Getting money right away is preferable to waiting for it - since some of what is owed may never get paid. The quicker a company gets its customers to make payments, the sooner it has cash to pay for salaries, merchandise, equipment, loans, and best of all, dividends and growth opportunities. Non-current assets are defined as anything not classified as a current asset. This includes items that are fixed assets, such as property, plant and equipment (PP&E). Unless the company is in financial distress and is liquidating assets, investors need not pay too much attention to fixed assets. Since companies are often unable to sell their fixed assets within any reasonable amount of time they are carried on the balance sheet at cost regardless of their actual value. As a result, it's is possible for companies to grossly inflate this number, leaving investors with questionable and hard-tocompare asset figures. Liabilities There are current liabilities and non-current liabilities. Current liabilities are obligations the firm must pay within a year, such as payments owing to suppliers. Non-current liabilities, meanwhile, represent what the company owes in a year or more time. Typically, non-current liabilities represent bank and bondholder debt.

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You usually want to see a manageable amount of debt. When debt levels are falling, that's a good sign. Generally speaking, if a company has more assets than liabilities, then it is in decent condition. By contrast, a company with a large amount of liabilities relative to assets ought to be examined with more diligence. Having too much debt relative to cash flows required to pay for interest and debt repayments is one way a company can go bankrupt. Look at the quick ratio. Subtract inventory from current assets and then divide by current liabilities. If the ratio is 1 or higher, it says that the company has enough cash and liquid assets to cover its short-term debt obligations.

Current Quick Ratio = Inventories Current Liabilities

Assets-

Equity Equity represents what shareholders own, so it is often called shareholder's equity. As described above, equity is equal to total assets minus total liabilities. Equity = Total Assets Total Liabilities
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The two important equity items are paid-in capital and retained earnings. Paid-in capital is the amount of money shareholders paid for their shares when the stock was first offered to the public. It basically represents how much money the firm received when it sold its shares. In other words, retained earnings are a tally of the money the company has chosen to reinvest in the business rather than pay to shareholders. Investors should look closely at how a company puts retained capital to use and how a company generates a return on it. Most of the information about debt can be found on the balance sheet - but some assets and debt obligations are not disclosed there. For starters, companies often possess hard-to-measure intangible assets. property (items such as patents, Corporate intellectual trademarks, copyrights and business

methodologies), goodwill and brand recognition are all common assets in today's marketplace. But they are not listed on company's balance sheets. There is also off-balance sheet debt to be aware of. This is form of financing in which large capital expenditures are kept off of a company's balance sheet through various classification methods. Companies will often use offbalance- sheet financing to keep the debt levels low. (To continue reading about the balance sheet, see Reading The Balance Sheet, Testing Balance Sheet Strength and Breaking Down The Balance Sheet.)

The Cash Flow Statement The cash flow statement shows how much cash comes in and goes out of the company over the quarter or the year. At first glance, that sounds a lot like the income statement in that it records financial performance over a specified period. But there is a big difference between the two. What distinguishes the two is accrual accounting, which is found on the income statement. Accrual accounting requires companies to record revenues and expenses when transactions occur, not when cash is exchanged. At the same time, the income statement, on the other hand, often includes non-cash revenues or expenses, which the statement of cash flows does not include. Just because the income statement shows net income of $10 does not means that cash on the balance sheet will increase by $10. Whereas when the bottom of the cash flow statement reads $10 net cash inflow, that's exactly what it means. The company has $10 more in cash than at the end of the last financial period. You may want to think of net cash from operations as the company's "true" cash profit. Because it shows how much actual cash a company has generated, the statement of cash flows is critical to understanding a company's fundamentals. It shows how the company is able to pay for its operations and future growth.

Indeed, one of the most important features you should look for in a potential investment is the company's ability to produce cash. Just because a company shows a profit on the income statement doesn't mean it cannot get into trouble later because of insufficient cash flows. A close examination of the cash flow statement can give investors a better sense of how the company will fare. Three Sections of the Cash Flow Statement Companies produce and consume cash in different ways, so the cash flow statement is divided into three sections: cash flows from operations, financing and investing. Basically, the sections on operations and financing show how the company gets its cash, while the investing section shows how the company spends its cash. (To continue learning about cash flow, see The Essentials Of Cash Flow, Operating Cash Flow: Better Than Net Income? and What Is A Cash Flow Statement?) Cash Flows from Operating Activities This section shows how much cash comes from sales of the company's goods and services, less the amount of cash needed to make and sell those goods and services. Investors tend to prefer companies that produce a net positive cash flow from operating activities. High growth companies, such as technology firms, tend to show negative cash flow from operations in their formative years. At the same time, changes in cash flow from operations typically offer a preview of changes in net future income. Normally it's a good sign when it goes up. Watch out for a widening gap between a company's reported earnings and its cash flow from operating

activities. If net income is much higher than cash flow, the company may be speeding or slowing its booking of income or costs. Cash Flows from Investing Activities This section largely reflects the amount of cash the company has spent on capital expenditures, such as new equipment or anything else that needed to keep the business going. It also includes acquisitions of other businesses and monetary investments such as money market funds. You want to see a company re-invest capital in its business by at least the rate of depreciation expenses each year. If it doesn't re-invest, it might show artificially high cash inflows in the current year which may not be sustainable. Cash Flow From Financing Activities This section describes the goings-on of cash associated with outside financing activities. Typical sources of cash inflow would be cash raised by selling stock and bonds or by bank borrowings. Likewise, paying back a bank loan would show up as a use of cash flow, as would dividend payments and common stock repurchases.

Cash Flow Statement Considerations Savvy investors are attracted to companies that produce plenty of free cash flow (FCF). Free cash flow signals a company's ability to pay debt, pay dividends, buy back stock and facilitate the growth of business. Free cash flow, which is essentially the excess cash produced by the company, can be returned to shareholders or invested in new growth opportunities without hurting the existing operations. The most common method of calculating free cash flow is:

Ideally, investors would like to see that the company can pay for the investing figure out of operations without having to rely on outside financing to do so. A company's ability to pay for its own operations and growth signals to investors that it has very strong fundamentals. To see more topics on companies and cash flow, read How Some Companies Abuse Cash Flow and Free Cash Flow: Free, But Not Always Easy.

A Brief Introduction To Valuation While the concept behind discounted cash flow analysis is simple, its practical application can be a different matter. The premise of the discounted cash flow method is that the current value of a company is simply the present value of its future cash flows that are attributable to shareholders. Its calculation is as follows:

For simplicity's sake, if we know that a company will generate $1 per share in cash flow for shareholders every year into the future; we can calculate what this type of cash flow is worth today. This value is then compared to the current value of the company to determine whether the company is a good investment, based on it being undervalued or overvalued.

There are several different techniques within the discounted cash flow realm of valuation, essentially differing on what type of cash flow is used in the analysis. The dividend discount model focuses on the dividends the company pays to shareholders, while the cash flow model looks at the cash that can be paid to shareholders after all expenses, reinvestments and debt repayments have been made. But conceptually they are the same, as it is the present value of these streams that are taken into consideration. As we mentioned before, the difficulty lies in the implementation of the model as there are a considerable amount of estimates and assumptions that go into the model. As you can imagine, forecasting the revenue and expenses for a firm five or 10 years into the future can be considerably difficult. Nevertheless, DCF is a valuable tool used by both analysts and everyday investors to estimate a company's value. Analysis tutorial. Ratio Valuation Financial ratios are mathematical calculations using figures mainly from the financial statements, and they are used to gain an idea of a company's valuation and financial performance. Some of the most well-known valuation ratios are price-to-earnings and price-to-book. Each valuation ratio uses different measures in its calculations. For example, price-to-book compares the price per share to the company's book value.

The calculations produced by the valuation ratios are used to gain some understanding of the company's value. The ratios are compared on an absolute basis, in which there are threshold values. For example, in priceto-book, companies trading below '1' are considered undervalued. Valuation ratios are also compared to the historical values of the ratio for the company, along with comparisons to competitors and the overall market itself.

Conclusion Whenever youre thinking of investing in a company it is vital that you understand what it does, its market and the industry in which it operates. You should never blindly invest in a company. One of the most important areas for any investor to look at when researching a company is the financial statements. It is essential to understand the purpose of each part of these statements and how to interpret them.

Let's recap what we've learned: Financial reports are required by law and are published both quarterly and annually. Management discussion and analysis (MD&A) gives investors a better understanding of what the company does and usually points out some key areas where it performed well. Audited financial reports have much more credibility than unaudited ones. The balance sheet lists the assets, liabilities and shareholders' equity. For all balance sheets: Assets = Liabilities + S h a reh o lde The rs E qu ity two sides must always equal each other (or balance each other). The income statement includes figures such as revenue,

expenses, earnings and earnings per share. For a company, the top line is revenue while the bottom line is net income. The income statement takes into account some non-cash items, such as depreciation. The cash flow statement strips away all non-cash items and tells you how much actual money the company generated. The cash flow statement is divided into three parts: operations, financing and investing. Always read the notes to the financial statements. They provide more cash from

in- depth information on a wide range of figures reported in the three financial statements.

