In this blog we will break what all constitutes fundamental analysis. Fundamental analysis is usually used by investors and is a useful skill to master.
Introduction - Fundamental Analysis
Annual Report
1. Qualitative
Corporate governance
Moat of the business
Competition landscape
Regulatory environment
Promoter background
2. Quantitative:
Profit & Loss
Balance Sheet
Cash Flow
Mindset of Investor
Trader: Design trade.
Speculator: Gut feel, Friend told.
Investor: Does deep down fundamental analysis.
How to read annual report of a Company
Download from the company website.
Includes financial and non-financial.
Figure out your main area 1. Management Discussion & Analysis. 2. General Shareholder Information. 3. Consolidated Financial Statements.
Management Discussion & Analysis 1. Business Strategy of the Company 2. Growth Prospects of the Company 3. Risk that the company faces.
Revenue (Top Line) Total Income = Revenue from operation + Other Income
Expense: Raw materials + Salary paid to the Employees + Depreciation & Amortization + Interest Payments + Electricity & Rent + Power & Advertisement.
Operating Profit = Revenue − Expenses
Tax: Profit after Tax (PAT: Final Profit or Bottom Line) PAT = Operating Profit − Tax
Understanding Balance Sheet
Year on Year basis
Two broad sections: Assets & Liability (Both are sub-divided into Non-current and Current)
Non-Current Assets 1. Have a long-term economic benefit to the company. 2. Includes: Tangible Assets (Like — Property, Plant & Machinery) and Intangible Assets (Like — Trademark, Patent & Certificate, Financial Instruments)
Current Assets: Economic output within a year time frame. 1. Inventories: Finished goods ready to be sold. (Dig Deep) 2. Trade Receivables 3. Repayment of Loan by others to them 4. Cash & cash balance held with the Bank
Non-current Liabilities: Financial obligations which can be fulfilled within a few years.
Current Liabilities: This should be fulfilled within a year.
Equity Liabilities: 2 Parts — Share Captial + Reserves & Suplusses(Profit from P&L)
The Cash Flow Statement
It gives the exact cash position of a company
Three Activities a company can conduct: Operating + Investing + Financing. Sum total forms cash statement
Generate or consume cash
Operating Cash: Represent the core operation of the company.
Investing: Capital expenditure: New plant, acquisitions.
Generate Cash: Positive Cashflow
Consume Cash: Negative Cashflow
Financing: Borrowing from banks, paying out dividends.
The Connection between Balance Sheet, P&L and Cash Flow Statement
All three are deeply connected.
P&L: Revenue + Significant Expense + Effective Tax Rates+ PAT
Balance: Borrowings +Account receivables + Cash available at hand or banks
Cashflow: Cashflow from Balance + Investing + Financing Activities
Financial Ratio Analysis
Metric that helps in understanding the financial health of a company. It is divided into 3 broad categories — Profitability ratio, leverage (or solvency) ratio, and valuation ratio.
The profitability ratio helps us understand the profitability of the business. Profits are important to expand the business and pay dividends to shareholders. To analyze a company on the basis of this ratio, ensure that the PAT margin and EBIDTA Margin are trending upwards and are stable.
Some of the Profitability ratios are:
Operating Profit Margins (OPM) Percentage of profit a company produces from its core operations. Calculated by calculating the EBITDA (Earning before Tax, the interest cost, depreciation & amortization) of a company. EBITDA = Total Income − Total Expenses OPM = EBITDA ÷ Revenue from operation
Net Profit Margin Calculate the percentage of profit a company produces from its total revenue. PAT Number ÷ Total Income
Return on Equity (ROE) The ratio measures the efficiency with which a company generated profits from each unit of shareholder’s equity or capital invested. The higher the ROE, the better it is (>25%). A company should not have much debt as it can skew the ROE number. It is different for different sectors. Like IT company has a very high ROE as they don’t have to re-invest more as compared to a manufacturing company which has a low ROE. ROE = Net Profit after Tax ÷ Shareholder’s Equity
Theleverage in the context of the balance sheet refers to the debt that a company has taken from the bank to run its operation. It is also called the Solvency ratio. This ratio measures the operational efficiency of the business. Some of the leverage ratios are:
Interest Coverage Ratio Helps us understand how much the company is earning wrt the interest burden it has. This ratio determines how efficiently a company repays interest on its outstanding debt. Higher the better(>1). Interest coverage ratio = EBIDTA ÷ Finance Costs (Interest Obligations)
Debt to Equity Ratio D/E = DEBT ÷ EQUITY A measure of the total debt of the company against the total shareholder’s equity in the company. Minimum the best. Lower than 1 is better.
The valuation ratiocompares the stock price with the valuation of the company to get a sense of how cheap or expensive a company’s stock is. Popular valuation ratios are:
Price to Sales Helps to compare the stock price of the share with the sales per share. Higher associated with PAT margins. Ratio = Current Share Price ÷ Sales per share
Price to Book Book value = Tangible Asset − Liabilities It is simply the amount of money that is left on the table after a company pays off all its obligations. Book value = Total Equity ÷ Total Outstanding Shares PB = Share Price ÷ Book value A higher price to book value ratio signifies that the firm is overvalued wrt the company’s equity/book value. A lower price to book value signifies that the firm is undervalued wrt the company’s equity/book value.
