FUNDAMENTAL ANALYSIS

SECURITY ANALYSIS It provides the bases for selecting individual issues to bur or sell from among available choices. Approaches to security analysis There are various approaches to security analysis which are as follows: 1. Fundamental analysis a. Economic analysis b. Company analysis 2. Technical analysis

MEANING OF FUNDAMENTAL ANALYSIS

In order to make a rational and scientific investment decision, an investor has to evaluate a lot of inform as to the part as well as the expected future performance of companies, industries and the economy as a whole in advance such evaluation or analysis is known as fundamental analysis

FUNDAMENTAL ANALYSIS
Fundamental Analysis really a logical and systematic approach for estimating the future dividends and share price. It assumes that their price is determined by a number of fundamental factors regarding economy industry and company Hence the fundamentals as to EIC have to be considered while analyzing a security for the purpose of investment Fundamental Analysis is in other words a detailed analysis of the fundamental factor affecting the performance of companies Fundamental Analysis forms the basis for the selection of securities for invests from among those available in market.

FUNDAMENTAL ANALYSIS
Fundamental Analysis thus involves 3 steps Economic analysis Company analysis Industry analysis

Economic Analysis
The performance of a company depends much on the performance of the economy if the economy is BOOM, the industries and companies in general said to be prosperous. On the other hand, if the economy is in RECESSION, the performance of companies will be generally poor. Investors are interested in studying those economic varieties, which affect the performance of the company in which they proposed to invest. An analyzed of those economic variable would give an idea about future corporate earnings and the payment of dividends and interest to investors.

Economic Analysis
We shall now discuss some of the key economic variables that can investor must monitor as part of this fundamental analysis: (1) GNP (2) SAVINGS AND INVESTMENT (3) INFLATION (4) AGRICULTURE (5) RATES OF INTEREST

Economic Analysis
(6) GOVT. REVENUE, EXPENDITURE & DEFICITS (7) INFRASTRUCTURE (8) MONSOON (9) POLITICAL STABILITY

(1) GNP
GNP represents the aggregate value of goods and services produced in the economy. It reflects the over all performance of the economy the growth rate of GNP indicates the growth rate of the economy the higher the rate of growth of GNP, the more favorable is it for the stock market and vice versa

(2) SAVINGS AND INVESTMENT

Savings and investment denote that position of GNP, which is saved and invested savings increases in India since eighties now the rate of savings is 25% from 21% in 80s, which indicates the growth of capital market. The higher the level of savings interest, the more favorable is it for the stock marketed vice versa

(3) INFLATION
Inflation has considerate impact on the performance of companies. Higher rates of inflation upset business plans and erode purchasing power in the hands of consumers. This will result in lower demand for products. Thus high rates of inflation in an economy are likely to affect the performance of companies adversely. However industries and companies prosper during periods of low inflation. Hence an investor has to evaluate the inflation rates prevailing in the economy currently as well as the trend of inflation likely to prevail in the future.

(4) AGRICULTURE
Agriculture forms a major part of the Indian economy. Some companies are using agricultural raw material as inputs and some others are supplying inputs to agriculture. Such companies are directly affected by changes in agricultural production. Hence, the increase/decrease in agricultural production has a significant bearing on the industrial production and corporate performance.

(5) RATES OF INTEREST

The cost and availability of credit for companies are determined by the rates of interest prevalent in an economy. A low interest rate stimulates investment by making credit available easily and cheaply. As a result cost of finance for companies decreases which assures higher profitability. On the other hand, higher interest rates result in higher cost of production, which may lead to lower profitability and lower demand. Hence an investor has to consider the interest rates prevailing in the economy and evaluate their impact on the performance and profitability of the companies.

(6) GOVT. REVENUE, EXPENDITURE & DEFICITS

Government is the largest investor and spender of money. So the trends in government revenue expenditure deficits have a significant impact on the performance of industries and companies. So the investor has to evaluate these carefully to assess their impact on his investments.

(7) INFRASTRUCTURE
The development of an economy very much on the availability of infrastructure. It includes electricity, roads and railways, communication channels etc. The availability of infrastructural facilities affects the performance of companies. Bas infrastructure leads to inefficiencies, lower productivity, wastage and delays and vice versa. Thus an investor should assess the status of infrastructural facilities available in the economy before finalizing his investment avenues.

(8) MONSOON
The Indian economy is essentially an agrarian economy and agriculture forms a very important sector of the Indian economy. But the performance of agriculture to a very great extent depends upon the monsoon. The adequacy of the monsoon ensures the success of the agricultural activities in India and vice versa. Hence the progress and adequacy of the monsoon becomes a matter of great concern for an investor in India.

