Using Fundamental Analysis to Examine Value Stocks. Long-Term. Investor. Track. Investor. Education. Conference. 2. PAT MULLALY. Education Coach . Fundamental Structural Analysis Equilibrium Analysis and Determinacy of Structures chapter 2: tOOls Of thE tradE: fundamental analysis and yet the most . 8) Fundamental Analysis: The Balance Sheet. 9) Fundamental Analysis: The Cash Flow Statement. 10) Fundamental Analysis: A Brief Introduction To Valuation.
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Fundamental Analysis. This presentation is being issued solely for information purposes. This presentation does not contain all of the information required by a . 𝗣𝗗𝗙 | In the equity market, the process of stock selection for the download decision is a complex task as there are many stocks available in the. PDF | 50+ minutes read | Every investor is advised to have enough knowledge Analysis of capital market can be done either by Fundamental.
Fundamental analyses study only the stock price movements themselves and believe that the history of previous data provides indicators for future stock price movements. Technical analysts have developed tools and techniques to study past patterns and predict future price. It is basically the study of markets only. They study the technical characteristics which may be expected at May or market turning points and their objective assessment.
The previous turning points are studied with a view to develop characteristics that would help in identification of major market tops and bottoms. Human reactions are, by and large consistent in similar though not identical reaction; with the help of various tools, the technician attempts to correctly catch changes in trend and take advantage of them. The purpose of doing this complex analysis is to help them decide whether it is advisable to download, sell or hold the security of that company.
Growth models can be made to gauge potential accumulation in the worth of the company. The difficulty is in trying to bridge this information to the market price of the shares, whereas the technical analyst often interprets the data by studying a chart.
He may look for price patterns, trends, conflicting signals, or slight changes in downloading momentum. Determining the success of technical analysis is very difficult due to the subjective nature of this practice. Ten technical analysts can examine the same chart and have differing opinions of how and when the price will move. Many famous technical analysts, such as George C.
Lane, have little written about their personal successes using such techniques.
Fundamental analysts will try to figure out what a stock is really Fundamental Analysis as a Method of Share Valuation in Comparison Technical analysts will attempt to gauge the current emotional state of the downloaders to forecast if further downloading or selling is likely. The aim of this article is not to determine which art is better.
Instead, should endeavor to find out which method is commonly used on a particular stock. Theoretically, the value of a company, hence its share price, is the sum of the present value of future cash flows discounted by the risk adjusted discount rate.
This conceptual valuation frame work is the spirit of the renowned dividend discount model developed by Gordon Thus, the subsequent studies along this line of literature searched for the cash flow that is unaffected by the dividend policy and can be obtained from the financial statements.
A study by Yu-Hon Lui and David Mole reports on the use by foreign exchange dealers in Hong Kong of fundamental and technical analyses to form their forecasts of exchange rate movements.
The findings of this study reveal that more than 90 per cent of the respondents rely on both fundamental and technical analyses for predicting future rate movements at different horizons. Thomas Oberlechner presents the findings of a questionnaire and an interview survey on the perceived importance of Technical and Fundamental analysis among foreign exchange traders and financial journalists in Frankfurt, London, Vienna and Zurich.
Foreign Exchange traders confirm that, out of the both forecasting approaches, technical analysis is more prominent than the other. But the Financial journalists put more emphasis on fundamental analysis than foreign exchange traders. Also the reviews from the study do not throw light on the complementarities of the two tools. Another gap exist that there may be difference of opinion with fundamental and technical analysis when investing for long term and short term investment which is not examined in previous studies.
Future earnings are a key its expected 12 month growth rate. A relatively price. In this case, the lower the number the less you higher than what the company's asset would be sold for pay for each unit of future earnings growth.
So, even a stock today. The company has the choice of paying out all of of 8. This could prove to be an expensive investment. However, it is usually expected One of the ways you define value is market capitalization or that a good company regularly pay a consistent dividend to how much money would you need to download every single share the investors.