Price to Equity Earnings per Share (EPS) = PAT ÷ Total Outstanding Shares PE = Share Price ÷ EPS For every unit of profit that a company generates the market participants are willing to pay PEx (times) more to acquire the share. Compare to industry-specific.
Compare the financial ratios of a company to its peers to have a better understanding.
How to value a company
Very elaborate process. The different techniques used
Intrinsic valuation Discounted Cash Flow analysis Model (DCF): It considers Free cash Flow and Growth rate of cash flow and risk.
Relative valuation Used when there is no positive free cash flow.
New Fund offers in mutual funds are like IPO for shares, where the fund houses come up with an investment proposal and public can subscribe to it.
What are NFOs?
An NFO or New Fund Offer is offered by Asset Management Company (AMC).
It is an invitation to the investors to subscribe to the units of a newly launched fund.
These are launched to introduce a new investment theme that any of AMCs existing funds do not offer.
A contribution is made to the pool of investment that is yet to be invested by subscribing to NFO.
How to Analyse an NFO (Checklist)
Asset Management Company (AMC): Good experience (At least 10 years), Good growth in its Asset Under Management (AUM), Lower expense ratio, Good portfolio of existing funds.
Fund Manager
Investment Strategy: Does the offering meets your investment needs (theme).
What is a Marubozu candlestick? In this blog we learn about Marubozu candles and the psychology behind trading the pattern.
In technical analysis of the stock market, traders look for patterns in the price and volume of securities to make predictions about future price movements. One such pattern is the marubozu, which is a single candle on a candlestick chart that has no shadow or wick on one end, signifying strong buying or selling pressure.
A bullish marubozu is a candlestick that has a long green body with no upper wick, indicating that buying pressure was strong throughout the trading session, pushing the price up from the open to the close. This pattern is usually seen as a strong bullish signal and traders may interpret this as a bullish trend reversal or a continuation of an existing bullish trend.
When a bullish marubozu forms, traders interpret it as a sign of strong buying pressure and confidence in the market. This may lead to increased optimism and a sense of security among traders, leading them to take long positions in the stock. The bullish sentiment may also lead to increased demand and further price appreciation, thus continuing the positive cycle.
First and Second green candles are Bullish Marubozu while fourth candle (Red) is an example of bearish Marubozu.
On the other hand, a bearish marubozu is a candlestick that has a long black body with no lower shadow, indicating that selling pressure was strong throughout the trading session, pushing the price down from the open to the close. This pattern is usually seen as a strong bearish signal and traders may interpret this as a bearish trend reversal or a continuation of an existing bearish trend.
When a bearish marubozu forms, traders interpret it as a sign of strong selling pressure and bearish sentiment in the market. This may lead to increased fear and caution among traders, leading them to take short positions or exit long positions in the stock. The bearish sentiment may also lead to decreased demand and further price depreciation, further worsening the selling pressure.
It is important to note that market psychology is not always rational and can be influenced by various factors, such as news events, economic data releases, and rumors. Therefore, traders should not solely rely on candlestick patterns and should always consider multiple factors before making a trading decision.
The other common single candlestick patterns are Bullish Engulfing, Bearish Engulfing, and Inverted Hammer. Please click on respective links to access the blog.
What are Doji and Spinning top candlestick patterns? In this blog, we will look into two very important candle patterns.
Doji and spinning top candles are two important candlestick patterns that traders use to interpret market sentiment and make informed trading decisions. In this article, we’ll discuss what doji and spinning top candles are, how they are formed, and how traders use them to make trading decisions.
What is a Doji Candle?
A doji candle is a candlestick pattern that signals indecision in the market. It is formed when the opening and closing price of a security is almost the same, resulting in a candle with long wicks on both the upper and lower end. The long wicks show that both buyers and sellers have attempted to push the price in opposite directions, but neither side was able to gain control. This results in a candle with a small real body that is often situated near the middle of the candle’s high and low range.
What is a Spinning Top Candle?
A spinning top candle is a similar pattern to the doji candle, but it is formed when the real body of the candle is larger and the upper and lower wicks are still relatively long. The spinning top candle also signals indecision in the market, as the larger real body shows that both buyers and sellers have taken control of the price at some point during the trading session, but neither side was able to gain a sustained advantage.
How to Use Doji and Spinning Top Candles in Trading
Doji and spinning top candles are most effective when used in conjunction with other technical analysis tools, such as trend lines, support and resistance levels, and moving averages. Traders often look for doji and spinning top candles at key levels of support and resistance, as they can signal a potential reversal in the trend.
Doji and Spinning top candles
In the pic above, the first green candle is close to what doji would look like. The third red candle which has a thicker body is close to what a spinning top would look like.
For example, if a doji or spinning top candle forms at a key resistance level, it may indicate that the price has reached a top and that a downward trend could soon follow. On the other hand, if a doji or spinning top candle forms at a key support level, it may indicate that the price has reached a bottom and that an upward trend could soon follow.
The other common single candlestick patterns are Marubozu and Inverted Hammer. Please click on respective links to access the blog.
