Fundamental Analysis

Security Analysis
Security Analysis is the Evaluation & Assessment of Stocks/Securities to
determine their Investment Potential.
It involves analyzing various factors, such as financial statements,
industry trends, market conditions, and company-specific information, to
make informed investment decisions.
• There are Two Primary Approaches to security analysis, Fundamental
Analysis and Technical Analysis.
Introduction
• Benjamin Graham is the father of ‘fundamental analysis’. He
introduced the term in 1928. He observed that a stock’s value and
its price in the market was different.
• Fundamental analysis is a method of evaluating the intrinsic value
of a stock.
• Fundamental analysis is a systematic approach used to find a stock’s
intrinsic value.
• Fundamental analysis is a way to avoid short-term information
about a company/stock.
• In accounting and finance, fundamental analysis is a method of
assessing the intrinsic value of a security by analyzing various
macroeconomic and microeconomic factors.
How does it include?
This form of analysis combines external events and influences, as well as
financial statements and industry trends. It is done using qualitative and
quantitative factors.
 • Qualitative factors are quality of management, corporate
governance etc.
• Quantitative factors include studying company’s profits, losses, cash
flows etc
Fundamental analysis uses three sets of data. One, historical data is used
to know things were earlier. Two, publicly known information about the
company including announcements made by the management, and what
others are saying about the company. Three, information that is not known
publicly but is useful i.e. instances of how management handles crises,
situations etc.

What is intrinsic value

Intrinsic value of a company is simply its total assets minus total
liabilities.
Let us understand the same concept to shares with an example .
The share price of Tata Consultancy Services Ltd (TCS) is Rs 3,100. You
believe the stock will do well in the future. But feel the current prices are
a bit ‘over’ valued. So, you wait for a fall to buy TCS at a discount. The
share price of TCS falls to Rs 2,800 after 1 month. You go ahead and buy
the shares. You think you got a discount of Rs 300. But what if I told you
that the ‘intrinsic value’ of TCS is Rs 2,500. Now, you have paid Rs 300
more for the stock! It is important to known a stock’s intrinsic value to
avoid such situations. It will help you decide whether you are buying
shares at a discount or paying extra.
• If Intrinsic Value is higher than stock price, the stock is undervalued.
• If Intrinsic Value is lower than stock price, the stock is overvalued.
Let’s see the example of undervalued
Stock prices generally revert to their intrinsic value in the long run. In the
above example, suppose TCS is trading at Rs 2,000. Its intrinsic value is
Rs 2,500.
In this case, TCS is undervalued. So, you will buy TCS Ltd at Rs 2,000 as
you expect it to revert to its intrinsic value (Rs 2,500).
If TCS was trading at Rs 3,100 then you will sell it as it will revert to its
intrinsic value (Rs 2,500).

Methods of Fundamental Analysis

• Qualitative
• Quantitative
Qualitative Fundamental Analysis includes studying a company’s: (It
is subjective)
• Quality of management
• Corporate governance
For example: Should a business be managed by promoters or experienced
professionals?
Some investors might think a business is better off being managed by its
promoters and owners as they have built it from the ground up and
understand everything about the business.
Other investors might believe the business is better off being managed by
experts in respective fields. This will help the company take tough
decisions and always be on top of the game.
Same situations, different conclusions. This is why qualitative financial
analysis is not solid science. It changes with every investor. But
investment decisions cannot be made based on emotions.
This is where ‘Quantitative Analysis’ comes into the picture.
Quantitative Fundamental Analysis is a study of a company’s
finances. It involves studying:
• Balance Sheet
• Cash flow statements
• Profit and Loss (P&L) statements.
Quantitative analysis is faced on formulas and ratios. It helps you find
how the company has performed year on year. Whether the revenues are
stable or not. Financial ratios play an important role in fundamental
analysis. There are five types of financial ratios. We will each these ratios
in detail later.
Steps to do fundamental analysis
Fundamental analysis can be performed using two main approaches:
1. Top-Down Approach:

