1. Security Analysis and Portfolio Management
Fundamental Analysis
5/23/2018
Dr.P.S DoMS

2. Fundamental Analysis
Fundamental Analysis is to evaluate a lot information about the past performance and the expected future performance of companies, industries and the economy as a whole before taking the investment decision. Such evaluation or analysis is called fundamental analysis.
5/23/2018
Dr.P.S DoMS

3. Fundamental Analysis (con’t)
Fundamental analysis is really a logical and systematic approach to estimating the future dividends and share price.
Fundamental analysis is performed on historical and present data, but with the goal of making financial forecasts. There are several possible objectives:
To conduct a company stock valuation and predict its probable price evolution,
to make a projection on its business performance,
to evaluate its management and make internal business decisions,
to calculate its risk.
5/23/2018
Dr.P.S DoMS

4. Fundamental analysis includes: Economic analysis Industry analysis
Company analysis
5/23/2018
Dr.P.S DoMS

5. Fundamental Analysis
The Analysis of economy, industry and company constitute the main activity in the fundamental approach to security analysis. And can be viewed as different stages in investment decision making process.
Three tier analysis depict that company performance dependent not only on its own effort but also on the general industry and economy factor.
5/23/2018
Dr.P.S DoMS

6. Economy Analysis
5/23/2018
Dr.P.S DoMS

7. Economy analysis (con’t)
Growth rates of national income(GRNI)
GRNI is an important variable can be calculated by GDP, NNP, and GDP to analysis the growth rate of economy.
Four stages of economy or economic cycle i.e boom, depression, recession, recovery, of nation also impact on security performance.
5/23/2018
Dr.P.S DoMS

8. Depression: At this stage demand is low and declining inflation often high and so are interest rate, companies usually reduce activities and securities performance is poor.
Recovery: Economy begin to revive after depression, demand pick up leading, production and activities increase.
Boom: High demand with high investment and production, companies earn more profit
Recession: Companies slowly begins downturn in demand, production and employment, profits are also decline.
5/23/2018
Dr.P.S DoMS

9. Inflation:
Inflation prevailing significant impact on company performance. High inflation upset company plan. Demand goes down because purchasing power fall, high inflation impact company performance adversely. Inflation is measured both in
WPI (Wholesale price index)
CPI (Consumer price index)
5/23/2018
Dr.P.S DoMS

10. Interest Rate
Interest rates determine the cost and availability of credit for companies operating in an economy.
Low interest rate=> easily and cheaply available credit.
=> lower cost of finance
=> high profitability
High interest rate => higher cost of production
=>lower profitability
=>Lower demand
5/23/2018
Dr.P.S DoMS

11. Government revenue, expenditure and deficit
Government is the largest investor in economy of any country thus revenue, expenditure and deficit have significance impact on the performance of industries and companies.
Expenditure stimulate demand and creates job.
The excess of expenditure over revenue is deficit, (budget deficit), most expenditure are spent on infrastructure, and deficit financing fuel inflation.
5/23/2018
Dr.P.S DoMS

12. Exchange rate
The balance of trade in import and export determine the rate of exchange rate.
Depreciation of local currency improve the competitive position in foreign market the performance of exported product but it would also make the imported product more expensive.
A foreign Exchange reserves is needed to meet several commitments such as payment for import and servicing of foreign depts.
5/23/2018
Dr.P.S DoMS

13. Infrastructure.
Development of a economy depends very much on the infrastructure available. Industry needs electricity for its manufacturing activities road and railways to transport raw material and finished good. Communication channels help supplier and customers.
Good infrastructure is symptoms of development.
Bad infrastructure lead to inefficiencies, low productivity wastages and delay.
Investors should analysis the infrastructure of any economy.
5/23/2018
Dr.P.S DoMS

14. Industry Analysis Classifying industries
Cyclical industry - performance is positively related to economic activity
Defensive industry - performance is insensitive to economic activity
Growth industry - characterized by rapid growth in sales, independent of the business cycle
5/23/2018
Dr.P.S DoMS

15. Industry Analysis Industry Life Cycle Theory:
Birth (heavy R&D, large losses - low revenues)
Growth (building market share and economies of scale)
Mature growth (maximum profitability)
Stabilization (increase in unit sales may be achieved by decreasing prices)
Decline (demand shifts lead to declining sales and profitability - losses)
5/23/2018
Dr.P.S DoMS

16. Industry Analysis Life Cycle of an Industry (Marketing view)
Start-up stage: many new firms; grows rapidly (example: genetic engineering)
Consolidation stage: shakeout period; growth slows (example: video games)
Maturity stage: grows with economy (example: automobile industry)
Decline stage: grows slower than economy (example: railroads)
5/23/2018
Dr.P.S DoMS

17. Industry Analysis Qualitative Issues Competitive Structure
Permanence (probability of product obsolescence)
Vulnerability to external shocks (foreign competition)
Regulatory and tax conditions (adverse changes)
Labor conditions (unionization)
5/23/2018
Dr.P.S DoMS

