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Submitted by:
Sakshi wali
MBA III Sem
Submitted to :
Mr. Bhanu Pratap Narania
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Fundamental analysis is a method of evaluating a
security or asset by attempting to measure itsintrinsic value by examining related economic,
financial and other qualitative and quantitative
factors.
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Fundamental analysts attempt to study everything
that can affect the security's value, includingmacroeconomic factors (like the overall economy
and industry conditions) and individually specific
factors.
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Fundamental analysis can be composed of many
different aspects: the analysis of the economy asthe whole, the analysis of an industry or that of
an individual company.
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Thus it is important for an analyst to identify the
factors that are likely to affect the value of the
underlying asset and then resort to the study of
the said factors.
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Fundamental Analysis thus involves 3
steps
Economic analysis
Company analysis
Industry analysis
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Economic Analysis
The performance of a company depends much on the
performance of the economy if the economy is BOOM, the
industries and companies in general said to be prosperous. On
the other hand, if the economy is in RECESSION, the
performance of companies will be generally poor.
Investors are interested in studying those economic varieties,
which affect the performance of the company in which they
proposed to invest. An analyzed of those economic variable
would give an idea about future corporate earnings and the
payment of dividends and interest to investors.
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Factors affecting economic analysis
GNP
SAVING AND INVESTMENT
INFLATION
INTEREST RATE
AGRICULTURE
MONSOON
GOVERNMENT EXPENDITURES, REVENUES AND
DEFICITS
POLITICAL STABILITY
INFRASTRUCTURE
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GNP/ Geometric Model
GNP represents the aggregate value of goods and services
produced in the economy. It reflects the over all performance
of the economy. The growth rate of GNP indicates the growth
rate of the economy the higher the rate of growth of GNP, themore favorable is it for the stock market and vice versa
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Saving & investment
Savings and investment denote that position of GNP, which is
saved and invested savings increases in India since eighties
now the rate of savings is 25% from 21% in 80s, which
indicates the growth of capital market. The higher the level ofsavings interest, the more favorable is it for the stock marketed
vice versa
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Inflation
Inflation has considerate impact on the performance of
companies. Higher rates of inflation upset business plans and
erode purchasing power in the hands of consumers. This will
result in lower demand for products. Thus high rates of inflation
in an economy are likely to affect the performance of companiesadversely. However industries and companies prosper during
periods of low inflation. Hence an investor has to evaluate the
inflation rates prevailing in the economy currently as well as the
trend of inflation likely to prevail in the future.
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Agriculture
Agriculture forms a major part of the Indian economy. Some
companies are using agricultural raw material as inputs and
some others are supplying inputs to agriculture. Such
companies are directly affected by changes in agriculturalproduction. Hence, the increase/decrease in agricultural
production has a significant bearing on the industrial production
and corporate performance
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Rate of interest
The cost and availability of credit for companies are
determined by the rates of interest prevalent in an economy. A
low interest rate stimulates investment by making credit
available easily and cheaply. As a result cost of finance for
companies decreases which assures higher profitability. Onthe other hand, higher interest rates result in higher cost of
production, which may lead to lower profitability and lower
demand. Hence an investor has to consider the interest rates
prevailing in the economy and evaluate their impact on the
performance and profitability of the companies.
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GOVT. REVENUE, EXPENDITURE &
DEFICITS
Government is the largest investor and spender of money. So
the trends in government revenue expenditure deficits have
a significant impact on the performance of industries and
companies. So the investor has to evaluate these carefully toassess their impact on his investments.
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Infrastructure
The development of an economy very much on the
availability of infrastructure. It includes electricity, roads and
railways, communication channels etc. The availability of
infrastructural facilities affects the performance of
companies. Bas infrastructure leads to inefficiencies, lowerproductivity, wastage and delays and vice versa. Thus an
investor should assess the status of infrastructural facilities
available in the economy before finalizing his investment
avenues.
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Monsoon
The Indian economy is essentially an agrarian economy and
agriculture forms a very important sector of the Indian
economy. But the performance of agriculture to a very great
extent depends upon the monsoon. The adequacy of the
monsoon ensures the success of the agricultural activities in
India and vice versa. Hence the progress and adequacy of
the monsoon becomes a matter of great concern for an
investor in India.
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Political Stability
A stable political environment is necessary for steady and
balanced growth. No industry or company can grow and
prosper in the midst of political turmoil. Such long term
economic policies are needed for industrial growth. Suchstable policies can be framed only by stable political
systems.
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Industry Analysis
Industry analysis indicates to an investor whether the
industry is a growth industry or not. It gives an investor a
choice of the industry in which the investments should be
made.
