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Fundamental analysis is a method of valuing securities an investor wishes to buy
It is an attempt to estimate the real worth of a security considering the earnings
potential of a company
The earnings potential depends on investment environmental factors and the real
worth of a security depends on the competitiveness, quality of management,
operational efficiency, profitability, capital structure and dividend policy
It is used to establish a true, intrinsic value of a security
The intrinsic value can be justified by the facts such as assets, earnings, dividends,
and prospects of the company
It is also measured as the present value of all future cash inflows on the security
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This value may be different from the current market price due to temporary market
conditions
Thus, determining the intrinsic value may assist an investor to buy undervalued
securities and sell overvalued securities
This analysis is based on the assumption that the stock price of the company
depends on its capacity to generate income and on various other factors
The total analysis of the investment environment can be grouped into the following
three types:-
Economic Analysis
Industry Analysis
Company Analysis
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The economic analysis involves an examination of fiscal and monetary policies
Economic activity in the country is influenced by domestic and international factors
In a globalised business environment, the national economy is greatly impacted by the
functioning of the global economy
In macro-economic analysis, the following are some of the key economic indicators used
to describe the state of macro economy:
GDP Growth Rate
Inflation indices
Savings and Investments
Foreign Investment Policy
Political Stability
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Industry analysis is the study of industries which are on the upswing or growing stage
The recent examples of such industries are petrochemicals, bio technology capital
goods industry, etc.
Its objective is to assess the prospects of various industrial groupings
A careful analysis can suggest which industries have a brighter future than others and
which industries are plagued with problems
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Pioneering stage
Rapid growth stage
Maturity and stabilization stage
Decline stage
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The basic objective of this analysis is to find competitively well placed companies
within a given industry
These companies are likely to perform better than the peers in the industry
This analysis consists of the following steps:-
Analysis of Management
Analysis of Competitive Strategies of the company
Analysis of company with respect to key factors for the company
Financial Analysis
SWOT Analysis
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Industry Analysis Company Analysis
Industry analysis focuses on the industry
itself not on the business
Company analysis focuses on internal
analysis of the company
Industry analysis is based on external
factors
Company analysis is based on internal
factors of a business
It often deals with analyzing a task
environment
In company analysis, one deals with inside
strengths. weaknesses, opportunities and
threats of the business
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Liquidity Ratios
Liquidity means the ability of the firm to meet its obligations in the short run
Liquidity ratios measure the ability of the firm to meet its current obligations and
indicate its short term financial stability
The liquid ratio is designed to show the amount of cash available for meeting
immediate payments
Liquidity ratios are generally based on current assets and current liabilities
The important liquidity ratios are:
Current Ratio
Liquid Ratio
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a) Current Ratio
= Current Assets
Current Liabilities
b) Liquid Ratio
= Quick Assets
Quick Liabilities
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Profitability Ratios
Profitability is the final result of business operations
Every business organization has to earn profit in order to survive and grow
Therefore it is necessary to know whether it is earning adequate profits or no
The following are the profitability ratios:
Gross Profit Ratio
Net Profit Ratio
Return on capital employed
Return on shareholders funds/Proprietary fund
Operating Profit to Sales Ratio
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a) Gross Profit Ratio
= Gross Profit x 100
Net Sales
b) Net Profit Ratio
= Net Profit x 100
Net Sales
c) Return on capital employed
= (NPBT + Interest Charges) x 100
Capital Employed
d) Return on shareholders funds/Proprietary fund
= NPAT x 100
Shareholders funds
e) Operating Profit to Sales Ratio
= Operating Profit x 100
Net Sales
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Solvency Ratios
Solvency of a firm is indicated by its ability to meet its immediate commitments
Whether the firm is solvent or otherwise, is determined by adequacy of its quick
assets as compared to its immediate liabilities
The solvency ratios are sub-set of other financial ratios
The following ratios are used to judge the solvency of a firm:
Proprietary Ratio
Debt Equity Ratio
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a) Proprietary Ratio
= Net Worth
Total Assets
b) Debt-Equity Ratio
= Total Debt
Equity
c) Interest Coverage Ratios
= PBIT
Interest On Debt
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Leverage Ratios
Leverage is an ability of a company to use fixed cost assets or funds to magnify the
return to its owners
The leverage ratios are useful as an analytical tools for creditors, financial institutions
and debenture holders
They are a measure of the extent to which company finances its assets through debt
and are the indicators of the financial risk
Leverage ratio includes:
Shareholders equity to total capital
Funded debt to net working capital
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a) