VCE Summer Internship Program 2021

Intern’s Details
SATAYAM GUPTA
Name
[email protected]
Email-ID
01
Smart Task No.
Equity Research
Project Topic

1. Task Q1 : What is fundamental analysis? Why is fundamental analysis relevant for

investing? How to use PE/PB charts to identify fundamental opportunities?
Task Q1 Solution :

Fundamental analysis is the process of evaluating a company's financial health and its potential for future
growth. This involves looking at things like the company's financial statements (income statement, balance sheet,
cash flow), management team, industry trends, and economic factors. The goal is to understand the company’s
intrinsic value (what it's truly worth) and see if the current stock price is above or below that value.

Fundamental analysis is relevant because it helps investors make informed decisions about which stocks to buy
or sell. By understanding a company's true value, investors can determine if the stock is overpriced, underpriced,
or fairly valued. This can help in identifying long-term investment opportunities, as the stock price should
eventually reflect the company's actual worth. It's especially useful for value investors who look for undervalued
companies.

PE (Price to Earnings) and PB (Price to Book) ratios are common tools in fundamental analysis. Here's how to
use them:
• PE Ratio: This compares a company’s stock price to its earnings per share (EPS). A lower PE ratio
compared to industry averages might indicate the stock is undervalued, while a higher PE could mean it’s
overvalued. But a low PE could also suggest the company has challenges, so context is important.
• PB Ratio: This compares the stock price to the book value of the company (what its assets are worth). A
PB below 1 could signal that the stock is undervalued, but again, it could mean the company is in trouble.

To identify fundamental opportunities:

• Look at the historical PE/PB chart for a company or industry.
• Identify points where the PE or PB ratios are below historical averages—this may signal an undervalued
stock.
• Use this in combination with other factors like earnings growth, dividends, and industry conditions to
confirm whether the stock is a good investment.

2. Task Q2 : How to do Financial Statement Analysis on stocks ? Elaborate key points on

the following;
1) A). Annual Report key points
2) B). Balance Sheet Analysis
3) C). Cash Flow Statement Analysis
4) D). Profit & Loss statement Analysis

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Task Q2 Solution :

A). Annual Report

The annual report provides an overview of the company’s activities and financial performance over the year. Key
sections include:
• Chairman’s Letter: Gives insight into the company’s vision, strategy, and future goals.
• Management Discussion & Analysis: This section explains the financial performance, key risks,
industry trends, and plans for the future.
• Corporate Governance Report: Shows how the company is governed, including board structure and
policies.
• Financial Statements: Includes the balance sheet, profit and loss statement, and cash flow statement.

B). Balance Sheet Analysis

The balance sheet gives a snapshot of a company's financial position at a specific point in time by showing what
it owns (assets) and what it owes (liabilities).
• Assets:
o Current Assets: Cash, receivables, inventory—assets that can be converted to cash within a
year.
o Non-Current Assets: Long-term investments, property, plant, and equipment.
• Liabilities:
o Current Liabilities: Obligations due within a year, like accounts payable or short-term debt.
o Non-Current Liabilities: Long-term debt, pensions, and other long-term obligations.
• Shareholders’ Equity: Represents the owners’ claim on the company after liabilities are paid. Key
metrics include retained earnings and common stock.
.

C). Cash Flow Statement Analysis

The cash flow statement shows how cash moves in and out of the business and is broken into three parts:
• Operating Cash Flow (OCF): Cash generated from core business activities. Positive OCF indicates the
company’s ability to generate sufficient cash from operations.
• Investing Cash Flow: Cash spent or received from buying/selling assets like equipment or investments.
Negative cash flow in this section is normal for growth companies but should be monitored.
• Financing Cash Flow: Cash from issuing or repurchasing stock, paying dividends, or borrowing.
Understand if the company is borrowing too much or issuing too much stock.

D). Profit & Loss Statement (Income Statement) Analysis

The income statement provides details about the company’s revenue, expenses, and profit over a specific
period.
• Revenue: Total income from sales. Growing revenue is a sign of increasing demand.
• Expenses:
o Cost of Goods Sold (COGS): Direct costs related to the production of goods or services sold.
o Operating Expenses: Costs like rent, salaries, and marketing.
o Interest & Taxes: Interest payments on debt and taxes due to the government.
• Net Profit: Bottom-line profit after all expenses are deducted from revenue. This reflects the company's
profitability.

3. Task Q3 : Understanding following approach and suggest some stocks which follows the
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approach,
a) A). Benjamin Graham and Buffett approach
b) B). Hidden Bond Component Approach
c) C). Peter Lynch Approach

Task Q3 Solution :

A). Benjamin Graham and Buffett Approach (Value Investing)

Key Approach:
Benjamin Graham, the father of value investing, focused on buying stocks that were trading below their intrinsic
value. Warren Buffett, Graham’s student, added his twist, looking for companies with strong competitive
advantages ("moats") and good management, while holding them for the long term.
Key Criteria:
• Low Price-to-Earnings (PE) and Price-to-Book (PB) ratios.
• Strong cash flow and profitability.
• Stable and predictable earnings.
• Low debt levels.
• Strong management and business moat.

B). Hidden Bond Component Approach

Key Approach:
This strategy identifies companies with stable earnings, where a significant portion of their valuation is tied to
predictable income, akin to a bond. These stocks often pay regular and reliable dividends, providing a "bond-like"
component to their return.
Key Criteria:
• Companies with stable cash flow.
• Consistent dividend payouts.
• Low business volatility, resembling bond characteristics.
• Low risk and typically defensive sectors like utilities, telecom, or consumer staples.