Starting you point: Macro level (Economic Environment)

Process: The analysis initiates with an assessment of broader economic
factors, such as overall economic conditions, industry trends, and market
conditions.
Focus areas:
1. Economic conditions: Understanding the general economic health,
interest rates, inflation, and other macroeconomic indicators.
2. Industry trends: Identifying sectors with growth potential or those
likely to outperform based on industry-specific factors.
3. Market conditions: Analysing the overall market trends, sentiment,
and risk factors.
Narrowing focus: After evaluating these macro factors, the investor
narrows down their focus to specific companies or assets that align with
the identified economic and market trends.
Top down approach involves:
1. Economy Analysis
2. Industry Analysis
3. Company Analysis
2. Bottom-up approach:
Starting point: Micro level (Individual Companies)
Process: The analysis begins with a detailed examination of individual
companies or assets, independent of broader economic considerations.
Focus areas:

1. Financial statements: Scrutinising financial statements to

assess revenue, profit margins, debt levels, and other financial
metrics.
2. Competitive position: Evaluating the company’s market share,
competitive advantages, and overall position within the
industry.
3. Management quality: Assessing the effectiveness and
reliability of the company’s leadership and management team.
Broader considerations: Once the specific companies are thoroughly
analysed, investors may then consider broader economic and market
conditions to ensure their chosen investments align with the overall
economic landscape.
Three pillars of fundamental Analysis
Which is also called as components of fundamental Analysis
Economy/Economic analysis
Every company functions in an environment which shapes its future.
This environment influences the stock’s intrinsic value. Hence,
economic analysis is an important part of fundamental analysis.
Economic Analysis is a study of the following factors.
1. Gross Domestic Product (GDP)
2. Inflation
 3. Interest rates
4. Economic & Political Stability
Industry Analysis
What is an industry?
An industry is a combination of companies engaged in similar kinds of
business activities. Industries can be present in various categories like
construction, manufacturing, light, heavy, durable, non-durable, domestic,
and foreign among others. Based on this, automobile companies can be
engaged in manufacturing, heavy and light vehicles, and other categories.

What is industry analysis?

Industry analysis means assessing a market/industry to understand its
competitive dynamics. It helps investors understand a company’s position
compared to its peers. It helps gauge the overall attractiveness of the
industry and the factors that determine a company’s success.
Industry analysis tells what is happening in an industry in terms of
demand-supply, competition within the industry and with other industries,
prospects considering technological changes, and the influence of
macroeconomic factors. All in all, it helps identify opportunities and
threats for a company in the current scenario and future.
This, in turn, gives you cues as to how well a company is positioned
compared to its peers now
Industry analysis is a type of investment research that begins by focusing
on the status of an industry or an industrial sector. A form of fundamental
analysis involving the process of making investment decisions based on
the different stages an industry is at during given point in time. The type
of position taken will depend on firm specific characteristics, as well as
where the industry is at in its life cycle.

Company Analysis
Financial statements: This includes analysing the balance sheet, income
statement, and cash flow statement to assess the financial health and
performance of the company.
• Balance sheet: Provides a snapshot of the company’s assets,
liabilities, and shareholders’ equity at a specific point in time.
• Income statement: Shows the company’s revenues, expenses, and
profits over a period.
• Cash flow statement: Details the cash inflows and outflows from
operating. Investing, and financing activities.
Ratios and metrics: Key financial ratios and metrics are used to gauge
various aspects of a company’s performance and financial health.
• Liquidity ratios: Such as current ratio and quick ratio, which
measure the company’s ability to meet short-term obligations.
• Profitability ratios: Such as net profit margin, return on assets
(ROA), and return on equity (ROE), which evaluate the company’s
ability to generate profit.
• Efficiency ratios: Such as inventory turnover and receivables
turnover, which assess how effectively the company is using its
assets.
• Leverage ratios: Such as debt-to-equity ratio and interest coverage
ratio, which measure the company’s use of debt to finance its
operations.
 • Valuation ratios: Such as price-to- earnings (P/E) ratio, price-to-
book (P/B) ratio, and dividend yield, which help in assessing
whether a stock is overvalued or undervalued.
Growth analysis: Evaluating past growth trends in revenue, earnings, and
cash flows, and estimating future growth potential.
Management quality: Assessing the competence, experience, and track
record of the company’s management team, as well as their strategy and
vision for the company’s future.
Competitive position: Analysing the company’s competitive
advantages, market share, and unique value proposition.