Fundamental vs technical Technical analysis and fundamental analysis are the two main schools of thought in the financial markets. As we've mentioned, technical analysis looks at the price movement of a security and uses this data to predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors, known as fundamentals. Let's get into the details of how these two approaches differ, the criticisms against technical analysis and how technical and fundamental analysis can be used together to analyze securities. The Charts vs. Financial Differences Statements

At the most basic level, a technical analyst approaches a security from the charts, while a fundamental analyst starts with the financial statements. (For further reading, see Introduction To Fundamental Analysis and Advanced Financial Statement Analysis.)

By looking at the balance sheet, cash flow statement and income statement, a fundamental analyst tries to determine a company's value. In financial terms, an analyst attempts to measure a company's intrinsic value. In this approach, investment decisions are fairly easy to make - if the price of a stock trades below its intrinsic value, it's a good investment. Although this is an oversimplification (fundamental analysis goes beyond just the financial statements) for the purposes of this tutorial, this simple tenet holds true.

Technical traders, on the other hand, believe there is no reason to analyze a company's fundamentals because these are all accounted for in the stock's price. Technicians believe that all the information they need about a stock can be found in its charts. Time Horizon

Fundamental analysis takes a relatively long-term approach to analyzing the market compared to technical analysis. While technical analysis can be used on a timeframe of weeks, days or even minutes, fundamental analysis often looks at data over a number of years. The different timeframes that these two approaches use is a result of the nature of the investing style to which they each adhere. It can take a long time for a company's value to be reflected in the market, so when a fundamental analyst estimates intrinsic value, a gain is not realized until the stock's market price rises to its "correct" value. This type of investing is called value investing and assumes that the short-term market is wrong, but that the price of a particular stock will correct itself over the long run. This "long run" can represent a timeframe of as long as several years, in some cases. (For more insight, read Warren Buffett: How He Does It and What Is Warren Buffett's Investing Style?)

Furthermore, the numbers that a fundamentalist analyzes are only released over long periods of time. Financial statements are filed quarterly and changes in earnings per share don't emerge on a daily basis like price and volume

information. Also remember that fundamentals are the actual characteristics of a business. New management can't implement sweeping changes overnight and it takes time to create new products, marketing campaigns, supply chains, etc. Part of the reason that fundamental analysts use a long-term timeframe, therefore, is because the data they use to analyze a stock is generated much more slowly than the price and volume data used by technical analysts. Trading Versus Investing

Not only is technical analysis more short term in nature than fundamental analysis, but the goals of a purchase (or sale) of a stock are usually different for each approach. In general, technical analysis is used for a trade, whereas fundamental analysis is used to make an investment. Investors buy assets they believe can increase in value, while traders buy assets they believe they can sell to somebody else at a greater price. The line between a trade and an investment can be blurry, but it does characterize a difference between the two schools.

The Critics Some critics see technical analysis as a form of black magic. Don't be surprised to see them question the validity of the discipline to the point where they mock its supporters. In fact, technical analysis has only recently begun to enjoy some mainstream credibility. While most analysts on Wall Street focus on the fundamental side, just about any major brokerage now employs technical analysts as well.

Much of the criticism of technical analysis has its roots in academic theory specifically the efficient market hypothesis (EMH). This theory says that the market's price is always the correct one - any past trading information is already reflected in the price of the stock and, therefore, any analysis to find undervalued securities is useless. There are three versions of EMH. In the first, called weak form efficiency, all past price information is already included in the current price. According to weak form efficiency, technical analysis can't predict future movements because all past information has already been accounted for and, therefore, analyzing the stock's past price movements will provide no insight into its future movements. In the second, semi-strong form efficiency, fundamental analysis is also claimed to be of little use in finding investment opportunities. The third is strong form efficiency, which states that all information in the market is accounted for in a stock's price and neither technical nor fundamental analysis can provide investors with an edge. The vast majority of academics believe in at least the weak version of EMH, therefore, from their point of view, if technical analysis works, market efficiency will be called into question. (For more insight, read What Is Market Efficiency? and Working Through The Efficient Market Hypothesis.) There is no right answer as to who is correct. There are arguments to be made on both sides and, therefore, it's up to you to do the homework and determine your own philosophy. Can They Co-Exist? Although technical analysis and fundamental analysis are seen by many as polar opposites - the oil and water of investing - many market participants

have experienced great success by combining the two. For example, some fundamental analysts use technical analysis techniques to figure out the best time to enter into an undervalued security. Oftentimes, this situation occurs when the security is severely oversold. By timing entry into a security, the gains on the investment can be greatly improved.

Alternatively, some technical traders might look at fundamentals to add strength to a technical signal. For example, if a sell signal is given through technical patterns and indicators, a technical trader might look to reaffirm his or her decision by looking at some key fundamental data. Oftentimes, having both the fundamentals and technicals on your side can provide the best-case scenario for a trade.

While mixing some of the components of technical and fundamental analysis is not well received by the most devoted groups in each school, there are certainly benefits to at least understanding both schools of thought.

Fundamental vs. Technical Analysis: There are many different ways to assess the value of a company, and the methods used to analyze securities and make investment decisions fall into two very broad categories: Fundamental analysis and technical analysis. Fundamental analysis is a method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and company-specific factors (like financial condition and management). Technical analysis takes a completely different approach. It is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. Figure 12. Technical analysis noted on the graph, Fundamental analysis income statement. Click on graph to enlarge: Out of the two, fundamental analysis is the more widespread discipline, by far. There is a lot of criticism concerning technical analysis, and the criticisms are derived from the Efficient Market Theory. The Efficient Market Theory states that the markets current price is accurate and correct and that past information (same as charts) is already discounted into the stock. There are variations of this theory;

however, most of these people believe that if technical analysis works then market efficiency may be questionable. There are many papers, in fact, that say TA is often more reliable and profitable using a few finely derived rules. Ramazan Genay wrote a paper entitled, The predictability of security returns with simple technical trading rules. Here is the abstract: Technical traders base their analysis on the premise that the patterns in market prices are assumed to recur in the future, and thus, these patterns can be used for predictive purposes. This paper uses the daily Dow Jones Industrial Average Index from 1897-1988 to examine the linear and nonlinear predictability of stock market returns with simple technical trading rules. The nonlinear specification of returns are modeled by single layer feed forward networks. The results indicate strong evidence of nonlinear predictability in the stock market returns by using the past buys and sell signals of the moving average rules. Does all of this mean that one is better than the other? No! Not only is it important to master TA, but you must also be aware of a companys financial strength. Because the stock market can move in an irrational manner, charts will not accurately represent the companys value. In addition, TA can be used because financial statements and management misstate the truth in some cases. Knowing how to perform both fundamental and technical due diligence is essential for both investors and traders. Long term vs. short term Are there times where one technique is more effective than the other? Yes! It all depends on 1) the time horizon, 2) the traders personality and type. Figure 13 is a chart that plots the effectiveness or ineffectiveness of both types of

analyses as the time horizon shifts from short-term to long-term. In my opinion, TA is most effective in the short-term and less effective in the longterm, and fundamental analysis is most effective in the long-term and less effective in the short-term. The ability to perform both analyses gives investors and traders flexibility throughout each timeframe. Short-term is defined as micro-trading (minutes), day trading (hours), and swing trading (days). Intermediate-term is defined as any holding period between several months up to a year and long-term is defined as 1+ years. Types of Technical Trading: Scalping, Day, Momentum, Swing, & Position Trading There are five main types of trading that technical traders can utilize: scalping, day, momentum, swing, and position trading. Scalping Scalping (or micro-trading) is all about taking very small profits, repeatedly (welcome HAL9000). Scalpers believe that stocks go in a certain direction, even for a little bit. They also believe that when trading, unfavorable events can be avoided. Even though scalping may not be suitable for the ordinary public trader, its important to know that scalpers provide liquidity throughout the day. Typically, trades last between seconds to minutes, so given the volume; it is not surprising that scalpers amass the most transaction fees. Scalping is an expert skill because it is easier to take a larger loss that will wipe out the entire days gains, so it is not recommended for beginners. The biggest benefit is if it is done correctly, the small profits will add up.