C). Peter Lynch Approach (Growth at a Reasonable Price - GARP)

Key Approach:
Peter Lynch's strategy combines value and growth investing. He focuses on finding stocks with good growth
prospects that are trading at reasonable valuations. Lynch liked companies with easy-to-understand business
models and those with room to expand earnings.
Key Criteria:
• Strong earnings growth.
• Low PEG ratio (Price/Earnings to Growth) – ideally below 1.
• Scalable business model.
• Companies that are often overlooked by Wall Street analysts.

4. Task Q4 : Understand following types of stocks and suggest some stocks of each type;
a) Multibagger Stocks
b) Magic Formula Stocks
c) Wide Moat Stocks
d) Defensive Stocks
e) Value Stocks
f) Momentum Stocks
g) Low PE and High EPS stocks
h) Defensive Stocks
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i) Bull Cartel Stocks

Task Q3 Solution :

a) Multibagger Stocks
Multibagger stocks are those that have the potential to deliver returns significantly higher than the initial
investment, often doubling or tripling in value over a few years.
Examples:
• Narayana Hrudayalaya: A healthcare provider that has shown significant growth due to rising healthcare
demand.
• PI Industries: An agrochemical company that has consistently delivered strong growth and returns.

b) Magic Formula Stocks

This strategy, popularized by Joel Greenblatt, focuses on finding high-quality companies at attractive prices
based on their earnings yield and return on capital.
Examples:
• Tata Power: With a solid return on capital and good earnings yield, it fits the criteria.
• Coal India: High earnings with reasonable valuations make it an attractive choice.

c) Wide Moat Stocks

Wide moat stocks have a competitive advantage that protects them from competition, leading to sustained
profitability.
Examples:
• Hindustan Unilever Limited (HUL): Strong brand presence and a diversified portfolio create a wide
moat.
• Nestle India: Known for its strong brand loyalty and market share in the FMCG sector.

d) Defensive Stocks
Defensive stocks are less sensitive to economic cycles and tend to provide stable earnings and dividends.
Examples:
• ITC Limited: A major player in FMCG and cigarettes, it offers consistent dividends and stability.
• Dabur India: A consumer goods company focusing on health and wellness, which remains stable during
downturns.

e) Value Stocks
Value stocks are those that are trading for less than their intrinsic value, often characterized by low price-to-
earnings (PE) ratios.
Examples:
• State Bank of India (SBI): With a low PE ratio compared to its growth potential, it represents value.
• L&T (Larsen & Toubro): Known for its strong fundamentals, yet trading at attractive valuations.

f) Momentum Stocks
Momentum stocks are those that have shown strong price performance in the past and are expected to continue
that trend.
Examples:
• Adani Green Energy: This stock has shown significant upward momentum in recent years due to the
renewable energy push.
• Tata Motors: Benefiting from the EV transition and strong demand for its vehicles.

g) Low PE and High EPS Stocks

These stocks have low price-to-earnings ratios and consistently high earnings per share, indicating good value
with strong profitability.
Examples:
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• Hindustan Aeronautics Limited (HAL): A defense company with strong earnings and a low PE ratio.
• Grasim Industries: Trading at a lower PE compared to its earnings potential, making it an attractive
investment.

h) Defensive Stocks (Repeated Entry)

Since defensive stocks are already covered, you can refer back to examples provided earlier (e.g., ITC Limited
and Dabur India).
i) Bull Cartel Stocks
Bull cartel stocks are shares that are aggressively pushed by a group of investors, leading to a sharp increase in
price. These can be riskier but may present short-term trading opportunities.
Examples:
• Zomato: As a high-profile IPO, it has seen speculative trading activity.
• Paytm: Initially trading above its issue price, it has garnered attention in the market, though caution is
advised.

5. Task Q5 : Understand and Explain following discounting methodology

a) CAGR
b) CAPM
c) CRP
d) WACC
e) Buffett & Munger Approach for Discounting

Task Q5 Solution :

CAGR (Compound Annual Growth Rate)

CAGR measures the mean annual growth rate of an investment over a specified period, assuming that profits
are reinvested at the end of each period.
Significance: CAGR provides a smooth annual growth rate, allowing investors to compare the growth of
different investments over time, making it easier to evaluate performance without the volatility of year-to-year
fluctuations.

2. CAPM (Capital Asset Pricing Model)

CAPM is a financial model that establishes a linear relationship between the expected return of an asset and its
systematic risk (beta). It calculates the expected return on an investment based on its risk compared to the
overall market.
Significance: CAPM helps investors assess the risk-return profile of an asset, determining if it's worth the risk
based on the expected market return. It is widely used in finance to evaluate stocks and investment portfolios.

3. CRP (Capital Recovery Factor)

CRP is used in finance to determine the annual amount that needs to be set aside to recover an investment over
a specific period, often applied in capital budgeting for project evaluation.
Significance: The CRP helps in understanding the cash flows needed to recover the cost of an investment over
time, making it essential for assessing projects with fixed investment costs.

4. WACC (Weighted Average Cost of Capital)

WACC represents a firm's average cost of capital from all sources, including debt and equity, weighted by their
respective proportions in the capital structure.
Significance: WACC is crucial for evaluating investment decisions and determining the discount rate for future
cash flows, reflecting the opportunity cost of capital. Companies aim to achieve returns that exceed their WACC
to create value.

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