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Fundamental analysis is a method of valuing securities an investor wishes to buy

It is an attempt to estimate the real worth of a security considering the earnings

potential of a company

The earnings potential depends on investment environmental factors and the real

worth of a security depends on the competitiveness, quality of management,

operational efficiency, profitability, capital structure and dividend policy

It is used to establish a true, intrinsic value of a security

The intrinsic value can be justified by the facts such as assets, earnings, dividends,

and prospects of the company

It is also measured as the present value of all future cash inflows on the security


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This value may be different from the current market price due to temporary market

conditions

Thus, determining the intrinsic value may assist an investor to buy undervalued

securities and sell overvalued securities

This analysis is based on the assumption that the stock price of the company

depends on its capacity to generate income and on various other factors

The total analysis of the investment environment can be grouped into the following

three types:-

Economic Analysis

Industry Analysis

Company Analysis


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The economic analysis involves an examination of fiscal and monetary policies

Economic activity in the country is influenced by domestic and international factors

In a globalised business environment, the national economy is greatly impacted by the

functioning of the global economy

In macro-economic analysis, the following are some of the key economic indicators used

to describe the state of macro economy:

GDP Growth Rate

Inflation indices

Savings and Investments

Foreign Investment Policy

Political Stability


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Industry analysis is the study of industries which are on the upswing or growing stage

The recent examples of such industries are petrochemicals, bio technology capital

goods industry, etc.

Its objective is to assess the prospects of various industrial groupings

A careful analysis can suggest which industries have a brighter future than others and

which industries are plagued with problems


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Pioneering stage

Rapid growth stage

Maturity and stabilization stage

Decline stage


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The basic objective of this analysis is to find competitively well placed companies

within a given industry

These companies are likely to perform better than the peers in the industry

This analysis consists of the following steps:-

Analysis of Management

Analysis of Competitive Strategies of the company

Analysis of company with respect to key factors for the company

Financial Analysis

SWOT Analysis


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Industry Analysis Company Analysis

Industry analysis focuses on the industry

itself not on the business

Company analysis focuses on internal

analysis of the company

Industry analysis is based on external

factors

Company analysis is based on internal

factors of a business

It often deals with analyzing a task

environment

In company analysis, one deals with inside

strengths. weaknesses, opportunities and

threats of the business


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Liquidity Ratios

Liquidity means the ability of the firm to meet its obligations in the short run

Liquidity ratios measure the ability of the firm to meet its current obligations and

indicate its short term financial stability

The liquid ratio is designed to show the amount of cash available for meeting

immediate payments

Liquidity ratios are generally based on current assets and current liabilities

The important liquidity ratios are:

Current Ratio

Liquid Ratio


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a) Current Ratio

= Current Assets

Current Liabilities

b) Liquid Ratio

= Quick Assets

Quick Liabilities


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Profitability Ratios

Profitability is the final result of business operations

Every business organization has to earn profit in order to survive and grow

Therefore it is necessary to know whether it is earning adequate profits or no

The following are the profitability ratios:

Gross Profit Ratio

Net Profit Ratio

Return on capital employed

Return on shareholders funds/Proprietary fund

Operating Profit to Sales Ratio


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a) Gross Profit Ratio

= Gross Profit x 100

Net Sales

b) Net Profit Ratio

= Net Profit x 100

Net Sales

c) Return on capital employed

= (NPBT + Interest Charges) x 100

Capital Employed

d) Return on shareholders funds/Proprietary fund

= NPAT x 100

Shareholders funds

e) Operating Profit to Sales Ratio

= Operating Profit x 100

Net Sales


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Solvency Ratios

Solvency of a firm is indicated by its ability to meet its immediate commitments

Whether the firm is solvent or otherwise, is determined by adequacy of its quick

assets as compared to its immediate liabilities

The solvency ratios are sub-set of other financial ratios

The following ratios are used to judge the solvency of a firm:

Proprietary Ratio

Debt Equity Ratio


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a) Proprietary Ratio

= Net Worth

Total Assets

b) Debt-Equity Ratio

= Total Debt

Equity

c) Interest Coverage Ratios

= PBIT

Interest On Debt


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Leverage Ratios

Leverage is an ability of a company to use fixed cost assets or funds to magnify the

return to its owners

The leverage ratios are useful as an analytical tools for creditors, financial institutions

and debenture holders

They are a measure of the extent to which company finances its assets through debt

and are the indicators of the financial risk

Leverage ratio includes:

Shareholders equity to total capital

Funded debt to net working capital


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a) Shareholders Equity to Total Capital

= Equity Capital + Reserves

Fixed Assets + Working Capital

b) Funded Debt to Net Working Capital

= Funded Debt.

Net Working Capital


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Efficiency Ratios

Efficiency ratios are useful for measuring the companys managerial efforts in

managing inventories, production process, credit and effectiveness of marketing and

sales force

These are useful in judging the overall performance of the company

These ratios indicate the managerial capabilities in effectively utilizing the assets of

the company

The following are the important efficiency ratios:

Average Collection Period

Stock Turnover

Total Assets Turnover

Net Working Capital Turnover


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a) Average Collection Period

= Receivables x 360

Net Sales

a) Stock Turnover

= Cost of Goods Sold

Average Stock

a) Total Assets Turnover

= Net Sales .

Total Assets

a) Net Working Capital Turnover

= Net Sales .

Net Working Capital


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Ratios relating to Equity Shareholders/Stock Market

These ratios are of primary interest to the companys shareholders.

a) Earnings Per Share (E.P.S)

= NPAT Preference Dividend

Number of Equity Shares

b) Dividend Per Share (D.P.S)

= Total Equity Dividend


c) Dividend Yield

= Dividend per Share x 100

Market Price per Share


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d) Book Value per Share

= Equity Share Capital + Reserves & Surplus


e) Price Earning Ratio (P/E Ratio)

= Market Price Per Share

Earnings Per Share

f) Capital Gearing Ratio

= Preference Capital + Debentures + Term Loans

Equity Share Capital + Reserves


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Technical Analysis Fundamental Analysis

It mainly seeks to predict short-term price

movementsIt tries to analyze long-term values

Its focus is mainly on internal market data,

particularly price and volume data

Its focus is mainly on fundamental factors relating

to the economy, the industry and the firm

Technical analysis appeals mostly to short-term

traders

Fundamental analysis appeals primarily to long-

term investors

Technical analyst looks only backward Fundamental analyst looks forward as well asbackward

Technical analyst thinks that stock market

behavior is 10%logical and 90% psychological

Fundamental analyst thinks that stock market

behavior is 90%logical and 10% psychological


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