Day Trading Day trading is all about buying and selling stocks on the same day and you are not holding positions overnight. Comparing day trading to scalping, this particular style calls for holding stocks for minutes to hours vs. seconds to minutes. Because of the short duration of trades, there is little room for error. Day traders even have their own set of tax rules by the IRS. The biggest benefit is that the trader liquidates their positions at the end of the day. Both scalping and day trading require strong discipline, the time and ability to learn how to rapidly trade, a tested and profitable strategy, and enough capital to withstand sudden and enormous draw downs (losses). The next two types of trading take advantage of short-term trends and they are momentum and swing trading (see Optrader for his website on swing trading). Both are not as rapid as Scalping and Day trading, but that doesnt make these strategies any less profitable just ask Optrader! Momentum Trading In momentum trading, the trader identifies a stock thats breaking out and jumps on to capture as much of the momentum on the way up as possible. The trader gets in at the very beginning of a trend and allows other buyers, who identify the trend, to provide the fuel to lift the stock higher. Momentum trading of ENI. The typical time frame for momentum trading is from several hours to several days. Although momentum trading does carry overnight risk and day trading or scalping do not, theres a possibility that there is enough force for the stock to gap up higher.

Swing Trading

Swing Trading is the art of capturing the short-term trend. This style and position trading are the only two types of trading where a person with a fulltime job can still consistently trade well part-time. Since the holding period is several days, intraday moves will not affect the swing trader as much as it would for a day trader. Typical holding periods for a swing trade is between 37 days. Swing trading is best used when the market or stock is in a neutral trading range, meaning the market isnt going anywhere but up and down without much price progress. In VZ, swing trading is effective if a trader wants to take advantage of the ups and downs of this range. Notice that long-term position trading (covered next) or momentum trading will not work in this type of environment but that doesnt mean you cannot make a profit. Use swing trading when the market or a particular stock is going nowhere. Figure 15 shows how a swing trader could follow the short term trends of Verizon (VZ).

Position Trading Position Traders hold stocks for weeks or months (see Figure 14 of ENI above). This style of trading is synonymous with trend following. The only reason to become a position trader is if you anticipate the current trend to continue for a much longer term than a momentum or swing trade. Another example of a position trade is in natural gas and oil. Petrohawk (HK) in Figure 16 has become a favorite in chat and many traders are long the stock (accumulation phase). For now, the traders are taking advantage of the stocks wild swings, but as a position trader, they can buy on the way up and sell or cover their stock with in-the-money options when the trend changed (e.g., HK had a bearish engulfing in July which would have signaled to sell or cover). The position trader is not limited to only buying, the trader can also short (or short sell the stock). In each instance, the holding periods are for

several weeks to months. Position trading gives traders a lot of freedom for those who cannot trade frequently. Profit potential is not diminished and position traders can make considerable gains. In HKs case, over 100% going long and over 100% going short! Now that the different strategies have been presented, the trader must decide how long the trader wants to hold a position. Here are some questions to ask:

Am I short-term or long-term oriented? How much time do I have during the day to trade? Do I work full-

time?

Am I patient and able to wait, or do I need to see results quickly?

Finally, the current market environment will greatly influence what type of trading is appropriate. Mastering one style is very important, but also the trader needs to be proficient in others. If in doubt, stay in cash.Standing aside is considered a defensive position and theres nothing wrong with waiting for an opportunity.

Analysis of Indian IT Companies

TCS:

TCS is the bell weather in IT sector and has maintained to be the large cap stock among all the IT stocks on the Indian Bourses. Recently TCS has earned the Xclent customer base award 2012 for its TCS BaNCS banking software. It sees better IT spends, ramp-up in its clients in the US as compared to earlier and the fact that TCS has 8% wage hike is showing that the company is expecting more revenue growth compared to its peers. This is the company that was affected by the recession during 2008-09 because of its diversified network, at that point of time it decreased its cost by firing 300000 employees and maintained 46.7 EPS higher compared to other years.

Looking at its financials:

TCS is allocating 15% of its income to its contingent liability which shows the ability of the company to maintain its growth even in its aggressive acquisitions. It has maintained good reserves and decreasing debt which will be the safest parameters for the investor to look at to invest.

Looking at the ratios:

Debt to Equity ratio is 0.01 this means TCS has one paisa of debt to equity which shows it has low debt and the PAT is 415 times higher than the interest paid by the company. It is a low beta stock which means it will not be affected

by the market forces, rather its performance is the key, it has shown a consistent EPS growth rate of 6% and the PE growth rate of 10%, using this parameter it is projected that the share price may stand at Rs.1372 in a year if the company maintains to continue its exports which inversely gain revenues from the dollar appreciation. The return on net worth is 37% which is the highest in the sector.

INFOSYS: Indias second-largest software services exporter by Revenues and which is another Bellwether IT stock, has been weak in keeping its financials than other IT companies and also Analysts estimates., In spite of the initiative of leading a government effort to give every Indian citizen an ID number, a crucial initiative in a country where most people have no drivers license, passport or even birth certificate. Apart from this the other factor that drove Infosys share price by 10% decrease in share price over the last year was due to Visa fraud charges leveled in the United States. It has continued to maintain the name of company with politics and bad reputation in the eyes of employees with regards to the salary hikes and work pressure. The company has been good to give employee appraisal rather than rewards, on the other side of the coin it has the ability to make any employee proficient to work in another company.

Looking at its Financials:

There is a perception among the accountants and the investors that in the presentation of the financial statement by Infosys is the best with its Zero Debt, increased revenues and reserves. Infosys has an average income growth rate of 19% and it has allocated 4% of its income to its contingent liability which is higher than past year and has been increasing YOY. Among all the other giants in the IT sector Infosys has the highest FII holding of 37.36% (as on 1 May 2012), If the company gives high growth rate in the next quarter it can become a good stock after HCL Technologies.

Looking at its ratios: Infosys is a low beta stock. Infosys has 10% average EPS growth rate and 6% P/E over the years. If the company continues to maintain the same momentum in generating more revenues and along with the continuity in its reserves and income, it is projected that the share price could be at Rs.3772 in a year with its current average growth rate.

Wipro: The company that started with the innovation and integrity in the consumer product business is now the 3rd largest IT services company in India and entered into the Forbes top 500 companies list. Wipros IT services and Hardware accounted for 75% of its total revenues till the year 2011 and its results has come in line with the expert expectations. After tasting sweet success with its Glucose Powder Brand Glucovita, Wipro Consumer Care & Lighting (WCCL) now plans to launch the product in the tablet form as well,

where an individual can have two tablets and get instant energy. WCCLs first major overseas acquisition was the Singapore-based Unza Holdings for around Rs 1,000 crore in 2007, through which it operates in 40 countries.

Looking at its financials: The consolidated result takes into account all the segments, in which the Consumer Care and Lighting accounted for more than the IT services during the year ended 2012. Wipro has 1% of its income as its contingent liability which is a good parameter for investment, it has good reserves, it has negative cash flows, and company is going to invest 100 crores this fiscal to increase the capacity in various categories, be it lighting, soaps or personal care, to meet demand.

Looking at Ratios: Wipro is a low beta stock. Wipro has 22 Paisa debt for every rupee of its equity. The average growth of EPS is 4% and P/E is 5% the estimated price stood at Rs.527, company has PAT 82 times to its interest cost.

HCL Technologies:

It occupied 4th placein the top IT companies in INDIA and it is after the Giant TCS in generating revenues, HCL consistently has been increasing its quarterly performance, through better revenue visibility and winning the market share. The share price has gained around 25% over the past and they won about USD 2.5 billion of deals over the last couple of quarters, it is expected that in the next two quarters HCL is going to outperform in the industry over the others. According to the Technical Analysis the resistance is at 519-521 now it is trading at 512(as on 30 April 2012) which can shoot up in the future. It is the hot stock in the IT sector of INDIA. It granted employee stock options of around 206.70crores which is the different treatment of employees in the entire sector.

Looking at Financials: It is maintaining 4% of its income as contingent liability which is the average of the industry, it has shown good income, reserves and the company have high debt when compared to the other companies so, compare with the return on the investment it has Rs.10 return on every one rupee it spends

Looking at the ratios: Return on net worth is 22% which shows that the company has good managerial abilities. It has 22 paise of debt for every rupee it spends. It maintained average EPS growth rate of 15% and P/E of 26% which is highest in the sector, using these parameters it can be said that the price of the share will stand at Rs.687 in the future, keeping a look on its financials and ratios it is for a short term investment until and unless it decreases it debt.

Conclusion: Among the top four companies of the IT sector in India, TCS is the good going stock and it has ability to double its share price in the near future by its outstanding numbers, It is a stock for long term holding, next is the HCL technologies which is in the race to occupy the top rank in the sector though it is a short term investment stock and can generate more revenues in the near future with its upcoming deals and it continued in paying dividends, Wipro is expected to grow in the near future by its investment activities and it is better to dont step onto Wipro and Infosys till they show big numbers like TCS.

