Fundamental Analysis¶

Examines various factors affecting supply and demand conditions, thereby influencing future income from and value of an investment

Studies fundamental factors that determine earnings and risks associated with a share

Suitable for

• Long-term investing: value of share that should prevail in capital market
• Determining intrinsic worth of share
• Explaining price-behavior of shares in terms of underlying fundamental factors

Why invest in assets with low P/E ratio?¶

• Store of value
• Expected future earnings

GEIC Model¶

• **G**lobal economy
• Domestic **e**conomy
• **I**ndustry
• **C**ompany

flowchart LR

subgraph ee[Economic<br/>Environment]
    direction LR
    ge[Global<br/>Economy]
    e[Domestic<br/>Economy]
    i[Industry] 
end

ee --> Company --> Performance --> v[Value<br/>of share]

Global Economy¶

• Prospects for Exports
• Price competition
• Cost of foreign inputs
• Profits through foreign investments
• Exchange rate fluctuations
• Risk of changing political environment in world
• Increasing/decreasing peace in international scenario

Stronger globalization and international collaboration, higher the importance of monitoring global economy. Eg: sub-prime crisis

Economy¶

Shocks: Change in macro-economic vars provide a force that goes against inertia inherent in the performance of firms, and hence the share prices

Types of shocks

• Supply
• Demand
• Financial market

PEST¶

SWOT¶

Strengths, Weaknesses, Opportunities, Threats

Industry¶

An industry is set of companies that serves a particular niche of consumers

Industry Phase¶

Identify which phase of the life cycle the industry belongs to

Structural Analysis¶

Intensity of competition among firms in the same industry determines its profitability

Michael Porter’s Model: Rivalry among existing competitors depends on

• Threat of entry: New supplier
• Threat of substitution: New industry
• Bargaining powers of consumers
• Bargaining powers of suppliers

Company¶

• Quantitative: Financial
• Qualitative: Non-Financial
• Quality of mgmt
• Product portfolio/range
• Collaborations
• Shareholders pattern and listing
• R&D, Innovation
• Diversification
• Does this company fall under strict Govt regulations
• Disputes & contingent liabilities
• Availability of inputs
• Industrial relations

Equity Valuation¶

07_Equity_Valuation.md

Check if stock is under-valued/over-valued

Ratios¶

P/E Ratio¶

Price that market is willing to pay for one unit of earning

Lower is better; extreme P/E ratios are not desirable

Provides a benchmark in determining the value of a share and hence the value of shareholders

There is a strong connection between P/E, dividend discount models, and fundamentals $$ \begin{aligned} \text{P/E} &= \dfrac{P_\text{Dividend Growth Model}}{\text{Earnings}} \ &= \dfrac{1}{\text{Earnings}} \times \dfrac{D_{t+1}}{k-g} \ &= \dfrac{1}{\text{Earnings}} \times \dfrac{D_t (1+g)}{k-g} \ &= \dfrac{D_t}{\text{Earnings}} \times \dfrac{1+g}{k-g} \ &= \text{Dividend Payout Ratio} \times \dfrac{1+g}{k-g} \end{aligned} $$

How to determine if P/E ratio is good

• Company growth rate
• How fast has company been growing in the past?
• Are these rates expected to increase in the future
• Industry

PEG Ratio¶

Good way to decide if P/E ratio of company is high/low $$ \text{PEG} = \dfrac{\text{P/E}}{\text{Earnings Growth}} $$

Preferred Values¶

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