18. Industry Analysis End use analysis Ratio analysis Regression analysis
identify demand for industry’s products
estimates of future demand
identification of substitutes
Ratio analysis
examining data over time
identifying favorable/unfavorable trends
Regression analysis
determining the relationship between variables
5/23/2018
Dr.P.S DoMS

19. Company Analysis: Qualitative Issues
Sales Revenue (growth)
Profitability (trend)
Product line (turnover, age)
Output rate of new products
Product innovation strategies
R&D budgets
Pricing Strategy
Patents and technology
5/23/2018
Dr.P.S DoMS

20. Company Analysis: Qualitative Issues
Organizational performance
Effective application of company resources
Efficient accomplishment of company goals
Management functions
Planning - setting goals/resources
Organizing - assigning tasks/resources
Leading - motivating achievement
Controlling - monitoring performance
5/23/2018
Dr.P.S DoMS

21. Company Analysis: Qualitative Issues
Evaluating Management Quality
Age and experience of management
Strategic planning
Understanding of the global environment
Adaptability to external changes
Marketing strategy
Track record of the competitive position
Sustainable growth
Public image
Finance Strategy - adequate and appropriate
Employee/union relations
Effectiveness of board of directors
5/23/2018
Dr.P.S DoMS

22. Company Analysis: Quantitative Issues
Operating efficiency
Productivity
Production function
Importance of Q.A.
Understanding a company’s risks
Financial, operating, and business risks
Financial Ratio Analysis
Past financial ratios
With industry, competitors, and
Regression analysis
Forecast Revenues, Expenses, Net Income
Forecast Assets, Liabilities, External Capital Requirements
5/23/2018
Dr.P.S DoMS

23. Company Analysis: Quantitative Issues
Balance Sheet
Snapshot of company’s Assets, Liabilities and Equity.
Income statement
Sales, expenses, and taxes incurred to operate
Earnings per share
Cash flow statement
Sources and Uses of funds
Are financial statements reliable?
G.A.A.P. vs Cleverly Rigged Accounting Ploys
5/23/2018
Dr.P.S DoMS

24. Company Analysis: Quantitative Issues
Financial Ratio Analysis
Liquidity (ability to pay bills)
Debt (financial leverage)
Profitability (cost controls)
Efficiency (asset management)
DuPont Analysis
Top-down analysis of company operations
Objective: increase ROE
5/23/2018
Dr.P.S DoMS

25. Liquidity Ratios Measure ability to pay maturing obligations
Current ratio
Current assets / current liabilities
Quick ratio
(Current assets less inventories) / current liabilities
5/23/2018
Dr.P.S DoMS

26. Debt Ratios
Measure extent to which firm uses debt to finance asset investment (risk attribute)
Debt-equity ratio
Total long-term debt / total equity
Total debt - total assets ratio
(Current liabilities + long-term debt) / total assets
Times interest earned
EBIT / interest charges
Fixed charge coverage ratio
(EBIT + Lease Exp.) / (Int. Exp. + Lease Exp.)
5/23/2018
Dr.P.S DoMS

27. Profitability Ratios Measure profits relative to sales
Gross profit margin ( % ) = Gross profit / sales
Operating Profit Margin = Operating profits / sales
Net profit margin = Net profit after taxes / sales
ROA = Net Profit / Total Assets
ROE = Net Profit / Stockholder Equity*
* Excludes preferred stock balances
5/23/2018
Dr.P.S DoMS

28. Efficiency Ratios Measure effectiveness of asset management
Average collection period (in days)
Average receivables / Sales per day
Inventory turnover (times per year)
Cost of Goods Sold / average inventory
Total asset turnover
Sales / average total assets
Fixed asset turnover
Sales / average net fixed assets
5/23/2018
Dr.P.S DoMS

29. Other Ratios
Earnings per share (EPS): (Net income after taxes – preferred dividends)/ number of shares
Price-earnings (P/E): Price per share/expected EPS
Dividend yield: Indicated annual dividend/price per share
Dividend payout: Dividends per share/EPS
Cash flow per share: (After-tax profits + depreciation and other noncash expenses)/number of shares
Book value per share: Net worth attributable to common shareholders/number of shares
5/23/2018
Dr.P.S DoMS

30. DuPont Analysis of ROE
Ratio 1 = NPM Ratio 2 = TATO Ratio 3 = Equity Kicker
The DuPont System suggests that ROE (which drives stock price) is a function
of cost control, asset management, and debt management.
5/23/2018
Dr.P.S DoMS

31. Estimating Earnings and Fair Market Value for Equity
Five Steps
1. Estimate next year’s sales revenues
2. Estimate next year’s expenses
3. Earnings = Revenue - Expenses
4. Estimate next year’s dividend per share
= Earnings Per Share * dividend payout ratio
5. Estimate the fair market value of stock given next years earnings, dividend, ROE, and growth rate for dividends.
Using Gordon Growth model or P/E Model
5/23/2018
Dr.P.S DoMS