THE INDIAN BANKING SECTOR REVIEW

Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades India's banking system has several outstanding achievements to its credit. It is no longer confined to only metropolitans or cosmopolitans in India; in fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons of India's growth process. The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalisation of 14 major private banks of India. Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dial a pizza. Money has become the order of the day. Post independence In 1948, the Reserve Bank of India, India's central banking authority, was nationalized, and it became an institution owned by the Government of India. In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bank of India (RBI) "to regulate, control, and inspect the banks in India. "The Banking Regulation Act also provided that no new bank or branch of an existing bank may be opened without a license from the RBI, and no two banks could have common directors. Liberalisation : The new policy shook the Banking sector in India completely. Bankers, till this time,were used to the 4-6-4 method (Borrow at 4%; Lend at 6%; Go home at 4) of functioning. In the early1990s the then Narsimha Rao government embarked on a policy of liberalisation and gave licenses to a small number of private banks, which came to be known as New Generation tech-savvy banks, which included banks such as Global Trust Bank (the first of such new

generation banks to be set up)which later amalgamated with Oriental Bank of Commerce, UTI Bank(now re-named as Axis Bank), ICICI Bank and HDFC Bank. Current situation Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks (that is with the Government of India holding a stake), 29 private banks (these do not have government stake; they maybe publicly listed and traded on stock exchanges) and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs . According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively. Over the last four years, Indias economy has been on a high growth trajectory, creating unprecedented opportunities for its banking sector. Most bank shave enjoyed high growth and their valuations have appreciated significantly during this period. Looking ahead, the most pertinent issue is how well the banking sector is positioned to cater to continued growth. A holistic assessment of the banking sector is possible only by looking at the roles and actions of banks, their core capabilities and their ability to meet systemic objectives, which include increasing shareholder value, fostering financial inclusion, contributing to GDP growth, efficiently managing intermediation cost, and effectively allocating capital and maintaining system stability

SWOT ANALYSIS OF BANKING SECTOR

STRENGTH

Indian banks have compared favorably on growth, asset quality and profitability with other regional banks over the last few years. The banking index has grown at a compounded annual rate of over 51 per cent since April 2001 as compared to a 27 per cent growth in the market index for the same period.

Policy makers have made some notable changes in policy and regulation to help strengthen the sector. These changes include strengthening prudential norms, enhancing the payments system and integrating regulations between commercial and co-operative banks.

Bank lending has been a significant driver of GDP growth and employment. Extensive reach: the vast networking & growing number of branches & ATMs. Indian banking system has reached even to the remote corners of the country.

In terms of quality of assets and capital adequacy, Indian banks are considered to have clean,strong and transparent balance sheets relative to other banks in comparable economies in its region.

WEAKNESS

Public Sector Banks need to fundamentally strengthen institutional skill levels especially in sales and marketing, service operations, risk management and the overall organisational performance ethic & strengthen human capital.

Old private sector banks also have the need to fundamentally strengthen skill levels. The cost of intermediation remains high and bank penetration is limited to only a few customer segments and geographies.

Structural weaknesses such as a fragmented industry structure, restrictions on capital availability and deployment, lack of institutional support infrastructure, restrictive labour laws, weak corporate governance and ineffective regulations beyond Scheduled Commercial Banks(SCBs), unless industry utilities and service bureaus.

Refusal to dilute stake in PSU banks: The government has refused to dilute its stake in PSU banks below 51% thus choking the head room available to these banks for raining equity capital.

Impediments in sectoral reforms: Opposition from Left and resultant cautious approach from the North Block in terms of approving merger of PSU banks may hamper their growth prospects in the medium term.

OPPORTUNITY

The market is seeing discontinuous growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in fee-based income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations.

With increased interest in India, competition from foreign banks will only intensify. Given the demographic shifts resulting from changes in age profile and household income,consumers will increasingly demand enhanced institutional capabilities and service levels from banks.

New private banks could reach the next level of their growth in the Indian banking sector by continuing to innovate and develop differentiated business models to profitably serve segments like the rural/low income and affluent/HNI segments; actively adopting

acquisitions as a means to grow and reaching the next level of performance in their service platforms. Attracting, developing and retaining more leadership capacity

Foreign banks committed to making a play in India will need to adopt alternative approaches towin the race for the customer and build a value-creating customer franchise in advance of regulations potentially opening up post 2009.Reach in rural India for the private sector and foreign banks.Liberalisation of ECB norms:The government also liberalised the ECB norms to permit financial sector entities engaged ininfrastructure funding to raise ECBs. This enabled banks and financial institutions, which were earlier notpermitted to raise such funds, explore this route for raising cheaper funds in the overseas markets.Hybrid capital:In an attempt to relieve banks of their capital crunch, the RBI has allowed them to raise perpetual bondsand other hybrid capital securities to shore up their capital. If the new instruments find takers, it wouldhelp PSU banks, left with little headroom for raising equity.

THREATS

Threat of stability of the system: failure of some weak banks has often threatened the stability of the system. Rise in inflation figures which would lead to increase in interest rates. Increase in the number of foreign players would pose a threat to the Public Sector Bank as well as the private players.

HDFC BANK COMPANY PROFILEHousing Development Finance Corporation Limited, more popularly known as HDFC Bank Ltd, wasestablished in the year 1994, as a part of the liberalization of the Indian Banking Industry by ReserveBank of India (RBI). It was one of the first banks to receive an 'in principle' approval from RBI, for settingup a bank in the private sector. The bank was incorporated with the name 'HDFC Bank Limited', with itsregistered office in Mumbai. The following year, it started its operations as a Scheduled CommercialBank. Today, the bank boasts of as many as 1412 branches and over 3275 ATMs across India.AMALGAMATIONSIn 2002, HDFC Bank witnessed its merger with Times Bank Limited (a private sector bank promoted byBennett, Coleman & Co. / Times Group). With this, HDFC and Times became the first two private banksin the New Generation Private Sector Banks to have gone through a merger. In 2008, RBI approved theamalgamation of Centurion Bank of Punjab with HDFC Bank. With this, the Deposits of the merged entity became Rs. 1,22,000 crores, while the Advances were Rs. 89,000 crores and Balance Sheet sizewas Rs. 1,63,000 crores.There will be IS and BS and Ratio

PERFORMANCE HIGHLIGHTS

Net profit has grown 41.2% to 2245cr in 2009 from 1590 in 2008 largely due to treasury gains. ROE is 17.2% in 2009 as compared to 17.7% in 2008. ROA is 1.4% in 2009 which is unchanged from last year. Net interest spread is 10.39 in 2009 as compared to 11.30 in 2008. NIM is 4.9% in 2009 which is unchanged from last year. P/E IS 28.38% in 2009 as compared to 30.4% in 2008. The banks CAR stood at comfortable 15.4% as at 30th June2009, with tier I at 10.6%. Warrant conversion by HDFC Ltd will further boost the tier I capital adequacy. CASA ratio is maintained at 45% this year. The NPA in 2008 was 903.64 crores.

OUTLOOK AND VALUATION I believe that HDFC Bank is among the most competitive banks in the Banking Sector and is poised tomaintain its profitable growth over the long term. I believe that theBanks competitive advantages, driving gains in CASA market share and traction inmultiple Fee Revenue streams, can support up to 5% higher core sustainable RoEs vis--vis sectoralaverages over the long term, creating a material margin of safety in our Target valuation multiples. Weshould maintain our view that the substantial inorganic and organic network expansion since 3QFY2008will enable the Bank regain strong traction in CASA Deposits and Fee Income market share gains overthe next 12 years, especially once the macro-environment starts improving,

progressively restoringfinancial parameters like CASA ratio and RoE back to pre-merger levels. While HR and IT integration of the eCBoP branches has been completed, it is likely to take the Bank 12-18 months for productivityimprovements to scale up closer to levels of its own branches, so that merger benefits start accruing toits Bottom-line.

HIERARCHY FOR CHOOSING BANKING STOCK FOR INVESTMENT1)


1) HDFC Bank Ltd

HDFC Bank is among the most competitive bank in the Banking Sector and is poised to maintain itsprofitable growth over the long term. Network expansion since 3QFY2008 will enable the Bank regainsstrong traction in CASA Deposits and Fee Income. Market share gains over the next 1-2 years. While HRand IT integration of the centurion bank of Punjab branches has been completed, it is likely to take theBank 12-18 months for productivity improvements to scale up closer to levels of its own branches, sothat merger benefits start accruing to its Bottom-line. The bank stock is likely to get highest returncomparatively with other bank. 2) ICICI Bank Ltd The banks strategy of strengthening its profitability by expanding branch network, replacing bulkdeposits with retail deposits and improving CASA ratio. These measures are likely to result in marginimprovement and subsequent increase in medium-term ROEs from the current levels. Looking at thefuture growth this bank is 2nd most preferred stock for investing.