It is assets and dividing the result by the number of shares essential to check if the dividends were paid from the current outstanding. A company which is subject to interpretation. Growing companies will typically expected to perform well would have a share price higher retain more profits to fund growth and pay lower or no than its NAV per share.
A struggling firm will trade at a dividends whereas, the company with flat growth or the discount to NAV; implying that shareholders are pessimistic company having no profitable project at hand may distribute about the future of the company and have started to sell all or most of its profits as dividend to the shareholders. But, in case of mutual funds and investment funds, the 8. Dividend Yield: Investors can normally The dividend yield is the yield that a company pays out to its find the net asset value in the balance sheet.
You can also shareholders in the form of dividends. It is a financial ratio find it in DSE website or its publications. It can be calculated as the stock. But stocks having relatively higher yields. High dividends are this does not always hold true.
Investors should consider the attractive but they are a representation of past payouts. We should keep fluctuating share prices. However, matured, well-established in mind that shareholding pattern in isolation is not sufficient companies that have already grown significantly, tend to enough to take any investment decision.
You must have to have higher dividend yield, while the young, growth-oriented consider other factors along with shareholding pattern. Now the Now the time for analysis: You will find most Perhaps, the shareholders are more concerned with capital of those data in ready form from DSE website, DSE gains rather than the dividend they will receive. If it is troublesome to 9. India went through a terrible recession for 4 years from The Investment Decision Investors should attempt to determine the stage of the economic cycle the country is in.
They should invest at the end of a depression when the economy begins to recover, and at the end of a recession. Investors should disinvest either just before or during the boom, or, at the worst, just after the boom.
Investment and disinvestment made at these times will earn the investor the greatest benefits. It must however be noted that there is no rule or law that states that a recession would last a certain number of years, or that a boom would be for a definite period of time.
Hence the length of previous cycles should not be used as a measure to forecast the length of an existing cycle. An investor should also be aware that government policy or other events can reverse a stage and it is therefore imperative that investors analyze the impact of government and political decisions on the economy before making the final investment decision.
It occurs when there is a lot of money in the system, interest rates are relatively low, credit is easy, unemployment is low. It occurs at a time when economic confidence is high.
Asset bubbles can affect many assets, including commodities, real estate and stocks. At the time of a bubble, there is usually euphoria and a widespread sense of excitement. Price rises are justified by reasoning and the expectation of further increases in price. After several years of a depressed market, prices begin to rise in the wake of an economic boom.
Such a relentless price rise was witnessed in the Indian stock markets through and , finally culminating on 8 January when the Bombay Stock Exchange Sensitivity Index Sensex soared to a high of 21, At the time, the euphoria was so great that there were predictions that the Sensex would soar to 50, by June Real estate prices, too, rose in tandem.
Credit was easy. Interest rates were relatively low. There was jubilation in the air. Bubbles burst. When the euphoria becomes unsustainable a crash is inevitable.
In the third week of January , the Sensex witnessed great falls. On 21 January , the Sensex fell by 1, points. Later, it went into a free fall, falling month on month to close below 9, in November Other assets too fell in sync as demand petered out in the face of an economic depression. There was a similar burst of an asset bubble after the Harshad Mehta scam in and in In stock markets, an asset bubble is an extended period of extreme overvaluation.
Bubbles occur when there is excessive speculation. As opposed to viewing the intrinsic value of a share based on fundamental analysis , speculators focus on its resale value. An asset is bought in the expectation that it would double or triple in a relatively short time.
Rumours fly. Examples are cited of investors who have made huge killings.
Economic data and sensible thought are abandoned for greed. Herd mentality takes over and the mass follow the leader — the bull — without thought or reasoning. In bubbles, it is of no consequence that the price is irrationally high. It only matters that it can be sold for an even higher irrational price at a later date.