Economy/Economic analysis
Every company functions in an environment which shapes its future. This
environment influences the stock’s intrinsic value. Hence, economic
analysis is an important part of fundamental analysis.

ECONOMIC ANALYSIS:
The state of the economy determines the growth of gross domestic
product. And investment opportunities. An economy with favourable
savings, investments, stable prices, balance of payments, and
infrastructure facilities 216,00,000 provides a best environment for
common stock investment.

If the company grows rapidly, the industry can also be expected to show
rapidly growth and vice versa. When the level of economic activity is low,
stock prices are low, and when the level of economic activity is high, stock
prices are high reflecting the prosperous outlook for sales and profits of
the firms. The analysis of macro economic environment is essential to
understand the behaviour of the stock prices. The commonly analyzed
macro economic factors are as follows:

Gross domestic product (GDP): GDP represents the aggregate value of

goods and services produced in the economy. It consists of personal
consumption expenditure, gross private domestic investment and
government expenditure on goods & services and net export of goods &
services. It indicates rate of growth of economy. The estimate on GDP
available on annual basis.

Business cycle:
Business cycles refer to cyclical movement in the economic activity in a
country as a whole. An economy marching towards prosperity passes
through different phases, each known as a component of a business cycle.
These phases are:
• Depression: Demand level in the economy is very low. Interest rates
and Inflation rates are high. These affect profitability and dividend
pay out and reinvestment activities.
• Recovery: Demand level starts picking up. Fresh investment by
corporate firms shows increasing trend.
• Boom: After a consistent recovery for a number of years, the
economy starts showing signs of boom which is characterized by
high level of economic activities such as demand, production and
profits.
 • Recession: The boom period is generally not able to sustain for a
long period. It slows down and results in the recession.

Savings & investment:

The growth requires investment which in turn requires substantial amount
of domestic savings. Stock market is a channel through which the savings
of investors are made available to the corporate bodies. Savings are
distributed over various assets like equity shares, deposits, mutual fund
unit, real estate and bullion. The saving and investment pattern of the
public effect the stock to great extent.

Inflation:
The inflation is raise in price, where its rate increases, than the real rate of
growth would be very little. The demand is the consumer product industry
is significantly affected. The industry which comes under the government
price control policy may lose the market. If the mild level of inflation, it
is good to the stock market but high rate of inflation is harmful to the stock
market.

Interest rates:
The interest rate affects the cost of financing to the firms. Higher interest
rates increase the cost of funds and lower interest rates reduce the cost of
funds resulting in higher profit. There are several reasons for change in
interest rates such as monetary policy, fiscal policy, inflation rate, etc,

Monetary Policy; Money supply and Liquidity:

The liquidity in the economy depends upon the money supply which is
regulated by the monetary policy of the government. RBI regulate the
money supply and liquidity in the economy. Business firms require funds
for expansion projects. The capacity to raise funds from the market is
affected by the liquidity position in the economy. The monetary policy is
designed with an objective to maintain a balance in liquidity position.
Neither the excess liquidity nor the shortage are desirable. The shortage
of liquidity will tend to increase the interest rates while the excess will
result in inflation.

Budget:
The budget draft provides an elaborate account of the government
revenues and expenditures. A deficit budget may lead to high rate of
inflation and adversely affect the cost of production. Surplus budget may
result in deflation. Hence, balanced budget is highly favourable to the
stock market.