2) SBI LTD

Banks balance sheet is coming to Rs10 trillion. SBI has maintained its leadership position across financialproduct and had aggressively expanded its book in recent past and had gained market share. SBIcurrently has 1111 branches and plans to add 1000 branches this fiscal catering to over 50000 villages. Itis also aiming at extending banking services to 100000 un banked villages in FY 10Key risk to bank is-1) sharper than expected asset quality deterioration,2) Slower credit growth,3) Margin compression.
3) Punjab National Bank Ltd

PNB Ltd has been ranked on 5th position in preference this is because there is asset quality concernscould continue to weigh in overseas branches. The bank is growing rapidly on the international front andplans to continue its growth globally. It has already acquired permission from RBI to open furtherbranches abroad especially one in DIFC, Dubai. Although it is a positive sign, there is a concern of FOREXlosses that could be reported by the bank in the future quarters due to adverse fluctuation in currency.Further spreads in countries abroad may not be as healthy as in India and asset quality concerns couldcontinue to weigh in overseas branches. CONCLUSION

Fundamental analysis can be valuable, but it should be approached with caution. If you arereading research written by a sell-side analyst, it is important to be familiar with the analystbehind the report.

We all have personal biases, and every analyst has some sort of bias. There is nothing wrongwith this, and the research can still be of great value.

Learn what the ratings mean and the track record of an analyst before jumping off the deepend. Corporate statements and press releases offer good information, but they should be read with ahealthy degree of skepticism to separate the facts from the spin.

Press releases don't happen by accident; they are an important Personal Research tool forcompanies. Investors should become skilled readers to weed out the important information and ignore thehype

ITC Ltd. A multi business conglomerate Latest Stock Price: Rs. 203.95 Latest Market Cap: Rs. 157424.86 Cr. (Large Cap Stock) 52 Week High Stock Price: Rs. 216.10 52 Week Low Stock Price: Rs. 150 Latest P/E: 28.53 Latest P/BV: 8.40 ITC Ltd. is the largest tobacco company in India. It enjoys the leadership position in theIndian cigarette market with a market share of ~80% in terms of value. It is the owner of several renowned brands like Bristol, India Kings, Classic, Gold Flake, Navy Cut, Berkeley and Insignia. The company has over the last few years taken steps to establish itself in other FMCG categories. It has expanded its presence to foods, personal care and lifestyle retailing spaces. It also owns the second largest hotel group in India, accounting for 3000 rooms in the luxury segment. Further, it is also present in Paper and paperboard, and agri-business segments which provide backward integration benefits for its other businesses.

Cigarettes contribute close to 65% of ITCs total gross revenues however owing to the high incidence of taxes, this segment amounts to ~50% of the revenue on a net basis. FMCG others segment has gradually increased its contribution over the years and is expected to be a major growth driver in the coming years. The 10 YEAR X-RAY of ITC Ltd. shows that the financial performance of the company has been very good for the last 10 years except for a bit of a slowdown in FY 2009. With a monopolistic position in the cigarette business (the major revenue contributor) and addictive nature of the product leading to inelastic demand, Net Sales have registered a growth of more than 12% for most of the years. Also, with this leadership position and a strong brand image, it has been able to pass on excise duty hikes by government to the consumers and thus maintained its margins. Infact cigarette EBIT margins have gone up from 21% in FY 2002 to close to 28% in FY 2011. Over the years ITC has also diversified into other businesses. This has led to a slight reduction in Operating Profit and Net Profit margins over the years; however with the other FMCG businesses showing good performance over the last 2 years and getting close to breaking even, margins have shown improvement in the last 2 years and are expected to improve further. ITC has thus shown good, consistent growth in EPS over the last 10 years and is expected to continue it going ahead. With retention of close to 50% of its profits over the last 6 years, Book value per share has also shown good growth except in FY 2010 when company paid out special dividend. The cigarette business is a strong cash generator while cash consuming businesses like Lifestyle retailing, Personal care, Foods etc are

slowly moving towards breaking even. This combined with very efficient working capital management has helped ITCs strong cash generation. The company has also managed its funds efficiently which is indicated by the Return on Invested Capital which stands at ~32% on an average over the last 6 years. The company is a virtually debt free company which is a big positive. Working capital days are on the higher side largely due to the large amount of cash in books (~Rs. 2240 Cr. as of FY 2011). Thus, considering all these factors, we can say that the 10 YEAR X-RAY of ITC Ltd. isGreen (Very Good). Cigarette business expected to continue domination: ITC dominates the cigarette market with close to 80% market share in terms of value and around 70% market share by volume. The nearest competitor is Godfrey Phillips with a 10% value market share and VST Industries with a 5% market share. It owns some of the most popular and valuable brands like Wills Filter, Gold Flake Filter, Classic, India Kings, Scissors, Capstan and Bristol present across the different cigarette segments. Leadership position and strong brands have enabled the company to pass on the excise duty hikes carried out by the government to its customers. Over the past eight years, ITC has raised its gross realization per stick by 10.8% CAGR, ahead of excise duty increase of 7.1% CAGR.

FMCG Sector in India 1. Introduction

Products which have a quick turnover, and relatively low cost are known as Fast Moving Consumer Goods (FMCG). FMCG products are those that get replaced within a year. These products are purchased by the customers in small quantity as per the need of individual or family. These items are purchased repeatedly as these are daily use products. The price or value of the products is not very high. These products are having short life also. It may include perishable and non perishable products, durable and non durable goods. Examples of FMCG generally include a wide range of frequently purchased consumer products such as toiletries, soap, cosmetics, tooth cleaning products, shaving products and detergents, as well as other non-durables such as glassware, bulbs, batteries, paper products, and plastic goods. FMCG may also include pharmaceuticals; consumer electronics, packaged food products, soft drinks, tissue paper, and chocolate bars.A subset of FMCGs are Fast Moving Consumer Electronics which include innovative electronic products such as mobile phones, MP3 players, digital cameras, GPS Systems and Laptops. These are replaced more frequently than other electronic products. White goods in FMCG refer to household

electronic items such as Refrigerators, T.Vs, Music Systems, etc. The Indian FMCG sector is explained below in detail: (a) Fast Growing Sector In 2005, the Rs. 48,000-crore FMCG segment was one of the fast growing industries in India. According to the AC Nielsen India study, the industry grew 5.3% in value between 2004 and 2005. The Indian FMCG sector is the fourth largest in the economy and has a market size of US$13.1 billion. Well-established distribution networks, as well as intense competition between the organised and unorganised segments are the characteristics of this sector. FMCG in India has a strong and competitive MNC presence across the entire value chain. The middle class and the rural segments of the Indian population are the most promising market for FMCG, and give brand makers the opportunity to convert them to branded products. Most of the product categories like jams, toothpaste, skin care, shampoos, 119 etc, in India, have low per capita consumption as well as low penetration level, but the potential for growth is huge. The Indian Economy is surging ahead by leaps and bounds, keeping pace with rapid

urbanization, increased literacy levels, and rising per capita income.The big firms are growing bigger and small-time companies are catching up as well. According to the study conducted by AC Nielsen, 62 of the top 100 brands are owned by MNCs, and the balance by Indian companies. Fifteen companies own these 62 brands, and 27 of these are owned by Hindustan Lever. Pepsi is at number three followed by Thums Up. Britannia takes the fifth place, followed by Colgate (6), Nirma (7), Coca-Cola (8) and Parle (9). These are figures the soft drink and cigarette companies have always shied away from revealing. Personal care, cigarettes, and soft drinks are the three biggest categories in FMCG. Between them, they account for 35 of the top 100 brands. Table 4.3.1: Top 10 Companies in FMCG Sector S. NO. Companies 1. Hindustan Unilever Ltd. 2. ITC (Indian Tobacco Company) 3. Nestl India 4. GCMMF (AMUL) 5. Dabur India 6. Asian Paints (India) 7. Cadbury India 8. Britannia Industries 9. Procter & Gamble Hygiene and Health Care

10. Marico Industries

SWOT analysis of this sector is carried as follows: (i) Strengths: Well-established distribution network extending to rural areas. Strong brands in the FMCG sector. Low cost operations (ii) Weaknesses: Low export levels. Small scale sector reservations limit ability to invest in technology and achieve economies of scale. Several "me-too products. (iii) Opportunities: Large domestic market. Export potential Increasing income levels will result in faster revenue growth. (iv) Threats: Imports Tax and regulatory structure Slowdown in rural demand

(a) Hindustan Uniliver Limited

(i) History: Hindustan Unilever Limited (HUL) is India's largest fast moving consumer goods company, touching the lives of two out of three Indians with over 20 distinct categories in home & personal care products and food & beverages. They endow the company with a scale of combined volumes of about 4 million tonnes and sales of over Rs. 13,000 crores [citation needed]. HUL is also one of the country's largest exporters; it has been recognised as a Golden Super Star Trading House by the Government of India. Since long its presence in Indian market the company is enjoying a very good reputation in the markets. The products, price and quality offered by the company are undoubtedly very high. Since long it is the leader in FMCG sector and future of the company is very bright in Indian markets. In the summer of 1888, visitors to the Kolkata harbour noticed crates full of Sunlight soap bars, embossed with the words "Made in England by Lever Brothers". With it, began an era of marketing branded Fast Moving Consumer Goods (FMCG).Soon after followed Lifebuoy in 1895 and other famous brands like Pears, Lux, and Vim.were launched. Vanaspati was 132

launched in 1918 and the famous Dalda brand came to the market in 1937. In 1931, Unilever set up its first Indian subsidiary, Hindustan Vanaspati Manufacturing Company, followed by Lever Brothers India Limited (1933) and United Traders Limited (1935). These three companies merged to form HUL in November 1956; HUL offered 10% of its equity to the Indian public, being the first among the foreign subsidiaries to do so. Unilever now holds 52.10% equity in the company. The rest of the shareholding is distributed among about 360,675 individual shareholders and financial institutions. The erstwhile Brooke Bond's presence in India dates back to 1900. By 1903, the company had launched Red Label tea in the country. In 1912, Brooke Bond & Co. India Limited was formed. Brooke Bond joined the Unilever fold in 1984 through an international acquisition. The erstwhile Lipton's links with India were forged in 1898. Unilever acquired Lipton in 1972 and in 1977 Lipton Tea (India) Limited was incorporated. Pond's (India) Limited had been present in India since 1947. It joined the Unilever fold through an international acquisition of Chesebrough Pond's USA in 1986. Since the very early years, HUL has

vigorously responded to the stimulus of economic growth. The growth process has been accompanied by judicious diversification, always in line with Indian opinions and aspirations. The liberalisation of the Indian economy, started in 1991, clearly marked an inflexion in HUL's and the Group's growth curve. Removal of the regulatory framework allowed the company to explore every single product and opportunity segment, without any constraints on production capacity. Simultaneously, deregulation permitted alliances, acquisitions and mergers. In one of the most visible and talked about events of India's corporate history, the erstwhile Tata Oil Mills Company (TOMCO) merged with HUL, effective from April 1, 1993. In 1996, HUL and yet another Tata company, Lakme Limited, formed a 50:50 joint venture, Lakme Unilever Limited, to market Lakme's market-leading cosmetics and other appropriate products of both the companies. Subsequently in 1998, Lakme Limited sold its brands to HUL and divested its 50% stake in the joint venture to the company. HUL formed a joint venture with US-based Kimberly Clark Corporation in 1994, KimberlyClark Lever Ltd, which markets Huggies Diapers and Kotex Sanitary Pads. HUL has also

set up a subsidiary in Nepal, Unilever Nepal Limited (UNL), and its factory represents the 133 largest manufacturing investment in the Himalayan kingdom. The UNL factory manufactures HUL's products like Soaps, Detergents and Personal Products both for the domestic market and exports to India. The 1990s also witnessed a string of crucial mergers, acquisitions and alliances on the Foods and Beverages front. In 1992, the erstwhile Brooke Bond acquired Kothari General Foods, with significant interests in Instant Coffee. In 1993, it acquired the Kissan business from the UB Group and the Dollops Icecream business from Cadbury India. As a measure of backward integration, Tea Estates and Doom Dooma, two plantation companies of Unilever, were merged with Brooke Bond. Then in 1994, Brooke Bond India and Lipton India merged to form Brooke Bond Lipton India Limited (BBLIL), enabling greater focus and ensuring synergy in the traditional Beverages business. 1994 witnessed BBLIL launching the Wall's range of Frozen Desserts. By the end of the year, the company entered into a strategic alliance with the Kwality Icecream Group families and in 1995 the Milkfood 100% Icecream marketing and distribution rights too were acquired.

Finally, BBLIL merged with HUL, with effect from January 1, 1996. The internal restructuring culminated in the merger of Pond's (India) Limited (PIL) with HUL in 1998. The two companies had significant overlaps in Personal Products, Speciality Chemicals and Exports businesses, besides a common distribution system since 1993 for Personal Products. The two also had a common management pool and a technology base. The amalgamation was done to ensure for the Group, benefits from scale economies both in domestic and export markets and enable it to fund investments required for aggressively building new categories. In January 2000, in a historic step, the government decided to award 74 per cent equity in Modern Foods to HUL, thereby beginning the divestment of government equity in public sector undertakings (PSU) to private sector partners. HUL's entry into Bread is a strategic extension of the company's wheat business. In 2002, HUL acquired the government's remaining stake in Modern Foods.In 2003, HUL acquired the Cooked Shrimp and Pasteurised Crabmeat business of the Amalgam Group of Companies, a leader in value

added Marine Products exports. HUL launched a slew initiatives in the

of new business

early part of 2000s. Project Shakti was started in 2001. It is a rural initiative that targets 134 small villages populated by less than 5000 individuals. It is a unique win-win initiative that catalyses rural affluence even as it benefits business. Currently, there are over 45,000 Shakti entrepreneurs covering over 100,000 villages across 15 states and reaching to over 3 million homes. In 2002, HUL made its foray into Ayurvedic health & beauty centre category with the Ayush product range and Ayush Therapy Centres. Hindustan Unilever Network, Direct to home business was launched in 2003 and this was followed by the launch of Pureit water purifier in 2004. In 2007, the Company name was formally changed to Hindustan Unilever Limited after receiving the approval of share holders during the 74th AGM on 18 May 2007. Brooke Bond and Surf Excel breached the the Rs 1,000 crore sales mark the same year followed by Wheel which crossed the Rs.2, 000 crore sales milestone in 2008. On 17th October 2008, HUL completed 75 years of corporate existence in India. In 2007, Hindustan Unilever was rated as the most respected company in India for the past

25 years by Businessworld, one of Indias leading business magazines. The rating was based on a compilation of the magazines annual survey of Indias Most Reputed Companies over the past 25 years. HUL is the market leader in Indian consumer products with presence in over 20 consumer categories such as soaps, tea, detergents and shampoos amongst others with over 700 million Indian consumers using its products. It has over 35 brands. Sixteen of HULs brands featured in the AC Nielsen Brand Equity list of 100 Most Trusted Brands Annual Survey (2008). number of brands in the Most Trusted Brands List. Its a company that has consistently had the largest number of brands in the Top 50 and in the Top 10 Hindustan Unilever's distribution covers over 1 million retails outlets across India directly and its products are available in over 6.3 million outlets in India, i.e., nearly 80% of the retail outlets in India. It has 39 factories in the country. Two out of three Indians use the companys products and HUL products have the largest consumer reach being available in over 80 per cent of consumer homes across India. The Anglo-Dutch company Unilever owns a majority stake (52%) in Hindustan Unilever Limited. 135 According to Brand Equity, HUL has the largest

The company has a distribution channel of 6.3 million outlets and owns 35 major Indian brands Some of its brands include Kwality Wall's ice cream, Knorr soups & meal makers, Lifebuoy, Lux, Breeze, Liril, Rexona, Hamam and Moti soaps, Pureit water purifier, Lipton tea, Brooke Bond tea, Bru coffee, Pepsodent and Close Up toothpaste and brushes, and Surf, Rin and Wheel laundry detergents, Kissan squashes and jams, Annapurna salt and atta, Pond's talcs and creams, Vaseline lotions, Fair and Lovely creams, Lakm beauty products, Clinic Plus, Clinic All Clear, Sunsilk and Dove shampoos, Vim dishwash, Ala bleach, Domex disinfectant, Rexona, Modern Bread, and Axe deosprays. HUL has produced many business leaders for corporate India, one of these, Manvinder Singh Banga has become a member of Unilever's Executive HUL is referred to as a 'CEO Factory' in the Indian press for this reason.[who?] It's leadership building potential was recognized when it was ranked 4th in the Hewitt Global Leadership Survey 2007 with only GE, P&G and Nokia ranking ahead of HUL in the ability to produce leaders with such regularity. Hindustan Unilever Limited is India's largest fast moving consumer goods

company, and estimates that two out of three Indians use its products. It has over 42 factories across India. HUL is also one of the country's largest exporters; it has been recognised as a Golden Super Star Trading House by the Government of India.The Hindustan Unilever Research Centre (HURC) was set up in 1958, and now has facilities in Mumbai and Bangalore. HURC and the Global Technology Centres in India have over 200 highly qualified scientists and technologists, many with post-doctoral experience acquired in the US and Europe. HUL also renders services to the community, focusing on health & hygiene education, empowerment of women, and water management. It is also involved in education and rehabilitation of underprivileged children, care for the destitute and HIV-positive, and rural development. HUL has also responded to national calamities, for instance with relief and rehabilitation after the 2004 tsunami caused devastation in South India. In 2001, the company embarked on a programme called Shakti, through which it creates micro-enterprises for rural women. Shakti also includes health and hygiene education through the Shakti Vani Programme, which now covers 15 states in India with over 45,000

women entrepreneurs in 135,000 villages. By the end of 2010, Shakti aims to have 100,000 136 Shakti entrepreneurs covering 500,000 villages, touching the lives of over 600 million people. HUL is also running a rural health programme, Lifebuoy Swasthya Chetana. The programme endeavours to induce adoption of hygienic practices among rural Indians and aims to bring down the incidence of diarrhoea. So far it has reached 120 million people in over 50,000 villages. During its operation the company was involve in some of the controversies. In 2001 a thermometer factory in Kodaikanal run by Hindustan Unilever was accused of dumping glass contaminated with mercury in municipal dumps, or selling it on to scrap merchants unable to deal with it appropriately. Hindustan Unilever's Fair and Lovely is the leading skin-lightening cream for women in India The company was forced to withdraw television advertisements for the product in 2007. Advertisements depicted depressed, darkcomplexioned women, who had been ignored by employers and men, suddenly finding new boyfriends and glamorous careers after the cream had lightened their skin. In 2008 Hindustan Unilever made former Miss World Priyanka ambassador for Chopra a brand

Pond's, and she then appeared in a mini-series of television commercials for another skin lightening product, White Beauty, alongside Saif Ali Khan and Neha Dhupia; these advertisements were widely criticised for perpetuating racism. (ii) Prodcuts: Hindustan Unilever Limited also called Hindustan Lever Limited (HLL) was established in 1933 as Lever Brothers India Limited. Hindustan Lever Limited (HLL) is India's largest Fast Moving Consumer Goods Company, with a customer base of 2 out of every 3 Indian in the category of Home & Personal Care Products and Foods & Beverages. The company has combined volumes of about 4 million tonnes and sales of Rs.10, 000 crores. HLL is also one of the country's largest exporters; the Government of India has recognized HLL as a Golden Super Star Trading House. Some of HLL brands are: Ice creams-Kwality Walls Ice Cream Bath soaps include Hamam, Lifebuoy, Rexona, Lux, Liril, Moti Soaps, Breeze, Peers.. Tea leaves include Lipton Tea, Brooke Bond Tea, Bru Coffee. Tooth pastes include Pepsodent, Close Up, 137 Detergents include cake and powders are Rin, Wheel Laundry Detergent, surf power, surf excel, excelmatic and surf blue.

Cosmatics include Pond cream, Ponds powder, Vaseline, Fair & Lovely, Lakm creans, Lakme powder, lipsticks etc. Shampoos include Clinic Plus, Clinic All Clear, Sunsilk and Lux Shampoos Cleaning material such as Vim, Ala Bleach, Domex, Pureit Water Purifier Other items such as Kisan drinks and jams, Annapurna salts and many more items. The Hindustan Lever Research Center (HLRC) was established in 1958, and now has facilities in Mumbai & Bangalore. HLRC has 200 highly qualified scientists and technologists, many of them with post-doctoral experience. HLL also runs various ambitious programmes like Shakti. Shakti's aim is to create opportunities for rural women thereby improving their livelihood and standard of living in rural sector. Shakti also includes health and hygiene education through the Shakti Vani Programme. The programme covers about 50,000 villages in 12 states. HLL's motive is to take this programme to 100,000 villages influencing the lives of over a 100 million rural Indians. HLL is also involved in running a rural health programme - Lifebuoy Swasthya Chetana. The programme aims to inculcate the hygienic practices among rural Indians to bring down the figure of diarrhea

patients. It has already covered 70 million people in approximately 15000 villages of 8 states. Consumer research plays a vital role in our brands' development. We're constantly developing new products and developing tried and tested brands to meet changing tastes, lifestyles and expectations. And our strong roots in local markets also mean we can respond to consumers at a local level. By helping improve people's diets and daily lives, we can help them keep healthier for longer, look good and give their children the best start in life. (iii) SWOT analysis: SWOT analysis of this sector is carried as follows: Strengths: HUL has presence across the world and coverage is very wide. It has its established distribution network in urban, suburban and rural areas in India. 138 Financial position of the company is very strong. Enjoying very high reputation in markets with popular brands in the FMCG sector. Low cost operations in India due to favourable factors. Weaknesses: Export of its products is low because it has its units across the world. There is no major weakness of the company in India. Opportunities: Indian market is very large and still it is uncovered.. Export potential is there and can be utilized.

Opportunity for boosting sales and revenue is very good. Threats: Imports from China at lower cost creating difficulty. Tax and regulatory structure of Indian government are to be followed Slowdown in demand due to local factors in India economy. Tough competition is being faced from local and international players in markets. (iv) Market shares: Hindustan Unilever Ltd makes fast-moving consumer goods (FMCG) such as detergents, toiletries, and food staples. The company has a distribution channel of 6.3 million outlets and 35 major Indian brands. HUL recorded 20.02% year over year (yoy) growth in revenue at Rs 16660.38 crores during the year ended Dec'08. Its Soaps and Detergents business was its largest contributor to revenues with 46% of total revenues where as Personal Care products contributed the most (46%) towards EBIT. Raw material prices for palm oil and other chemicals increased of 31% from Nov'07-Apr'08 which led the company to implement a price hike by a weighted average of 10% from April to June 2008 in order to protect its margins. From April to October 2008, however, palm oil prices declined 62.2% so Hindustan has accrued higher revenue on lower volume sales in late

2008, early 2009. Increase in per capita income in urban, as well as rural areas, of India has 139 a positive effect on demand of consumer goods along with a shift in demand towards high end lifestyle products. Long a provider of low cost consumer goods, HUL has recently launched products in its high end segments. HUL, the largest FMCG Company in India by revenues merging three subsidiaries of Unilever in 1956. At present, Unilever Plc holds a 51.6% stake in the company. HULs portfolio of products covers a wide spectrum including soaps, detergents, skin creams, shampoos, toothpastes, tea, coffee and branded flour. HUL's brands spread across 20 distinct consumer categories. It owns 35 major Indian brands. HUL has consistently had the most number of brands in the Top 10 list for the most trusted brands in India from 2003 to 2008. Surf Excel, 'Pepsodent and Ponds in Home and Personal Care segment and Lipton, Kissan and Brooke Bond in Foods and Beverages Segment are some of its top brands. In 2008, it launched Ponds Age Miracle, Vaseline range of products in skin care category and Axe-Dark Temptation in personal care segment as part of their expansion into higher end products was formed by

Sales growth of 13.36% in CY'07 (Calendar Year 2007) and 9.38% in CY'06 can be attributed to aggressive launches, re-launches of products and a hike in product prices. The net Income of the company has not increased at the same pace as revenues because of a decline in margins (from 18.5% in CY'04 to 16.7% in CY'07) in its soaps and detergents business and investment in IT and water purifier business in CY 05-06. There is an insignificant change in company's revenue mix in CY04-07 period. Soaps and Detergents business contributes highest (46%) towards revenues followed by Personal care products (26%). Despite being highest revenue generator soaps and detergents business is not the most profitable segment. Personal care contributes highest (46.2%) towards the EBIT which is due to high margins and low penetration of the market. Discussion FY'09 (Financial Year 2009): HUL has shown steady sales growth by 19-20 % in Jan - Sep'08 but it was largely price led due to a hike in product prices in the previous two quarters . Volume growth has decreased from 10.2% in Q1CY08 (1st quarter Calendar Year 2008) to 6.8% in Q3CY08. EBIT margins fell by 30bps to 12.9 due to inflation of Commodities prices but net profit

saw a raise to 34% on account of income from sale of properties

General Steps to Fundamental Evaluation Even though there is no one clear-cut method, a breakdown is presented below in the order an investor might proceed. This method employs a top-down approach that starts with the overall economy and then works down from industry groups to specific companies. As part of the analysis process, it is important to remember that all information is relative. Industry groups are

compared against other industry groups and companies against other companies. Usually, companies are compared with others in the same group. For example, a telecom operator (Verizon) would be compared to another telecom operator (SBC Corp), not to an oil company (ChevronTexaco). Economic Forecast First and foremost in a top-down approach would be an overall evaluation of the general economy. The economy is like the tide and the various industry groups and individual companies are like boats. When the economy expands, most industry groups and companies benefit and grow. When the economy declines, most sectors and companies usually suffer. Many economists link economic expansion and contraction to the level of interest rates. Interest rates are seen as a leading indicator for the stock market as well. Below is a chart of the S&P 500 and the yield on the 10-year note over the last 30 years. Although not exact, a correlation between stock prices and interest rates can be seen. Once a scenario for the overall economy has been developed, an investor can break down the economy into its various industry groups.