As happened to the Sensex, bubbles end with steep declines, where most of the speculative gains are quickly wiped out. The problem is that it is hard to tell a bubble until it bursts. When central or other regulatory bodies intervene, it brings about what it was intended to prevent — a free fall. There are two types of bubbles. The first type of asset bubble is created by banks or brokerage houses. They pump up the price of an asset. The assets can be shares, currencies or other financial instruments.
In the second type of bubble, avaricious and susceptible investors are lured into investment swindles by the promise of impossibly high profits and interest payments.
In India, the late s and early s witnessed many initial public offerings IPOs of investment and other companies which hinted at huge returns and ensnared gullible investors. When a bubble lasts, a whole host of pundits, analysts and schools try and justify it. I recollect during the Harshad Mehta led boom, pundits justifying it by stating Indian stocks were greatly undervalued and that they had nowhere to go but up.
During the boom of , the bubble was justified by saying that the potential of Indian companies was unimaginable — India is the glowing star and the economy is going to grow even faster, went the refrain.
They insisted that productivity had surged and established a steeper but sustainable, trend line. I remember an argument with regard to the valuation of ACC in the early s. The gurus argued that the company should not be valued on the basis of its fundamentals but on what it would cost to build a similar company. The trouble is that these learned people sound authoritative and so sure of themselves that individual investors believe them.
If you cannot understand the reason for the rise in the prices of stocks; if the reason for growth is speculative; if everyone including your maids and taxi drivers are talking of shares, then it would be wise to sell your holdings.
I remember in late , a friend wondering when the boom would end and another replying that it would not happen in the foreseeable future. He said it so forcefully that a couple of others sought tips from this individual and bought shares. Also, you must not get carried away by television interviews and newspaper reports. You should remember that these authorities are usually as clueless as you are. If they could actually see the future so clearly, would they be sharing their knowledge with you?
He would have liked to believe, as these people believed, in the eternal upswing of the big bull market or else to meet just one person with whom he might discuss some general doubts without being regarded as an imbecile or a person of deliberately evil intent — some kind of anarchist, perhaps.
Newspapers even misled people. Investments made on hearsay as opposed to those made on the basis of fundamental analysis are doomed from the start.
It is shortsighted to download a share whose intrinsic value is Rs. Its intrinsic fundamental value is what it should be downloadd at. If its market price is below Rs. One bubble burst in The next bubble may not be far away. You must always beware of this possibility. Previously, investors downloadd shares of companies without concerning themselves about the industry it operated in.
And they could get away with it three decades ago. Those happy days are over. Now, there is intense competition. Consumers have now become quality, cost and fashion conscious.
Foreign goods are easily available and Indian goods have to compete with these. If not months.
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In the late s and early s, movie cameras and projectors were prized possessions. With the advent of the video camera in the mid 80s they became obsolete. Everyone raved about the invention and how technology could compress a huge computer into such a small box. These early models did not have a hard disk but two fixed disk drives. A few months later hard disks were incorporated, initially having a capacity of 20 megabytes. The memory was then increased to 40 megabytes.
In eighteen months, the laptop became obsolete with the creation of the notebook. These notebooks, some having a capacity of as much as megabytes, are still not the last word in compressed computing. The palm tops have now arrived. Mobile phones today have computing capabilities. One really and honestly does not know what will be next. I have used these examples to illustrate how technological advances make a highly regarded product obsolete.
In the same way, technological advances in one industry can affect another industry. The jute industry went into decline when alternate and cheaper packing materials began to be used. The popularity of cotton clothes in the West affected the manmade synthetic textile industry.
An investor must therefore examine the industry in which a company operates because this can have a tremendous effect on its results, and even its existence. However, the company may not have diversified and the industry within which it operates may be in a depression. This can result in a tremendous decline in revenues and even threaten the viability of the company. Cycle The first step in industry analysis is to determine the cycle it is in, or the stage of maturity of the industry.
