Fundamental Analysis - Part-1

-

Question 1.: Can I be a fundamental analyst?

Answer: Of course you can be. It is a common misconception that only chartered accountants and professionals from a commerce background can be good fundamental analysts. This is not true at all. A fundamental analyst just adds 2 and 2 to ensure it sums up to 4. 

To become a fundamental analyst you will need few basic skills:

1. Understanding the basic financial statements

2. Understand businesses with respect to the industry in which it operates

3. Basic arithmetic operations such as addition, subtraction, division, and multiplication

The objective of this article on Fundamental Analysis is to ensure that you gain the first two skill sets.


Question 2.: I am happy with Technical Analysis, so why bother about Fundamental Analysis?

Answer: Technical Analysis helps you gain quick short term returns. It helps you time the market for a better entry and exit. However Technical Analysis is not an effective approach to create wealth. Wealth is created only by making intelligent long term investments. However, both Technical Analysis & Fundamental Analysis must coexist in your market strategy. 


Question 3.: Tools for Fundamental Analysis? 

Answer: The tools required for Fundamental Analysis are extremely basic, most of which are available for free. Specifically you would need the following:

1. Annual report of the company – All the information that you need for Fundamental Analysis is available in the annual report. You can download the annual report from the company’s website for free

2. Industry related data – You will need industry data to see how the company under consideration is performing with respect to the industry. Basic data is available for free, and is usually published in the industry’s association website

3. Access to news – Daily News helps you stay updated on latest developments happening both in the industry and the company you are interested in. A good business news paper or services such as Google Alert can help you stay abreast of the latest news

4. MS Excel – Although not free, MS Excel can be extremely helpful in fundamental calculations


Question 4.: Does investing work?

Answer: 

Think about a sapling – if you give it the right amount of water, manure, and care would it not grow? Of course it will. 

Likewise, think about a good business with healthy sales, great margins, innovative products, and an ethical management. Is it not obvious that the share price of such companies would appreciate? In some situations the price appreciation may delay, but it certainly will always appreciate. This has happened over and over again across markets in the world, including India.

An investment in a good company defined by investable grade attributes will always yield results. However, one has to develop the appetite to digest short term market volatility.


Question 5.: Investible grade attributes? What does that mean?

Answer: 

an investible grade company has a few distinguishable characteristics. These characteristics can be classified under two heads namely the ‘Qualitative aspect’ and the ‘Quantitative aspects’. The process of evaluating a fundamentally strong company includes a study of both these aspects.

The Qualitative aspect mainly involves understanding the non numeric aspects of the business. This includes many factors such as:

1. Management’s background – Who are they, their background, experience, education, do they have the merit to run the business, any criminal cases against the promoters etc

2. Business ethics – is the management involved in scams, bribery, unfair business practices

3. Corporate governance – Appointment of directors, organization structure, transparency etc

4. Minority shareholders – How does the management treat minority shareholders, do they consider their interest while taking corporate actions

5. Share transactions – Is the management buying/selling shares of the company through clandestine promoter groups

6. Related party transactions – Is the company tendering financial favors to known entities such as promoter’s relatives, friends, vendors etc at the cost of the shareholders funds?

7. Salaries paid to promoters – Is the management paying themselves a hefty salary, usually a percentage of profits

8. Operator activity in stocks – Does the stock price display unusual price behavior especially at a time when the promoter is transacting in the shares

9. Shareholders – Who are the significant shareholders in the firm, who are the people with above 1% of the outstanding shares of the company

10. Political affiliation – Is the company or its promoters too close to a political party? Does the business require constant political support?

11. Promoter lifestyle – Are the promoters too flamboyant and loud about their lifestyle? Do they like to display their wealth?

A red flag is raised when any of the factors mentioned above do not fall in the right place. For example, if a company undertakes too many related party transactions then it would send a signal of favoritism and malpractice by the company. This is not good in the long run. So even if the company has great profit margins, malpractice is not acceptable. It would only be a matter of time before the market discovers matters pertaining to ‘related party transactions’ and punishes the company by bringing the stock price lower. Hence an investor would be better off not investing in companies with great margins if such a company scores low on corporate governance.