Group Selection If the prognosis is for an expanding economy, then certain groups are likely to benefit more than others. An investor can narrow the field to those groups that are best suited to benefit from the current or future economic environment. If most companies are expected to benefit from an expansion, then risk in equities would be relatively low and an aggressive growth-oriented strategy

might be advisable. A growth strategy might involve the purchase of technology, biotech, semiconductor and cyclical stocks. If the economy is forecast to contract, an investor may opt for a more conservative strategy and seek out stable income-oriented companies. A defensive strategy might involve the purchase of consumer staples, utilities and energy-related stocks. To assess a industry group's potential, an investor would want to consider the overall growth rate, market size, and importance to the economy. While the individual company is still important, its industry group is likely to exert just as much, or more, influence on the stock price. When stocks move, they usually move as groups; there are very few lone guns out there. Many times it is more important to be in the right industry than in the right stock! The chart below shows that relative performance of 5 sectors over a 7-month time frame. As the chart illustrates, being in the right sector can make all the difference. Narrow Within the Group Once the industry group is chosen, an investor would need to narrow the list of companies before proceeding to a more detailed analysis. Investors are usually interested in finding the leaders and the innovators within a group. The first task is to identify the current business and competitive environment within a group as well as the future trends. How do the companies rank according to market share, product position and competitive advantage? Who is the current leader and how will changes within the sector affect the current balance of power? What are the barriers to entry? Success depends on an edge, be it marketing, technology, market share or innovation. A comparative analysis of the competition within a sector will help identify those companies with an edge, and those most likely to keep it.

Company Analysis With a shortlist of companies, an investor might analyze the resources and capabilities within each company to identify those companies that are capable of creating and maintaining a competitive advantage. The analysis could focus on selecting companies with a sensible business plan, solid management and sound financials. Business Plan The business plan, model or concept forms the bedrock upon which all else is built. If the plan, model or concepts stink, there is little hope for the business. For a new business, the questions may be these: Does its business make sense? Is it feasible? Is there a market? Can a profit be made? For an established business, the questions may be: Is the company's direction clearly defined? Is the company a leader in the market? Can the company maintain leadership?

Management In order to execute a business plan, a company requires top-quality management. Investors might look at management to assess their capabilities, strengths and weaknesses. Even the best-laid plans in the most dynamic industries can go to waste with bad management (AMD in semiconductors). Alternatively, even strong management can make for extraordinary success in a mature industry (Alcoa in aluminum). Some of the questions to ask might include: How talented is the management team? Do they have a track record? How long have they worked together? Can management deliver on its promises? If management is a problem, it is sometimes best to move on. Financial analysis The final step to this analysis process would be to take apart the financial statements and come up with a means of valuation. Below is a list of potential inputs into a financial analysis. Putting it All Together After all is said and done, an investor will be left with a handful of companies that stand out from the pack. Over the course of the analysis process, an understanding will develop of which companies stand out as potential leaders and innovators. In addition, other companies would be considered laggards and unpredictable. The final step of the fundamental analysis is to synthesize all data, analysis and understanding into actual picks.

Strengths of Fundamental Analysis Long-term Trends Fundamental Analysis is good for long-term investments based on very longterm trends. The ability to identify and predict long-term economic, demographic, technological or consumer trends can benefit patient investors who pick the right industry groups or companies. Value Spotting Sound fundamental analysis will help identify companies that represent a good value. Some of the most legendary investors think long-term and value. Graham and Dodd, Warren Buffett and John Neff are seen as the champions of value investing. Fundamental analysis can help uncover companies with valuable assets, a strong balance sheet, stable earnings, and staying power. Business Acumen One of the most obvious, but less tangible, rewards of fundamental analysis is the development of a thorough understanding of the business. After such painstaking research and analysis . An investor will be familiar with the key revenue and profit drivers behind a company. Earnings and earnings expectations can be potent drivers of equity prices. Even some technicians will agree to that. A good understanding can help investors avoid companies that are prone to shortfalls and identify those that continue to deliver. In addition to understanding the business, fundamental analysis allows investors to develop an understanding of the key value drivers and companies within an industry. A

stock's price is heavily influenced by its industry group. By studying these groups, investors can better position themselves to identify opportunities that are high-risk (tech), low-risk (utilities), growth oriented (computer), value driven (oil), non-cyclical (consumer staples), cyclical (transportation) or income-oriented (high yield). Knowing Who's Who Stocks move as a group. By understanding a company's business, investors can better position themselves to categorize stocks within their relevant industry group. Business can change rapidly and with it the revenue mix of a company. This happened to many of the pure Internet retailers, which were not really Internet companies, but plain retailers. Knowing a company's business and being able to place it in a group can make a huge difference in relative valuations. Weaknesses of Fundamental analysis Time Constraints Fundamental analysis may offer excellent insights, but it can be extraordinarily time-consuming. Time-consuming models often produce valuations that are contradictory to the current price prevailing on Wall Street. When this happens, the analyst basically claims that the whole street has got it wrong. This is not to say that there are not misunderstood companies out there, but it is quite brash to imply that the market price, and hence Wall Street, is wrong.

Industry/Company Specific Valuation techniques vary depending on the industry group and specifics of each company. For this reason, a different technique and model is required for different industries and different companies. This can get quite timeconsuming, which can limit the amount of research that can be performed. A subscription-based model may work great for an Internet Service Provider (ISP), but is not likely to be the best model to value an oil company. Subjectivity Fair value is based on assumptions. Any changes to growth or multiplier assumptions can greatly alter the ultimate valuation. Fundamental analysts are generally aware of this and use sensitivity analysis to present a base-case valuation, an average-case valuation and a worst-case valuation. However, even on a worst-case valuation, most models are almost always bullish, the only question is how much so. The chart below shows how stubbornly bullish many fundamental analysts can be. Analyst Bias The majority of the information that goes into the analysis comes from the company itself. Companies employ investor relations managers specifically to handle the analyst community and release information. As Mark Twain said, "there are lies, damn lies, and statistics." When it comes to massaging the data or spinning the announcement, CFOs and investor relations managers are

professionals. Only buy-side analysts tend to venture past the company statistics. Buy-side analysts work for mutual funds and money managers. They read the reports written by the sell-side analysts who work for the big brokers (CIBC, Merrill Lynch, Robertson Stephens, CS First Boston, Paine Weber, DLJ to name a few). These brokers are also involved in underwriting and investment banking for the companies. Even though there are restrictions in place to prevent a conflict of interest, brokers have an ongoing relationship with the company under analysis. When reading these reports, it is important to take into consideration any biases a sell-side analyst may have. The buyside analyst, on the other hand, is analyzing the company purely from an investment standpoint for a portfolio manager. If there is a relationship with the company, it is usually on different terms. In some cases this may be as a large shareholder. Definition of Fair Value When market valuations extend beyond historical norms, there is pressure to adjust growth and multiplier assumptions to compensate. If Wall Street values a stock at 50 times earnings and the current assumption is 30 times, the analyst would be pressured to revise this assumption higher. There is an old Wall Street adage: the value of any asset (stock) is only what someone is willing to pay for it (current price). Just as stock prices fluctuate, so too do growth and multiplier assumptions. Are we to believe Wall Street and the stock price or the analyst and market assumptions? It used to be that free cash flow or earnings were used with a multiplier to arrive at a fair value. In 1999, the S&P 500 typically sold for 28 times free cash flow. However, because so many companies were and are losing money,

it has become popular to value a business as a multiple of its revenues. This would seem to be OK, except that the multiple was higher than the PE of many stocks! Some companies were considered bargains at 30 times revenues. Conclusion Fundamental analysis can be valuable, but it should be approached with caution. If you are reading research written by a sell-side analyst, it is important to be familiar with the analyst behind the report. We all have personal biases, and every analyst has some sort of bias. There is nothing wrong with this, and the research can still be of great value. Learn what the ratings mean and the track record of an analyst before jumping off the deep end. Corporate statements and press releases offer good information, but they should be read with a healthy degree of skepticism to separate the facts from the spin. Press releases don't happen by accident; they are an important PR tool for companies. Investors should become skilled readers to weed out the important information and ignore the hype.