All industries evolve through the following stages: 1. Entrepreneurial, sunrise or nascent stage, Expansion or growth stage, Stabilization, stagnation or maturity stage, and Decline or sunset stage. The Entrepreneurial or Nascent Stag e At the first stage, the industry is new and it can take some time for it to properly establish itself.
In these early days, it may actually make losses. At this time there may also not be many companies in the industry. It must be noted that the first 5 to 10 years are the most critical period.
At this time, companies have the greatest chance of failing. It takes time to establish companies and new products.
Key Concepts in Fundamental Analysis for Forex Traders
There may be losses and the need for large injections of capital. If a company or an industry is not nurtured or husbanded at this stage, it can collapse. A good journalist I know began a business magazine.
His intention was to start a magazine edited by journalists without interference from industrial magnates or politicians.
It was an exceptionally readable magazine. However, it did not have the finance needed in those critical initial years to keep it afloat and had to fold up. Had it, at that time, had the finance it needed it may have survived and thrived. In short, at this stage investors take a high risk in the hope of great reward should the product succeed. The Expansion or Growth Stage Once the industry has established itself it enters a growth stage. As the industry grows, many new companies enter the industry.
At this stage, investors can get high reward at low risk since demand outstrips supply. In , a good example was the Indian software industry. In , the BPO industry is arguably in the growth stage.
The mobile phone industry is also in the growth stage — with newer models and newer entrants. The growth stage also witnesses product improvements by companies that have survived the first stage.
In fact, such companies are often able to even lower their prices. Investors are more keen to invest at this time as companies would have demonstrated their ability to survive. The Stabilization or Maturity Stag e After the halycon days of growth, an industry matures and stabilizes. Rewards are low and so too is the risk. Growth is moderate. Though sales may increase, they do so at a slower rate than before. Products are more standardized and less innovative and there are several competitors.
The refrigerator industry in India is a mature industry. Growth is slow. It is for the time seeing safe. Investors can invest in these industries for comfort and average returns. They must be aware though that should there be a downturn in the economy and a fall in consumer demand, growth and returns can be negative. The Decline or Sunset Stag e Finally, the industry declines. This occurs when its products are no longer popular.
This may be on account of several factors such as a change in social habits the film and video industry, for example, has suffered on account of cable and satellite television , changes in laws, and increase in prices. The risk at this time is high but the returns are low, even negative. The various stages can be likened to the four stages in the life cycle of a human being — childhood, adulthood, middle age and old age.
Investors should begin to download shares when an industry is at the end of the entrepreneurial or nascent stage and during its growth stage, and should begin to disinvest when at its mature stage.
The Industry vis-a-vis the Economy Investors must ascertain how an industry reacts to changes in the economy. Some industries do not perform well during a recession, others exhibit less buoyancy during a boom. On the other hand, certain industries are unaffected in a depression or a boom.
What are the major classifications? Industries that are generally unaffected during economic changes are the evergreen industries. These are industries that produce goods individuals need, like the food or agro-based industries dairy products, etc. Then there are the volatile cyclical industries which do extremely well when the economy is doing well and do badly when depression sets in. The prime examples are durable goods, consumer goods such as textiles and shipping.
During hard times individuals postpone the download of consumer goods until better days. Interest sensitive industries are those that are affected by interest rates. When interest rates are high, industries such as real estate and banking fare poorly. Growth industries are those whose growth is higher than other industries and growth occurs even though the economy may be suffering a setback. What should investors do?
Investors should determine how an industry is affected by changes in the economy and movements in interest rates. If the economy is moving towards a recession, investors should disinvest their holdings in cyclical industries and switch to growth or evergreen industries. If interest rates are likely to fall, investors should consider investment in real estate or construction companies.
If, on the other hand, the economy is on the upturn, investment in consumer and durable goods industries are likely to be profitable. Competition Another factor that one must consider is the level of competition among various companies in an industry.