Tax structure:
Every year in March, the business community eagerly awaits the
Government’s announcement regarding the tax policy. Concessions and
incentives given to the certain industry encourage investment in particular
industry. Tax relief given to savings encourages savings. The minimum
alternative tax (MAT) levied by finance minister in 1996 adversely
affected the stock market. Ten years of tax holiday for all industries to be
set up in the northeast is provided in the 1999 budget. The type of tax
exemption has impact on the profitability of the industries.
Monsoon and agriculture:
Agriculture is directly and indirectly linked with the industries. For
example, sugar, cotton, textile and food processing industries depend
upon agriculture for raw material. Fertilizer and insectide industries are
supplying inputs to agriculture. A good monsoon leads to higher demand
for input and results in bumper crop. This would lead to buoyancy in the
stock market. When the monsoon is bad, agricultural and hydro power
production would suffer. They cast a shadow on a share market.

Infrastructure facilities:
Infrastructure facilities are essential for the growth of industrial and
agricultural sector. A wide network of communication system is a must
for the growth of the economy. Good infrastructure facilities affect the
stock market favourably. The government are liberalized its policy
regarding the communication, transport and power sector.

Demographic factors:
The Demographic data provides details about the population by age,
occupation, literacy and geographic location. This is needed to forecast
the demand of customer goods. The population by age indicates the
availability of able work force.

Economic forecasting:

To estimate the stock price changes, an analyst the macro economic

environment and the factor peculiar to industry concerned to it. The
economic activities affect the corporate profits, Investors, attitude and
share prices.

Economic indicators:
The economic indicators are factors that indicate the present status,
progress or slow down of the economy. They are capital investment,
business profits, money supply, GNP, interest rate, unemployment rate,
etc. The economic indicators are grouped into leading, coincidental and
lagging indicators. The indicators are selected on the following criteria
Economic significance, Statistical adequacy, Timing, conformity.

Other factors:
a. Industrial growth rate
b. Fiscal policy of the Government
c. Foreign exchange reserves
d. Growth of infrastructural facilities
e. Global economic scenario and confidence
f. Economic and political stability.

What Is Economic Forecasting?

While it’s impossible to tell the future, economic forecasting can help you
understand what the near future may look like. This process allows
economists to analyze relevant data and make predictions about an
economy’s future. Learning more about the process can help you make
informed decisions at work or in your personal life. In this article, we
explain what economic forecasting is and how businesses use it, discuss
common economic indicators, and outline its advantages and
disadvantages.

What is economic forecasting?

Economic forecasting is a prediction about how the economy is going to
perform in the future. The process can forecast how prosperous different
sectors of the economy may be, such as employment or gross domestic
product (GDP). To make predictions about the future, economists use
historical data and indicators such as inflation and unemployment rates.
Economists also consider potential risks when assessing the future of the
economy, like a fiscal crisis or energy price shock.

Economic indicators
Economists use specific indicators to determine where the economy is
heading.
There are three types: leading, lagging, and coincident. Leading
indicators tell economists more about upcoming changes. Lagging
indicators don’t help economists make predictions about the future, they
confirm the trends or results that other indicators forecasted. Coincident
indicators tell economists more about the present economy to help them
make informed predictions.
Here are some of the most common indicators economists use to predict
the future of the economy:
Gross domestic product (GDP)
GDP is a lagging indicator that economists use to assess the economy’s
health. The number represents the market value of all of a country’s goods
and services during a specific time period, such as the past year or quarter.
Economists use GDP to estimate the economy’s growth rate and compare
it to previous time periods. For example, if the economy’s growth rate was
2% in 2018, 2019, and 2020, economists might assume it will be 2% again
in 2021.

