Fundamental Analysis Introduction Fundamental analysis is used to determine the intrinsic value of the share by examining the underlying

forces that affect the well being of the economy, Industry groups and companies. Fundamental analysis is to first analyze the economy, then the Industry and finally individual companies. This is called as top down approach. Figure 1.3.1: The top down approach of fundamental analysis At the economy level, fundamental analysis focus on economic data (such as GDP, Foreign exchange and Inflation etc.) to assess the present and future growth of the economy. At the industry level, fundamental analysis examines the supply and demand forces for the products offered. At the company level, fundamental analysis examines the financial data (such as balance sheet, income statement and cash flow statement etc.), management, business concept and competition. In order to forecast the future share price, fundamental analysts combines the economic, industry and company analysis. If the intrinsic value is lower than the current value, fundamental analysis recommends to buy the share and the vice versa is also true. Economic analysis Economic analysis occupies the first place in the Financial analysis top down approach. When the economy is having sustainable growth, then the industry group (Sectors) and companies will get benefit and grow faster. The analysis of macro economic environment is essential to understand the behavior of the stock prices. The commonly analysed macro economic factors are as follows. Gross domestic product (GDP): GDP indicates the rate of growth of the economy. GDP represents the value of all the goods and services produced by a country in one year. The higher the growth rate is more favorable to the share market. Savings and investment: The economic growth results in substantial amount of domestic savings. Stock market is a channel through which the savings of the investors are made available to the industries. The savings and investment pattern of the public affect stock market. Inflation: Along with the growth of GDP, if the inflation rate also increases, then the real rate of growth would be very little. The decreasing inflation is good for corporate sector. Interest rates: The interest rate affects the cost of financing to the firms. A decrease in interest rate implies lower cost of finance for firms and more profitability. Budget: Budget is the annual financial statement of the government, which deals with expected 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 favorable to the stock market. The tax structure: The tax structure which provides incentives for savings and investments. The balance of payment: The balance of payment is the systematic record of all money transfer between India and the rest of the world. The difference between receipts and payments may be surplus or deficit. If the deficits increases, the rupee may depreciate against other currencies. This would affect the industries, which are dealing with foreign exchange. Monsoon and agriculture: India is primarily an agricultural country. The importance of agricultural in Indian economy is evident. Agriculture is directly and indirectly linked with the industries. For example, Sugar, Textile and Food processing industries depend upon agriculture for raw material. Fertilizer and Tractor industries are supplying input to the agriculture. A good monsoon leads better harvesting; this in turn improves the performance of Indian economy. Infrastructure: Infrastructure facilities are essential for growth of Industrial and agricultural sector. Infrastructure facilities include transport, energy, banking and communication. In India even though Infrastructure facilities have been developed, still they are not adequate. Demographic factors: The demographic data provides details about the population by age, occupation, literacy and geographic location. This is needed to forecast the demand for the consumer goods. Political stability: A stable political system would also be necessary for a good performance of the economy. Political uncertainties and adverse change in government policy affect the industrial growth. The economic factors are explained in detail in the chapter 2. Industry or Sector analysis The second step in the fundamental analysis of securities is Industry analysis. An industry or sector is a group of firms that have similar technological structure of production and produce similar products. These industries are classified according to their reactions to the different phases of the business cycle. They are classified into growth, cyclical, defensive and cyclical growth industry. The industry analysis should take into account the following factors. Characteristics of the industry: When the demand for industrial products is seasonal, their problems may spoil the growth prospects. If it is consumer product, the scale of production and width of the market will determine the selling and advertisement cost. The nature of industry is also an important factor for determining the scale of operation and profitability. Demand and market: If the industry is to have good prospects of profitability, the demand for the product should not be controlled by the government. Government policy: The government policy is announced in the Industrial policy

resolution and subsequent announcements by the government from time to time. The government policy with regard to granting of clearances, installed capacity, price, distribution of the product and reservation of the products for small industry etc are also factors to be considered for industrial analysis. Labour and other industrial problems: The industry has to use labour of different categories and expertise. The productivity of labour as much as the capital efficiency would determine the progress of the industry. If there is a labour problem that industry should be neglected by the investor. Similarly when the industries have the problems of marketing, investors have to be careful when investing in such companies. Management: In case of new industries, investors have to carefully assess the project reports and the assessment of financial institutions in this regard. The capabilities of management will depend upon tax planning, innovation of technology, modernisation etc. A good management will also insure that their shares are well distributed and liquidity of shares is assured. Future prospects: It is essential to have an overall picture of the industry and to study their problems and prospects. After a study of the past, the future prospects of the industry are to be assessed. When the economy expands, the performance of the industries will be better. Similarly when the economy contracts reverse will happen in the Industry. Each Industry is different from the other. Cement Industry is entirely different from Software Industry or Textile Industry in its products and process. The Industry or Sector analysis is explained in more detail in Chapter 3. Company or Corporate analysis Company analysis is a study of variables that influence the future of a firm both qualitatively and quantitatively. It is a method of assessing the competitive position of a firm, its earning and profitability, the efficiency with which it operates, its financial position and its future with respect to earning of its shareholders. The fundamental nature of the analysis is that each share of a company has an intrinsic value which is dependent on the company's financial performance. If the market value of a share is lower than intrinsic value as evaluated by fundamental analysis, then the share is supposed to be undervalued. The basic approach is analysed through the financial statements of an organisation. The company or corporate analysis is to be carried out to get answer for the following two questions. How has the company performed in comparison with the similar company in the same Industry? How has the company performed in comparison to the early years? Before making investment decision, the business plan of the company, management, annual report, financial statements, cash flow and ratios are to be examined for better returns. These are explained in more detail in chapter 4.

Conclusion Fundamental analysis can be used to identify companies that represent good value. Hence it is good for long term investments. Valuation techniques vary depending on the industry group. For this reason, a different techniques or model is required for different industry. This can get quite time consuming and limit the amount of research that can be performed. In fundamental analysis, companies should be compared against other companies in the same sector. For example, a software company (Infosys Technologies) should be compared with a software company (Wipro), not to a bank (ICICI Bank).