Fundamental Analysis

Frequently Asked Questions

Contents ..................................................................................................................................................................
Fundamental Analysis – Frequently asked Questions .......................................................................................... 3
 What is Fundamental Analysis? ................................................................................................................. 3
 What is intrinsic value and how is it measured? ........................................................................................ 3
 What is the difference between rights and bonus shares?.......................................................................... 3
 What are DVR Shares? .............................................................................................................................. 4
 What is free float? ...................................................................................................................................... 4
 What is earnings period?............................................................................................................................ 4
 What is the difference between revenues and earnings? ........................................................................... 5
 What is MPS? ............................................................................................................................................ 5
 What is P/E?............................................................................................................................................... 6
 What is EPS- Earning Per Share? .............................................................................................................. 6
 What is difference between cost of sales and operating expenses? ........................................................... 7
 What is market capitalization? ................................................................................................................... 7
 What is OPM-Operating Profit Margin? ................................................................................................... 7
 What is Operating Earning? ....................................................................................................................... 7
 What is NIM-Net Interest Margin? ............................................................................................................ 7
 What is outstanding share? ........................................................................................................................ 8
 What is EBDITA? ...................................................................................................................................... 8
 What is the difference between amortization and depreciation? ............................................................... 8
 What do you mean by the statement – “valuations are attractive at P/E of 11.7x FY16E EPS of
Rs178.4” ............................................................................................................................................................ 9
 What is CAGR? ......................................................................................................................................... 9
 Quick check list – for Fundamental Analysis? .......................................................................................... 9
 What is an annual report? ........................................................................................................................ 10
 What is face value? .................................................................................................................................. 10
 What are preference shares? .................................................................................................................... 10
 What is debt-equity ratio? ........................................................................................................................ 11
 What is dividend yield? ........................................................................................................................... 11
 What is dividend payout ratio? ................................................................................................................ 11
 What is Return on Equity (RoE)? ............................................................................................................ 12
 Fundamental Analysis – Frequently asked Questions

 What is Fundamental Analysis?

 Fundamental analysis is based on the premise that every share has a certain intrinsic value at a period
of time.

 This intrinsic value changes from time to time as a consequence of both internal and external factors.

 The theory of fundamental analysis suggests that one should purchase a share when it is available
below its intrinsic value and sell it when it rises above its intrinsic value.

 When the market value of share is below its intrinsic value it is undervalued, whereas if the market
value of a share is above its intrinsic value it is overvalued.

 What is intrinsic value and how is it measured?

 The present value of future benefits (that accrue to investors in the share) like dividends, growth in
stock price etc.

 Calculation :
 Let us assume that one expects a return of 20% on an investment every year for 3 years.

 Let us also assume that the company would pay dividends of 20%, 25% and 30% on its Rs.10 share
(face value )

 The dividend received on a share would therefore be Rs.2.00 in the first year, Rs.2.50 in the second,
and Rs.3.00 in the third. Let us also assume that the share can be sold at Rs.200 at the end of 3 years.
The intrinsic value of the share will be:

 If the market price of the share is below Rs.120.88 then the share is below its intrinsic value and
therefore well worth purchasing. If, on the other hand, the market price is higher, it is a sell signal and
the share should be sold.

 What is the difference between rights and bonus shares?

 Bonus shares means new shares given free of cost to all the existing shareholders of the company, in
proportion to their holdings. For example a company announcing bonus issue of 1:2 – would issue one
new bonus share for every 2 shares held by the shareholders of the company
  Rights issues are a proportionate number of shares available to all the existing shareholders of the
company, which can be bought at a given price (usually at a discount to CMP). This offer stays valid
for a fixed period of time. For example a company announcing rights issue of 2:3 at Rs 100 (assuming
CMP is at Rs 120)

 It means company is issuing 2 rights issue (new) shares for every 3 shares held by the shareholders of
the company at Rs 100 per share. Shareholder has the right to accept or not to accept the offer.

 What are DVR Shares?

 It stands for differential voting rights

 Generally they are lower privileged in terms of voting rights in comparison to ordinary equity share
holders.

 DVR investors are generally compensated with a higher dividend rate. This makes the DVRs attractive
for retail investors who do not want control in the company, but are looking at the long-term growth
prospects.