(9) POLITICAL STABILITY

A stable political environment is necessary for steady and balanced growth. No industry or company can grow and prosper in the midst of political turmoil. Such long term economic policies are needed for industrial growth. Such stable policies can be framed only by stable political systems.

INDUSTRY ANALYSIS
Industry analysis indicates to an investor whether the industry is a growth industry or not. It gives an investor a choice of the industry in which the investments should be made. Industry analysis refers to an evaluation of the relative strength and weakness of particular industries which can be divided in to three parts, viz., 1. Life cycle of an industry 2. Characteristics of an industry 3. Profit potential of an industry

1. Life cycle of an industry

Marketing experts believe that each product has a life cycle. In the same way industry is also said to have a life cycle. They are (a) Pioneering Stage: Technology and product are newly introduced. (b) Expansion stage: Those companies which reached first stage grow further and becomes stronger. (c) Stagnation Stage: In this stage the growth of the industries Stabilizes. Sales increases at slower rate. (d) Decay stage: The industry becomes obsolete and gradually ceases to exist.

2. Characteristics of an industry
In an Industry Analysis the analyst should consider a number of key characteristics (a) Relationship between Demand & supply: Excess supply reduces the profitability of the industry and insufficient supply tends to improve the profitability. Thus an investor should estimate the demand and supply gap in an industry. (b) Period of life: Life of the industry depends on the products and the technology used by the industry. Technological changes leads to product obsolete. No investment should be made in such industries. (c) State of labour: When there is labour revolution, industries cannot become bright. (d) Governments attitude: The Government may encourage the growth and development of certain industries by giving much assistance to such industries. (e) Availability of Raw Material: An industry may depend on internal / external country for raw material. Sometimes they depend on import of raw material. (f) Cost structure: It refers to the proportion of fixed costs to variable costs. (Discuss about Marginal Cost)

3. Profit potential of an industry

It depends on the following:

(i) Threat new entrants: New entrants inflate cost, push down the prices and reduce profitability. An industry which is well protected from the entry of new firms would be ideal for investment. (ii) Competitions among existing firms: The firm competes with each other on the basis of price, quality, promotion, service, warranties and so on. If the rivalry between the firms in an industry is strong average profitability of the industry may be discouraged. The rivalry in an industry is high when the following conditions prevail in the market: (a) There is a sustained competitive battle (b) The industry growth is dull (c) The level of fixed cost is high (d) There is over capacity in the industry continuing for a long time. (e) The industry product is considered as a commodity, which stimulates strong competition. (f) The industry struggles much to withstand.

(iii) Pressure from substitute products: Each firm in an industry face competition from other firms in the same industry producing substitute products. Substitute products may affect the profit potential of the industry badly. The pressure from the substitute products is found to be high under the following circumstances: (a) When the price of the products is attractive (b) When the cost for the prospective buyers to switch over to a substitute product is minimum. (c) When the substitute products are earning greater profits.

(iv) Bargaining power of buyers: Buyers can bargain for price reduction asks for better quality and better service. The bargaining power of a buyer group is said to be high under the following conditions: (a) If its capacity to buy is more than the capacity of the seller to sell. (b) If the cost of the switch over to a substitute product is low. (c) If it poses a threat of backward integration strongly.

(v) Bargaining power of sellers: Sellers also can exert a competitive force in an industry and bargain for rise in prices, lower quality, curtail some of the free services they offer etc. Powerful suppliers can affect the profitability of the buyer industry badly. Suppliers are said to be powerful under the following circumstances. (a) Few suppliers dominate the entire market. (b) There is no viable substitute for the products supplied. (c) The switching poses a strong threat of forward integration. (d) Suppliers also pose a strong threat of forward integration.

Company Analysis
It involves a close investigative scrutiny of the companies financial and non financial aspects with a view to identifying its strength, weaknesses and future business prospects. The financial and non financial aspects are as follows: Marketing success Accounting Policies Profitability

Marketing success
The success of the market of the firm depends on (a) The share of the company in the industry (b) Growth of its sales and stability of sales (c) Sales.

Accounting Policies
A. Inventory Pricing
Cost/market value method FIFO LIFO

B. Depreciation methods
Straight line method Sum of the years digit method

C. Non operating income

Dividend Interest

D. Tax Carry over

Provision for taxation

Profitability
A.(a) Gross profit Margin Analysis (b) Net profit Margin Balance Sheet Analysis (c) Earning power C. Ratio Analysis Liquidity Ratios (d) Return on equity Leverage Ratios (e) Earning per share Profitability Ratios (f) Cash EPS Activity / Efficiency Ratio B.Financial Statement Analysis Trading, P& L A/C