Industry analysis refers to an evaluation of the relative
strength and weakness of particular industries which can be
divided in to three parts, viz.,
1. Life cycle of an industry
2. Characteristics of an industry
3. Profit potential of an industry
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Life Cycle
(a)Pioneering Stage: Technology and product arenewly introduced.
(b)Expansion stage: Those companies which reachedfirst stage grow
further and becomes stronger.
(c)Stagnation Stage: In this stage the growth of theindustries Stabilizes. Sales increases at slower rate.
(d)Decay stage: The industry becomes obsolete andgradually ceases to exist.
Ch i i f i d
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Characteristics of an industry
(a) Relationship between Demand & supply: Excess supply reduces the profitabilityof the industry and insufficient supply tends to improve the profitability. Thus an
investor should estimate the demand and supply gap in an industry.
(b) Period of life: Life of the industry depends on the products and the technology
used by the industry. Technological changes leads to product obsolete. No
investment should be made in such industries.
(c) State of labour: When there is labour revolution, industries cannot become bright.
(d) Governments attitude: The Government may encourage the growth and
development of certain industries by giving much assistance to such industries.
(e) Availability of Raw Material: An industry may depend on internal / external
country for raw material. Sometimes they depend on import of raw material.
(f) Cost structure: It refers to the proportion of fixed costs to variable costs. (Discuss
about Marginal Cost)
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Profit potential of industry
(i) Threat new entrants: New entrants inflate cost, push down the
prices and reduce profitability. An industry which is well protectedfrom the entry of new firms would be ideal for investment.
(ii) Competitions among existing firms: The firm competes with eachother on the basis of price, quality, promotion, service, warrantiesand so on. If the rivalry between the firms in an industry is strong
average profitability of the industry may be discouraged. The rivalryin an industry is high when the following conditions prevail in themarket:
(a) There is a sustained competitive battle
(b) The industry growth is dull
(c) The level of fixed cost is high
(d) There is over capacity in the industry continuing for a long time.
(e) The industry product is considered as a commodity, which
stimulates strong competition.
(f) The industry struggles much to withstand.
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(iii) Pressure from substitute products: Each firm in anindustry face competition from other firms in the same industry
producing substitute products. Substitute products may affect
the profit potential of the industry badly. The pressure from thesubstitute products is found to be high under the following
circumstances:
(a) When the price of the products is attractive
(b) When the cost for the prospective buyers to switch over to
a substitute product is minimum.
(c) When the substitute products are earning greater profits.
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(iv)Bargaining power of buyers: Buyers can bargain for price
reduction asks for better quality and better service. The bargaining
power of a buyer group is said to be high under the following
conditions:
(a) If its capacity to buy is more than the capacity of the seller tosell.
(b) If the cost of the switch over to a substitute product is low.
(c) If it poses a threat of backward integration strongly.
(v) Bargaining power of sellers: Sellers also can exert a competitive
force in an industry and bargain for rise in prices, lower quality, curtail
some of the free services they offer etc. Powerful suppliers can affect
the profitability of the buyer industry badly. Suppliers are said to be
powerful under the following circumstances.
(a) Few suppliers dominate the entire market.
(b) There is no viable substitute for the products supplied.
(c) The switching poses a strong threat of forward integration.
(d) Suppliers also pose a strong threat of forward integration.
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Company Analysis
It involves a close investigative scrutiny of the companiesfinancial and non financial aspects with a view to identifying its
strength, weaknesses and future business prospects.
The financial and non financial aspects are as follows:
Marketing success
Accounting Policies
Profitability
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1. Marketing success: The success of the market of the firm depends on
(a) The share of the company in the industry
(b) Sales
(c) Growth of its sales and stability of sales.
2. Accounting Policies:
A. Inventory Pricing
Cost/market value method
FIFO
LIFO
B. Depreciation methods Straight line method
Sum of the years digit method
C. Non operating income
Dividend
Interest
D. Tax Carry over Provision for taxation
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Profitability: A.(a) Gross profit Margin
(b) Net profit Margin
(c) Earning power
(d) Return on equity
(e) Earning per share
(f) Cash EPS
B. Financial Statement Analysis
> Trading, P& L A/C Analysis> Balance Sheet Analysis
C. Ratio Analysis
> Liquidity Ratios
> Leverage Ratios> Profitability Ratios
> Activity / Efficiency Ratio
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Benefits of fundamental analysis
Finding the value of the company. Determining what thecompany is worth at todays price will enable you to make a
decision to either buy or sell the company
Enables to read the pulse of the company. One can
understand the financial dynamics within the company anddetermine whether is it in a good state or are there some
problems.
Helps to identify potential companies before the general
market.