Reasons for issuing DVR -

 Prevent hostile takeover
 Dilution of Voting Rights
 Roping in a passive strategic investor
 DVR shares are listed on the stock exchanges and are traded in the same manner as ordinary equity
shares, but they mostly trade at a discount, sometimes as high as 30%, due to fewer voting rights.
 Example – TATA MOTOR DVR carry voting rights which are 1/10th of the ordinary equity shares

 What is free float?

 It refers to the shares that are freely available for trading in the stock exchanges. It excludes the
holdings which are lying with promoters / government or any other strategic holdings – which are not
available for trading in the market.

 What is earnings period?

 Generally a company earns though out the year. Companies report earnings every quarter. However
based on the product or service the company is in – in some season its earnings would pick up and in
some season it would not.

 The quarter results come out by the mid of the subsequent quarter. The market always approaches the
earnings reporting day with caution. That day can be a time of some volatility, either up or down for
particular stocks and/or sectors.

 Companies are required to declare its earnings figures every quarter.

 In India, a financial year starts from 1st of April and ends on the subsequent march 31st. So the
 quarters are as follows-

 Quarter 1 (Q1)-1st April to 30th June (AMJ) Earnings for the quarter will be declared around July-
August.

 Quarter 2 (Q2) – 1st July to 30th Sept (JAS). Earnings for the quarter will be declared around October
– November.

 Quarter 3 (Q3) – 1st Oct to 31st Dec (OND). Earnings for the quarter will be declared around January
– February.

 Quarter 4 (Q4) – 1st Jan to 31st Mar (JFM). Earnings for the quarter will be declared around April –
May.

 Companies also declare half yearly results clubbing two quarters. Investors, based on the given facts,
try to figure out the expected earnings of the company.

 This expectation of the investors is what is actually reflected in the share price movements. So, in
addition to the actual earnings, the expectation of earnings also plays an important part in stock prices.
Companies that fail to meet the expectations of the investors get beaten by the market.

 So it is not the actual business figures or the news (even non-biased) does not move the market but
how the people (investors / traders) react to the news moves the price.

 What is the difference between revenues and earnings?

 Revenue means the total money a company receives from the sale of goods and services. Receipts
BEFORE deducting all expenses.

 Also known as Top Line / Total Sales / Gross Income

 Earnings mean Profits. It is arguably the ultimate measure of growth of a business.

 Also known as Bottom Line / Net Income

 Earnings = Revenue – Expenses ( payroll , raw material , taxes , interests on loans etc )

 What is MPS?
 MPS stands for Market Price per Share.

 It is not necessarily the same as Current Trading Price or Current Market Price of a share.

 The market price per share is also called the intrinsic value of a share of stock or the actual value based
on the actual variables taken from the company's financial statements where as the current trading price
 is based on investor buying and selling behavior.

 What is P/E?
 It is a valuation ratio. Calculated as CMP / EPS

 Example –

Company made a profit of 400 lakh (post tax and preference dividend) in 2013. No of ordinary shares
is 50 lakh. The share of the company is trading at Rs 112

EPS = 400 / 50 = Rs 8

P/E = 112 /8 = Rs 14

 It means that the investor would take 14 years to recover the investment through earnings. This also
indicates the yield is 7.14% (100 /14 years )

 The P/E ratios of well established and financially sound companies are high and as the returns are high
for weaker companies the P/E ratio is low since they are riskier investments.

 The P/E ratio would be high so long as the investing public has faith in a company's ability to grow and
to earn a return or an appreciation in its share price. It will fall as soon as this confidence in the earning
capacity of the company falls. This is why prices rise dramatically in boom periods. In periods of
depression, they fall.

 What is EPS- Earning Per Share?

 EPS = (Net income – Dividends on Preferred Stock) / (Average Outstanding Shares)

 Company earnings is calculated by deducting the „cost of sales‟, „operating expenses‟ and „taxes‟ from
its total sales revenues.

 The part of the company‟s profit that is attributed to each individual share of stock.

 EPS is a good indicator of a company‟s profitability.

 Example, if a company earned Rs 200 Crores in the third quarter and had 50 Crore shares outstanding,
the EPS would be Rs 4 (200 / 50).

 It is better not to compare EPS of companies falling under different industries.

 EPS calculated with the last year end actual earnings figure is called “trailing EPS”. It is the actual EPS
figure.

 EPS calculated with Future earnings figures - it‟s called “forward EPS”.
 What is difference between cost of sales and operating expenses?
 Cost of sales are direct costs incurred towards goods or service production ( labor charges , raw
materials etc )

 Operating expenses are indirect costs incurred towards the production of goods or service ( advertising
cost , legal cost , staff salary etc )

 What is market capitalization?

