Fundamental Analysis

Chapter Objectives

To understand fundamental analysis

To know economic analysis

To explain industry analysis To learn about company analysis

Concept of Fundamental Analysis

It is the examination of various factors such as earnings of the company, growth rate and risk exposure that affects the value of shares of a company. The objective of fundamental analysis is not to make speculative profit but it views investment as long term decision. It is an approach to determine what ought to be price i.e. to identify underpriced & overpriced stock. Fundamental analysis consists of:
Economic analysis Industry analysis Company analysis

Economic Analysis

It is the analysis of various macro economic factors that have a significant bearing on the stock market. The various macro economic factors are:
Gross Domestic Product (GDP) Inflation Interest rates Budget Economic policies of the govt.(exim, fiscal, industrial) BOP Govt. spending

Economic Forecasting

Forecasting the future state of the economy is needed for decision making. The following forecasting methods are used for analyzing the state of the economy:

Economic indicators: Indicate the present status, progress or slow down of the economy. Leading indicators: suggests the direction of change in economic activity by providing advance signal. Utilization of manufacturing capacity, corporate profit, rainfall and capital investment. Coincidental indicators: Indicate what the economy is GDP, industrial production, interest rates and so on. Lagging indicators: Changes occurring in leading and coincidental indicators are reflected in lagging indicators. Unemployment rate, consumer price index and flow of foreign funds are examples of such indicators. Diffusion index: it counts the number of leading indictors that rise during a particular period & expressing as a proportion or percentage form of total number of lead indicators

Industry Analysis

It is used to analyze the performance of the industries over the years. An investor must analyze the following factors:

Growth of the industry Nature of the product Attitude of Government

Cost structure and profitability Nature of the competition

Industry life cycle Pioneering stage- rapid growth in demand occurs- may offer highest potential returns

Expansion stage- survivors from pioneering stage- rate of growth moderate Stabilization stage- co. at this stage may relatively high dividend pay out as their growth prospects are fewer.

Industry Analysis

Industries can be classified into:

Growth industry: Has high rate of earnings and growth is independent of business cycle. Cyclical industry: Growth and profitability of the industry move along with the business cycle. Defensive industry: It is an industry which are least affected by recessions & economic adversity, e.g. food Cyclical growth industry: It is an industry that is cyclical and at the same time growing.

Company Analysis

It involves analyzing the financial statements of the company. The financial statements of the company include:

Balance sheet: It shows the status of a companys financial position at the end of the year. Profit and loss account: It shows the profit and loss made by the company during a period.

Analysis of Financial Statements

It helps the investor in determining the financial position and progress of the company. The various simple analyses that are performed to ascertain the financial position of the company are:

Comparative financial statement: In this , data from the current years balance sheet is compared with similar data from the previous years balance sheet. Trend analysis: It shows the growth and decline of sale and profit over the years. Common size income statement: It shows each item of expense as a percentage of net sales. Fund flow analysis: It is a statement of the sources and application of funds. Cash flow analysis: It shows cash inflow and outflow of a company during the year. Ratio analysis: It is the numerical relationship between the two items.

Chapter Summary
By now, you should have:

Understood the concept of fundamental analysis

Understood the concept of industry analysis Learnt about company analysis