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Investment Analysis and Management - BU

This document provides an overview of fundamental analysis for investment purposes. It discusses analyzing macroeconomic factors, industries, and individual companies. Key steps include understanding the macroeconomic environment, analyzing industry life cycles and characteristics, studying company financials, management, and estimating the company's intrinsic value using metrics like earnings growth, risk assessment, and establishing a price-to-earnings multiple. Challenges for analysts are also noted, such as data limitations and market irrationality.

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68 views

Investment Analysis and Management - BU

This document provides an overview of fundamental analysis for investment purposes. It discusses analyzing macroeconomic factors, industries, and individual companies. Key steps include understanding the macroeconomic environment, analyzing industry life cycles and characteristics, studying company financials, management, and estimating the company's intrinsic value using metrics like earnings growth, risk assessment, and establishing a price-to-earnings multiple. Challenges for analysts are also noted, such as data limitations and market irrationality.

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mail2975682
Copyright
© Attribution Non-Commercial (BY-NC)
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You are on page 1/ 13

12/14/2008

Investment Analysis and


Management - BU
Module 6: Fundamental Analysis

Agenda
• Pointer.
• Economic Analysis.
• Steps in Fundamental Analysis.
• Key Macroeconomic factors analysed.
• Industry Analysis.
• Company Analysis.

• Estimation of Intrinsic value


• Obstacles in the way of Analyst.
• Empirical evidence of P/E.

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Pointer

• Key determinants of intrinsic value:


• Earnings per share

• Payout ratio

• Discount rate

• Growth rate

• Explain the impact of above factors on the intrinsic value.


• Explain the impact of growth and discount rates on P/E
multiple.

Economic Analysis

• The IV of a equity share is a function of earnings level,


growth rate and risk exposure of the company.
• The above factors to a great extent depend upon the
prospects of the industry to which the company belongs.
• The prospects of various industries, in turn are largely
influenced by the developments in macro-economic env.

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Economic Analysis

• Empirically, researchers have found the stock price


changes can be attributed to the following factors:
• Economic wide factors: 30 – 35 percent.

• Industry factors: 15 – 20 percent.

• Company factors: 30 – 35 percent.

• Other factors: 15 – 25 percent.

• Based on the above evidence a three pronged procedure


is adopted for fundamental analysis.

Steps in Fundamental Analysis

• Understanding of the macro-economic environment and


developments.
• Analyzing the prospects of the industry to which the firm
belongs; and
• Assessing the projected performance of the company.

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Key Macroeconomic Factors – Analyzed.

• Gross National Product.


• Savings and Investment.
• Price level and inflation.
• Agriculture and monsoons.
• Fiscal and monetary framework.
• Infrastructural facilities and agreements.

Fiscal and Monetary Policy


• Favourable Budget:
• A reasonably balanced budget (no high surplus / deficit).
• A level of internal and external debt that can be serviced
comfortably.
• A satisfactory balance of payment situation.
• A tax structure which provides incentive for savings and
investment.
• A rate of increase in money supply which ensures that inflation is
within permissible limit.
• A credit policy which accommodates reasonable business
demands.

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12/14/2008

Industry Analysis

• Objective of this analysis is to assess the prospects of


various industrial groupings.
• It is almost impossible to forecast exactly which industrial
groups will appreciate the most.
• Most careful analysis can suggest which industries have a
brighter future than others.
• Industry analysis can be performed:
• Industry life cycle analysis.
• Study of the structure and characteristics of an industry.

Industry Life Cycle Analysis

• Industrial economists believe that the development of


almost every industry may be analyzed in terms of LCA.
• The four well-defined stages are
• Pioneering stage.

• Rapid growth stage.

• Maturity and stabilisation stage.

• Decline stage.

• Explain the investment implications for each stage.

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12/14/2008

Industry Structure and Characteristics

• Since each industry is unique,


• A systematic study of its specific features and characteristics is
an integral part of the decision process.

• The following points are focus on the following:


• a. Structure of the industry and nature of competition.

• b. Nature and prospect of demand.

• c. Cost, efficiency, and profitability.

• d. Technology and Research

Company Analysis

• This is the last leg in the economy – industry – company


analysis sequence.
• Company analysis is organised by three parts:
• Study of financial information.

• Sizing up of present situation and prospects.

• Evaluation of management.

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Study of Financial Information

• Study of GAIL (appended in Excel sheet)

Sizing up – Present Situation & Prospects

• The analyst should question along the following lines:


• Availability and cost inputs.
• Order position.
• Regulatory framework.
• Technological and production capabilities.
• Marketing and distribution.
• Finance and accounting.
• Product Portfolio.
• Human resource and personnel.

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Evaluation of Management

• The analyst should ask the following questions:


• What is the grand design of the management? (Conglomerate or
close knit).

• What is the caliber, motivation, integrity, dynamism and


commitment of the top management personnel?

• Does the management have specific objectives, plans and time-


bound programmes?

• What emphasis is accorded to research and development?

Evaluation of Management

• The analyst should ask the following questions:


• How effective is the organisational structure?

• How sound are the management systems of the company?

• What is the importance assigned to management development?

• How investor friendly is the management?

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Estimation of Intrinsic Value

• Commonly adopted procedure by investment analysts:


• Estimate the earnings per share for the current year.

• Forecast the growth rate in earnings per share.

• Assess the risk.

• Establish a P/E ratio.

• Develop a value anchor and value range.

Estimate EPS – Current year

• Estimate the EPS based on the current published annual


reports and based on interview with management.
• Apart from EPS, establish the CFPS.

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Forecast the g in EPS

• If there is a stable cost and profit structure is expected in


the foreseeable future:
• The g in EPS may be equated with the projected growth
rate in sales?
• g in sales can be expressed in monetary terms as =
growth rate in physical terms + inflation rate.

Assess the Risk Exposure

• Investment analyst look commonly for the following


aspects of risk:
• Business Risk.

• Financial Risk.

• Market Risk (with respect to stock market).

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Establish a P/E Multiple

• Growth prospects and risk exposure are the key


determinants of P/E multiple.
• Following factors will also have a bearing:
• Dividend and bonus policy of the firm (liberal to niggardly).

• The size of the firm (very large to very small).

• The general image of the firm (very favourable to unfavourable).

Determine – Value Anchor & Range

• The value anchor is obtained as follows:


• Projected EPS * Appropriate P/E multiple.

• Practical wisdom calls for defining an intrinsic value range


around the single point estimate.

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Obstacles – Way of Analyst

• Inadequacies or incorrectness of data.


• Future uncertainties.
• Irrational market behaviour.
• Fallibility of experts.

Empirical Estimation of P/E

• Whitbek and Kisor in one of the earlier studies conducted


in the U.S found the following relationship:
• 8.2 + 1.5 * Growth rate in earnings + 6.7 Payout ratio – 0.2 *
Variability in earnings.

• Obaidullah and Kalyani Ramachandran estimated the


following relationship for Indian stock market in 1992:
• 0.0003 + 1.153 * Growth rate in earnings – 0.392 * Required rate
of return + 0.2 Growth rate in funds flowing into the securities
market.

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Reasons of Lack in Success – B/S

• Almost most of the variables discussed are fairly


successful in explaining P/E multiples.
• The models discussed are not so successful in selecting
the appropriate stocks to buy or sell.
• The following are the three reasons why they are not so
successful:
• Shift in market taste.
• Change in input values
• Firm effects.

Word of Caution

• Update the model periodically to reflect the most current


valuation mode.
• Define input variables taking into account the changing
corporate fortunes.
• Adjust the value estimate provided by the model in the
light of firm effects which the model does not capture.

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