 In short it is also known as Market Cap.

 Market Capitalization = Current Market Price x No. of Outstanding Shares.

 Market Cap is divided into 3 popular categories. There is no formal categorization on this. However in
Indian context we can go by the stated below figures (approx )

Large Cap – Above 4000 cr

Mid Cap – Between 750 cr to 4000 cr
Small Cap – Below 750 cr

 What is OPM-Operating Profit Margin?

 Operating Margin = Operating Earning / Revenue.

 Operating margins are important because they measure efficiency. The higher the operating margin, the
more profitable a company's core business is.

 What is Operating Earning?

 Operating Earning = Revenue – (Cost of Goods Sold + Labour Charges + General and Admin Charges
etc)

 Revenue hinted at in the above formula means the revenue generated from company's core business.

 What is NIM-Net Interest Margin?

 It is a ratio of Net Interest Income to invested assets (i.e. income generating asset). This ratio is widely
used in banks and other financial institutions. It is similar to the gross margin of non-financial
companies.

 Example: A bank forwards loan of Rs 100 to customer at a rate of 15% and this Rs 100 the banker has
borrowed from investors through NCD at 12%.
M = (15-12)/100 = .03 = 3 %
  NII stands for Net interest income equals the interest earned minus the interest paid out to
customers.NII is similar to Interest Spread.
Interest Spread = Interest Rate charged for lending – Interest Rate paid to the depositors.

 What is outstanding share?

 Outstanding means shares / securities held by the public.

 Promoter holding needs to be excluded from the total float (i.e. total shares issued while calculating
outstanding share.

 What is EBDITA?
 It stands for EBDITA means earnings before interest, taxes, depreciation and amortization.

 It is a form of representing earning numbers.

 Different companies assume different methods to prepare their financials( like depreciation, tax
provisions etc ) Hence to bring things at par analyst at times look out for vanilla Earnings figures
before tax, interest expense , depreciation etc .

 EBDITA margin = EBDITA / Revenue.

 The higher the EBDITA margin, less operating expenses eat into company's bottom line which leads to
more profitable situation.

 The prime concern is profit – we can also call it as Earnings. The real issue is what goes into that
number. There are many flavors to it – EBDITA. Other popular flavors are -

o EBDIT – Earnings before Depreciation, Interest and Tax

o EBIT – Earnings before Interest and Tax
o EBT – Earnings before Tax
o EAT – Earnings after Tax

 What is the difference between amortization and depreciation?

 Both Amortization and Depreciation refers to spread the cost of an asset over that of the assets useful
life.

 Purpose of both is same – that is to RECOVER COST.

 However Amortization is used for Intangible Asset and Depreciation is used for Tangible Asset.

o Intangible assets examples – patents, trademark, loan etc.

o Tangible asset examples – building, furniture, plant and machinery.

 What do you mean by the statement – “valuations are attractive at P/E of 11.7x

FY16E EPS of Rs178.4”

 It means - The security is valued at 11.7 times the estimated earnings of FY15-16 ( which is Rs 178.4)
i.e. 11.7 x 178.4 = Rs 2087.28

 Now this price needs to be compared with CMP of the security and then any possible decision like –
buy – sell or hold etc should be taken.

 In the above statement –

o FY 16E :Estimated or Projected Earnings of Financial Year 2015 – 2016

o EPS: Earnings per Share.

o P/E : Price Earnings Multiple ( CMP/EPS ) CMP : Current Market Price ( i.e. current trading
price of the stock )

 What is CAGR?
 CAGR Compound Annual Growth Rate.

 It is calculated as ((Ending Value / Beginning Value)) ^ (1/no. Of years ) - 1

 Example :

If a portfolio of 100000 INR in 2010 becomes 147000 INR in 2013. It means CAGR for the portfolio
is 13.71% pa.

The portfolio has grown by 13.71% pa (interest has been compounded year on year from 2010 to 2013)

Working: Ending Value: 147000, Beginning Value: 100000, No of years: 3

CAGR = (147000/100000) ^ (1/3)-1 = 13.71%

 Quick check list – for Fundamental Analysis?

 1. Political Situation
Example - Is there any major problem? Could the government be overthrown and could there be
difficulties as a consequence?

 2. Economic Indicators
Example - Is the growth rate reasonable? How comfortable is the balance of payment position?

 3. Industry in which the company operates

 Example - At which stage of the business cycle company is in? Entry and exit barriers. Technology etc.