Competition within an industry initially leads to efficiency, product improvements and innovation. As competition increases even more, cut throat price wars set in resulting in lower margins, smaller profits and, finally, some companies begin to make losses. The more inefficient companies even close down. To properly understand this phenomenon, it is to be appreciated that if the return is high, newcomers will invest in the industry and there will be an inflow of funds.
Existing companies may also increase their capacity. However, if the returns are low, or lower than that which can be obtained elsewhere, the reverse will occur.
Mastering Fundamental Analysis
Funds will not be invested and there will be an outflow. In short high returns attract competition and vice versa. However, competition in the form of new companies do not bacterially multiply just because the returns are high. There are competitive forces and it is these competitive forces determine the extent of the inflow of funds, the return on investment and the ability of companies to sustain these returns.
These competitive forces are: barriers to entry, the threat of substitution, bargaining power of the downloaders, bargaining power of the suppliers, and the rivalry among competitors. Barriers to Entry New entrants increase the capacity in an industry and the inflow of funds.
The question that arises is how easy is it to enter an industry? There are some barriers to entry: 1.
Economies of Scale: In some industries it may not be economical to set up small capacities. This is especially true if comparatively large units are already in existence producing a vast quantity. The products produced by such established giants will be markedly cheaper. Product Differentiation: A company whose products have product differentiation has greater staying power. The product differentiation may be because of its name or because of the quality of its products — Mercedes Benz cars; National VCRs or Reebok shoes.
People are prepared to pay more for the product and consequently the products are at a premium. It is safe usually to invest in such companies as there will 3. Capital Requirement: Easy entry industries require little capital and technological expertise.
As a consequence, there are a multitude of competitors, intense competition, low margins and high costs. On the other hand, capital intensive industries with a large capital base and high fixed cost structure have few competitors as entry is difficult.
The automobile industry is a prime example of such an industry. Its high fixed costs have to be serviced and a fall in sales can result in a more than proportionate fall in profits. Large investments and a big capital base will be barriers to entry. This may include employee retraining costs, cost of equipment and the likes. If the switching costs are high, new entrants have to offer a tremendous improvement for the downloader to switch.
A prime example is computers. A company may be using a honeywell computer. If it wishes to change to an IBM computer, all the terminals, the unit and even the software would have to be changed.
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Access to Distribution Channels: Difficulty in securing access to distribution channels can be a barrier to entry, especially if existing firms already have strong and established channels. Cost Disadvantages Independent of Scale: This barrier occurs when established firms have advantages new entrants cannot replicate.
These include: Proprietary product technology; Favourable access to raw materials; Government subsidies; Long learning curves. A prime example is Coca Cola. The company has proprietary product technology. Similar cold drinks are available but it is not easy for a competitor to compete with it. Government Policy: Government policy can limit fresh entrants to an industry, usually by not issuing licenses. Till about the mids, the Indian motor car industry was the monopoly of two companies. Even though others sought licenses these were not given.
Expected Retaliation: The expected retaliation by existing competitors can also be a barrier to potential entrants, especially if existing competitors aggressively try to keep the new entrants out.
Cost of Capacity Additions: If the cost of capacity additions are high, there will be fewer competitors entering the industry. International Cartels: There may be international cartels that make it unprofitable for new entrants. The Threat of Substitution New inventions are always taking place and new and better products replace existing ones.
An industry that can be replaced by substitutes or is threatened by substitutes is normally an industry one must be careful of investing in. An industry where this occurs constantly is the packaging industry — bottles replaced by cans; cans replaced by plastic bottles, and the like.
To ward off the threat of substitution, companies often have to spend large sums of money in advertising and promotion. The industries that have to worry most are those where the substitutes are either cheaper or better, or are produced by industries earning high profits.
It should be noted that substitutes limit the potential returns of a company. Barg aining Power of the downloaders In an industry where downloaders have control, i. The factors one should check are whether: A particular downloader downloads most of the products large download volumes. If such downloaders withdraw their patronage, they can destroy an industry.