Qualitative aspects are not easy to uncover because these are very subtle matters. However a diligent investor can easily figure this out by paying attention to annual report, management interviews, news reports etc. As we proceed through this module we will highlight various qualitative aspects.


The Quantitative aspects are matters related to financial numbers. Some of the quantitative aspects are straightforward while some of them are not. For example cash held in inventory is straight forward however ‘inventory number of days’ is not. This is a metric that needs to be calculated. The stock markets pay a lot of attention to quantitative aspects. Quantitative aspects include many things, to name few:

1. Profitability and its growth

2. Margins and its growth

3. Earnings and its growth

4. Matters related to expenses

5. Operating efficiency

6. Pricing power

7. Matters related to taxes

8. Dividends payout

9. Cash flow from various activities

10. Debt – both short term and long term

11. Working capital management

12. Asset growth

13. Investments

14. Financial Ratios








j

j


Comments

Post a Comment

Popular posts from this blog

GST - Important Reconciliations must be done before finalization of the Financial Statement

-
Image
To Ensure that there are no major / material misstatements, It is important to check compliance with GST laws and rules even during the finalization of the Financial Statement. An important list of reconciliations is given below:  Balance of Electronic Credit ledger with Balance of Input Tax credit (ITC) in Books of Accounts  Balance of Electronic Cash ledger with Balance of excess cash paid in Books of Accounts  GST paid in cash in March return, with GST Payables as per Books of Accounts  Refund claimed in GST portal with ITC refund receivable in Books of Accounts  Output Liability in GST returns with Books of Accounts  ITC Reconciliation in FORM GSTR-2A/ 2B with FORM GSTR-3B and Books of Accounts  ITC reversed in FORM GSTR-3B with Books of Accounts  Ineligible ITC in FORM GSTR-3B with Books of Accounts  Reconciliation of Gross Turnover in Books of Accounts with FORM GSTR-1, e-Way Bills and FORM GSTR-3B  Reconciliation of accounts of the suppliers  Adjustments of previous year, do
Read more

Non-Profit Organisation (NPO)

-
Image
Non-Profit Organisatoin’s (NPO) have played a crucial role in development of India. There are various NPOs that work all over India and for a wide range of causes.  The World Bank defines NPO’s as “private organizations that pursue activities to  relieve suffering,  promote the interest of the poor,  protect the environment,  provide basic social services, or  undertake community development.”  NPOs do not work for profit motive and apart from own sources, NPO utilises funds raised through donations. NPOs receiving foreign contributions in India come under the purview of Foreign Contribution Regulation Act, 2010 i.e. FCRA. Corporate Social Responsibility (CSR) is practical way to give back to society and NPOs are the best way to do this. NPOs can be registered in any of the applicable acts as mentioned below, according to the type of organisation chosen to be formed. Major laws and acts applicable to NPO are as follows – Society registered under Societies Registration Act, Central or r
Read more

Panel Finalises GST Rate Structure, Fixes Rates at 5%, 12%, 18% & 28%

-
A 4-tier GST tax structure of 5, 12, 18 and 28 per cent, with lower rates for essential items and the highest for luxury and de-merits goods that would also attract an additional cess, was decided by the all- powerful GST Council today. With a view to keeping inflation under check, essential items including food, which presently constitute roughly half of the consumer inflation basket, will be taxed at zero rate. The lowest rate of 5 per cent would be for common use items while there would be two standard rates of 12 and 18 per cent under the Goods and Services Tax (GST) regime targetted to be rolled out from April 1, 2017. Announcing the decisions arrived at the first day of the two-day GST Council meeting, Finance Minister Arun Jaitley said highest tax slab will be applicable to items which are currently taxed at 30-31 per cent (excise duty plus VAT). Luxury cars, tobacco and aerated drinks would also be levied with an additional cess on top of the highest tax rate. The coll
Read more