 4. Company
Example - Need to look at Annual Reports / Management / Management Practices

 5. Check the intrinsic value of the company ( per share basis )

Example - A decision should be taken only after this.

 What is an annual report?

 An annual report is a summary of all that‟s happened in the business in a financial year – growth in
revenues, new opportunities, new milestones, changes in management team, new appointments of key
personnel‟s, future plans etc.

 It is prepared by the management and distributed to the shareholders, promoters, government

authorities, general public and to anybody who‟s interested in the affairs of the company.

 Most annual reports are in the form of a book. It runs into many pages starting from a chairman‟s
message to future plans and prospects. An annual report is presented in the annual general meeting.

 Content of Annual Report :

1. Letter from the CEO

2. Summary of the operations-milestones, achievements, prospects.
3. Past Annual summary of all financial figures.
4. Management discussion and analysis of the performance of the company
5. The director‟s report.
6. The balance sheet
7. The income statement
8. Auditor‟s report
9. Subsidiaries, brands, addresses, registered office, head quarters etc.
10. Names of directors
11. Stock price history

 What is face value?

 The unit value into which the equity capital of a company is split is called as the face value.

 It is also the value of a share printed on the face of a share certificate hence the name.

 The most common face value used in India is 10 but there are stock listed shares having a face value of
1.2.5. And even 100.

 What are preference shares?

 Preference shares are shares in which the owners of the shares are entitled to a fixed dividend or
dividend calculated at a fixed rate to be paid regularly before dividend can be paid in respect of equity
share.
  They also enjoy priority over the equity shareholders in payment of surplus. But in the event of
liquidation, their claims rank below the claims of the company's creditors, bondholders / debenture
holders.

 In short they get preference over equity shareholders in case of payment of dividends on in case of
winding up of the company.

 What is debt-equity ratio?

 Debt-equity ratio is a measure of leverage, indicating proportion of company's total capital contributed
by secured and unsecured debt.

 A high debt-equity ratio, generally 2:1 and above, is not considered favorable for companies. Also, this
ratio
Varies from industry to industry and may not be relevant for the banking and financial sectors.

 Debt-equity ratio = (Secured + Unsecured debt) / Shareholders Funds, Example : As on 31st March
2013, company had secured loan of Rs. 70 crore, unsecured loan of Rs. 30 crore, shareholders funds
(equity and reserves) of Rs. 200 crore.

 Debt-equity ratio = (70 + 30) / 200= Debt-equity ratio = 0.5

 What is dividend yield?

 Dividend yield is dividend to price ratio. It is the percentage calculated by dividing dividend per share
by price per share. Dividend yield tells an investor what is the return they are making in the form
dividends.

 It is used to calculate the earnings on investment (shares) considering only the returns in the form of
total dividends declared by the company during the year.

 Dividend Yield = ((Interim + Final Dividend) / (Market Price of the share)) x 100

Example: For a company for FY10, Interim dividend = Rs. 2 per share, Final dividend = Rs. 3 per
share, Share price = Rs. 50, Dividend yield = (2 + 3) / 50, Dividend yield =10%

 What is dividend payout ratio?

 Dividend Payout ratio, or simply payout ratio, is the percentage of a company's earnings paid as
dividends to the shareholders. It indicates how well the company's earnings support the dividend
payment.

 Dividend Payout ratio = (Dividend per equity share) / Earnings per share (EPS) x 100

 Example: For FY13, a company had EPS of Rs.20. It paid dividend of 20% (Rs. 2 per equity share of
Rs. 10 each) for the year. Here , Dividend payout ratio = ( 2 /20 ) x 100 = 10%
 What is Return on Equity (RoE)?
 Return on Equity, also known as Return on Networth or Return on Shareholders‟ Funds or Return on
Investment, indicates how profitably a company is utilizing the shareholders funds. The higher the
percentage, the more efficiently the shareholders funds have been utilized, indicating better return to
investors.

 RoE is ratio of net income (available for equity shareholders) to average shareholders' equity.

 RoE = Profit After Tax / Net Worth

 Net Worth = Equity Share capital + Free Reserves - Miscellaneous Expd.

 Example: If net profit is Rs.200 crore, Equity share capital is Rs.100 crore, Reserves and Surplus is
Rs.400 crore, Miscellaneous Expd. Nil

RoE = 200 / (100+400) = 20%.