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).
A candlestick is a type of chart that is commonly used in technical analysis to display the price movements of a financial instrument, such as a stock, currency, or commodity, over a specific period of time. Each candlestick is represented by a “real body” which displays the open and close prices and “tails/wicks”, which display the highest and lowest prices reached during the period.
A bearish Candlestick
The red rectangular part as seen in the image above is called body and the thin line on top and bottom of body is called tail/wick/shadow.
In a candlestick pattern, the body represents the area between the open and close prices of a financial instrument during a specific period of time. The body is typically shown as a rectangle and its color can indicate the direction of price movement. A white or green body indicates that the closing price was higher than the opening price, indicating a bullish movement, while a black or red body indicates that the closing price was lower than the opening price, indicating a bearish movement.
The tail/wick is the line above or below the body that represents the high or low price for the period. A tail above the body is called an upper tail or upper wick, and it represents the highest price reached during the period. A tail below the body is called a lower tail or lower shadow, and it represents the lowest price reached during the period.
In a candlestick chart, the upper and lower tails can provide insight into market sentiment. For example, a long upper tail on a candle can indicate that bears (sellers) tried to push the price down and were ultimately successful, indicating that bulls (buyers) lost the grip. Similarly, a long lower tail on a candle can indicate that bears(sellers) tried to push the price down but were ultimately unsuccessful, indicating that bulls (buyers) tightened the control.
It’s worth noting that the length and position of the tails can provide additional information about the market sentiment and can be used to identify potential buying and selling opportunities.
In other blogs we will look into most common single candlestick patterns like Hammer and Shooting star, Marubozu, spinning top, Doji and Hanging Man.
How to pick long term stocks? This question puzzles every investor during their initial days in the stock market. No set of filters can work always in the stock market. The market is very dynamic but following few basics goes a long way. Let us look at some of them.
The bussiness should be profitable, quarter after quarter, year after year. Positive EPS is desirable.
Beginners should stick to businesses that are profitable. To check if a business is profitable, we can quickly check a ratio EPS which stands for Earnings per Share. you can read more about EPS here in this blog. A positive EPS number is advised. Positive EPS shows that the company is making profits. We can check EPS of any stock by looking at google or visiting websites like Moneycontrol etc.
PE ratio
PE ratio helps us to filter a stock out of its peers for investment. The IT sector has multiple companies listed on the stock exchange, which one is relatively underpriced? We can answer this question by looking at the PE ratio of every stock listed in the IT sector. As a rule of thumb, the lesser the PE ratio, the more it can grow to reach the P/E of its peers. P/E is nothing but the current price of stock/EPS.
PEG
PEG stands for PE / Earnings Growth. This ratio goes a long way to indicate how the business might perform in future. The lower the PEG ratio, the better the stock is. Negative PEG is a warning that the business is either making losses or expected to make losses in future. A very insightful explanation of the PEG ratio can be read here.
Debt to equity ratio
Suppose you have to start a business and you need some working capital. You can use some of your own savings but if you run short of capital, you ask your friends/banks to fund your business and promise to pay back. The amount that you have to pay back, is a liability. Debt to equity is a simple measure of the amount you have to pay back/Your own capital infused in business. Even if your business doesn’t perform well, you will be under pressure to return money to friends/banks. But if you did not ask for any help from friends and banks, you have one less issue.
Ideally, debt to equity of 0 is desirable. This simply means that you do not have to pay back anyone.
Mutual fund holdings
Mutual funds have very qualified fund managers at the helm of affairs. They are vastly experienced and usually are early and fast movers. They know when to enter a stock; if they should keep buying it, if they should book partial profits and if it is the right time to exit the stock. We can take a clue from the activity of mutual fund managers in a particular stock. We can check mutual fund activity by clicking this link here and inputting the scrip name. Suppose we entered CDSL, we can see how the holdings of funds houses change over time.
Change in Funds holdings over time
Dividend yield
The dividend yield is a ratio in percentage, which conveys how much dividend is paid that year/Current market price of the scrip. Higher the dividend yield, the better it is. Zero or low dividend yield should not stop us from buying a stock though. Dividend yield should act as one of the last filters when one is confused between two businesses with very similar potential.
Have you ever thought of what you will do after your retirement from work generally at the age of 60? This question will have different answers for many people. Some people will just stay away from any work and enjoy the time with their families, children and grandchildren. Some will keep running small errands to earn their living and the rest might have to depend on their children for their various needs that might arise in their old age.
Nevertheless, whatever the answer might fit your case, it is always better to remain financially independent even after the retirement.
National Pension Scheme(NPS) was started in 2004 by the Govt of India for the Govt Employees but in the year 2009 onwards it was thrown open to all the individuals who are in between the age of 18-60 years. It is regulated by the Pension Fund Regulatory and Development Authority.
For more information on regulations you can check out here – NPS
Are you an office going person, or doing work from home(WFH) these days from morning to evening and do not have much time to look for what is going in the market, and are looking to find some avenues for investing your funds/savings/assets in some asset classes for excepting a better return, then this the right place for you. After reading this page, you will understand the basics of Mutual Funds and how you can invest in mutual funds of various categories.
What are Mutual funds ? Mutual Funds is a mixed bag of various asset classes or financial instruments. Based on the type of the asset class or the financial instrument, mutual funds can be classified into different types-
Equity Mutual Funds
Debt Mutual Funds
Hybrid Funds ( Equity + Debt Funds)
Let us check out in detail about these funds.
Equity Mutual funds – In these funds, the fund managing company also know as the Asset Management Company(AMC) takes the amount from the customer, and invests the amount in the equity shares of various companies of different sectors. The percentage allocation in different shares is decided by the fund manager of that fund to maximize the return on investment for its customers. These funds are High Risk and High return funds as they are susceptible to the fluctuations in the market, but in the long term, they can generate a good return for your wealth creation and future lifestyle goals.
Debt Mutual Funds – These mutual funds are the low risk, low return funds usually preferred by the conservative investors who wish to invest their savings in some safe instruments which are always increasing. In such type of funds, the fund manager invests the amount into various Debt instruments such as the Govt Securities issued by RBI, Reverse Repo Rate Instruments, State/Central Govt Treasury Bills, Bonds etc. These funds move slow and steadily but at a constant pace and are considered as the most safe funds.
Hybrid Funds – These are not a separate category fund but it is a mixture of the above two funds in certain ratio such as 50:50 or 60:40 or anything chosen by the AMC or the fund manager of the fund. They are the most popular funds for those type of investors who want a high return but also don’t want a high exposure for risky funds.