They can also force prices down. downloaders can play one company against another to bring prices down. This is especially true if the switching costs for downloaders are low. If downloaders have achieved partial backward integration, sellers face a threat as they may become fully integrated.
If downloaders are well informed about trends and details they are in a better position vis-a-vis sellers as they can ensure they do not pay more than they need to.
In short, an industry that is dictated by downloaders is usually weak and its profitability is under constant threat. Barg aining Power of the Suppliers An industry unduly controlled by its suppliers is also under threat.
This occurs when: The suppliers have a monopoly, or if there are few suppliers. Suppliers control an essential item. Demand for the product exceeds supply. The supplier supplies to various companies. The switching costs are high. The downloader is not important to the supplier. Rivalry Among Competitors Rivalry among competitors can cause an industry great harm.
This occurs mainly by price cuts, heavy advertising, additional high cost services or offers, and the like. This rivalry occurs mainly when: There are many competitors and supply exceeds demand. Companies resort to price cuts and advertise heavily in order to attract customers for their goods.
The industry growth is slow and companies are competing with each other for a greater market share. The economy is in a recession and companies cut the price of their products and offer better service to stimulate demand.
There is a lack of differentiation between the product of one company and that of another. In such cases, the downloader makes his choice on the basis of price or service. In some industries economies of scale will necessitate large additions to existing capacities in a company. The increase in production could result in over capacity and price cutting. Competitors may have very different strategies in selling their goods and in competing they may be continuously trying to stay ahead of the other by price cuts or improved service.
Rivalry increases if the stakes profits are high. Firms will compete with one other intensely if the costs of exit are great, i. In such a situation, companies would prefer remaining in business even if margins are low and little or no profits are being made. Companies also tend to remain in business at low margins if there are strategic interrelationships between the company and others in the group; due to government restrictions the government may not allow a company to close down ; or in case the management does not wish to close down the company out of pride or employee commitment.
If exit barriers are high, excess capacity can not be shut down and companies lose their competitive edges; profitability is eroded. If exit barriers are high the return is low but risky. If exit barriers are low the return is low but stable. On the other hand, if entry barriers are low the returns are high but stable.
High entry barriers have high, risky returns. Entry Barriers Exit Barriers Chart 5. Invest in an industry at the growth stage. The faster the growth of a company or industry, the better. Indian software industry, for example, was growing at a rate of more than 50 per cent per annum at the dawn of the new millennium. It is safer to invest in industries that are not subject to governmental controls and are globally competitive. Cyclical industries should be avoided if possible unless one is investing in them at the time the industry is prospering.
Export oriented industries are presently in a favourable position due to various incentives and government encouragement. On the other hand, import substitution companies are presently not doing very well due to relaxations and lower duties on imports. It is important to check whether an industry is right for investment at a particular time. There are sunrise and sunset industries. There are capital intensive and labour intensive industries.
Each industry goes through a life cycle.
Investments should be at the growth stage of an industry and disinvestment at the maturity or stagnation stage before decline sets in. Part Three Company Analysis At the final stage of fundamental analyses, the investor analysis the company.
This analysis has two thrusts: How has the company performed vis-a-vis other similar companies; and How has the company performed in comparison to earlier years? What does one look at when analysing a company?In contrast, technical analysis involves company shares to download only on the basis of earning. Journal of International Financial Management Accounting. Ten technical analysts can examine the same chart and have differing opinions of how and when the price will move.
On the other hand, in the emerging financial markets, we find that it is difficult to use both DDM, and DCFM, because of the difficulty in calculating the Terminal Value VT for future periods extending to the next three years Subramanyam and Venkatachalam, , so the best models to predict stock prices in those markets, are the models that rely on financial ratios e. This money could have been spent elsewhere for the development of the country.
The various stages can be likened to the four stages in the life cycle of a human being — childhood, adulthood, middle age and old age. Competition within an industry initially leads to efficiency, product improvements and innovation.
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