The stock market

The stock market is a leading indicator as economists look at it to
determine which way the economy may go. For example, if it’s a down
market, that indicates that businesses aren’t expecting to earn much in the
upcoming months so the economy could be heading towards a recession.
Many people look to the stock market to forecast the economy, but it’s not
always the most accurate indicator. Earnings estimates are not guaranteed
and stocks are subject to price manipulations that don’t reflect how the
economy is actually doing. Pairing this indicator with another can help
economists produce more accurate results.
Unemployment rate
An economy's unemployment rate is a lagging indicator. The rate
indicates what percentage of a population is unemployed. This is an
economic indicator because if the unemployment rate is low, it typically
means businesses are hiring. If businesses are hiring, they are performing
well, so the economy is likely doing well too. Similarly, if the
unemployment rate is low, employed people are likely to spend more
money, helping the economy.
To calculate an unemployment rate, you can divide the number of
unemployed people over 15 years old by the number of people working.
Then, multiply that number by 100 to get a percentage. For example, if
Toronto had 500,000 workers and 55,000 unemployed people in 2021,
here's what the formula would look like:
55,000 / 500,000 = 0.11 x 100 = 11%
The consumer price index (CPI)
The consumer price index is a lagging indicator that helps economists
measure inflation and cost of living. CPI looks at the price consumers are
paying for goods and services over a specific time period. For example,
an economist may look at the price of gas last year compared to this year
to determine whether the cost of living is increasing or decreasing. If the
cost went up, economists may assume a period of inflation is coming. If
they decreased, it could indicate a period of deflation.
Housing starts
Housing starts are a leading indicator that estimates the number of houses
people are performing construction on in a certain period. The National
Housing Agency assesses housing starts every month and releases the
information to the public. Economists use this information to assess the
current financial condition of the economy. If a lot of people are
renovating their houses, they may have more disposable income than
usual, so the economy is likely doing well.
Interest rate
Interest rates are a lagging indicator that reflects the economy’s current
condition and predicts how it may look in the future. If interest rates are
high, the GDP may not increase, as borrowers are reluctant to take out any
loans. If they’re low, the demand for loans may increase, potentially
causing inflation and distorting the economy.

Advantages of forecasting
There are plenty of advantages to forecasting an economy’s future, such
as the following:
Create insight:
Learn from past mistakes:
Lower costs:
Informed planning:

Disadvantages of forecasting
Not completely accurate:
Time-consuming:
Costly:

Industrial Analysis
What is an industry?
An industry is a combination of companies engaged in similar kinds of
business activities. Industries can be present in various categories like
construction, manufacturing, light, heavy, durable, non-durable, domestic,
and foreign among others. Based on this, automobile companies can be
engaged in manufacturing, heavy and light vehicles, and other categories.
What is industry analysis?
Industry analysis means assessing a market/industry to understand its
competitive dynamics. It helps investors understand a company’s position
compared to its peers. It helps gauge the overall attractiveness of the
industry and the factors that determine a company’s success.
Industry analysis tells what is happening in an industry in terms of
demand-supply, competition within the industry and with other industries,
prospects considering technological changes, and the influence of
macroeconomic factors. All in all, it helps identify opportunities and
threats for a company in the current scenario and future.

This, in turn, gives you cues as to how well a company is positioned

compared to its peers now
Companies belong to an industry. Infosys, Tata Consultancy Services
(TCS) belong to ‘Information Technology’ industry. So which industry
should you invest in? How should you analyse a particular industry? Here
are factors that Investors should consider while analyzing an industry.

1. Demand Supply Gap: The demand for any product grows at a

steady rate. But its production increases with time. At a particular
point, there is an oversupply. Oversupply reduces a product’s
demand which decreases a company’s overall profitability. High
demand and low supply increases the price of the product. This
leads to higher profitability for the business and investors. Ideally
you should invest in companies with marginal demand supply
gap.
2. Competitiveness in the industry: Extreme competition can
bring down a company’s future earning potential. Hence it is
important to invest in companies with ‘economic moat’.
Industries with high moat have high barriers to entry, high cost of
production etc. This keeps competition to a minimum. Example:
Telecom industry has high entry barriers in terms of spectrum
cost, set up costs etc. Similarly FMCG, Pharma, airlines also have
high entry barriers. Whereas clothing industry has relatively low
entry barriers. [Read More: Best Penny Stocks to Buy now in
India]

3. Evergreen Companies: With advancements in technology,

products are getting out of fashion quickly. In 1990s, everyone
owned a Walkman. Today, mobiles have replaced Walkman.
Floppy disks are replaced by cloud storage! Investing in
industries with a high replacement rate is not recommended.
Investors should invest in ‘evergreen companies’. These are
companies whose products will never go out of use. Like FMCG,
Pharma etc.

4. Government Regulations: There are certain industries which

are heavily punished by the government. These include Alcohol,
Cigarette industries etc. ITC, United Breweries Ltd are such
stocks. A change in regulation or taxation can heavily impact such
companies. This can lead to substantial long term loss for
 investors. Hence, investors need to be careful while investing in
such industries.

5. Production Factors: Cost of raw materials and labor is an

important part of industry analysis. An industry with a history of
labor strikes should be avoided. High cost of production is
another key aspect while analyzing an industry. Every product
has a fixed cost and a variable cost. Higher fixed cost = more time
required to break even. Example: Airline Industry Lower fixed
cost = easy to break even. Example: IT Industry Ideally, investors
should invest in companies with lower fixed cost and fewer labor
strikes.

Characteristics of Industry Analysis

Post sales and Earnings performance: The historical
performance of sales and earnings should be given due
consideration, to know how the industry have reacted in the
past. With the knowledge and understanding of the reasons
of the past behaviour, the investor can assess the relative
magnitude of performance in future. The cost structure of an
industry is also an important factor to look into. The higher
the cost component, the higher the sales volume necessary
to achieve the firm’s break-even point, and vice-versa.
Nature of Competition: The top firms in the industry must be
analyzed. The demand of particular product, its profitability
and price of concerned company scrip’s also determine the
nature of competition. The investor should analyze the scrip
and should compare it with other companies. If too many
firms are present in the industry, this will lead to a decline
in price of the product.

Raw Material and Inputs: We need to have a look on

industries which are dependent on raw material. An industry
which has limited supply of raw material will have a less
growth. Labor in also an input and problems with labor will
also lead to growth difficulties.

Attitude of Government towards Industry: The government

policy with regard to granting of clearance, installed capacity
and reservation of the products for small industry etc. are
also factors to be considered for industry analysis.

Management: An industry with many problems may be well

managed, if the promoters and the management are efficient.
The management has to be assessed in terms of their
capabilities, popularity, honesty and integrity. A good
management also ensures that the future expansion plans
are put on sound basis.

Labor Conditions and Other Industrial Problems: The

industries which depend on labor, the possibility of strike
looms as an important factor to be reckoned with. Certain
industries with problems of marketing like high storage costs,
high transport costs etc leads to poor growth potential and
investors have to careful in investing in such companies.

Nature of Product Line: The position of industry in the

different stages of the life cycle is to be noted. And the
importance attached by planning commission on these
industries assessment is to be studied.

Capacity Installed and Utilized: If the demand is rising as

expected and market is good for the products, the utilization
of capacity will be higher, leading to bright prospects and
higher profitability. If the quality of the product is poor,
competition is high and there are other constraints to the
availability of inputs and there are labor problems, then the
capacity utilization will be low and profitability will be poor.
Industry Share Price Relative to Industry Earnings: While
making investment the current price of securities in the
industry, their risk and returns they promise is considered. If
the price is very high relative to future earnings growth, the
investment in these securities is not wise. Conversely, if
future prospects are dim but prices are low relative to fairly
level future patterns of earnings, the stocks in this industry
might be an attractive investment.

Research and Development: The proper research and

development activities help in increasing economy of an
industry and so while investing in an industry, the expenditure
should also be considered.

Pollution Standards: These are very high and restricted in

the industrial sector. These differ from industry to industry,
for example, in leather, chemical and pharmaceutical
industries the industrial effluents are more.

Company analysis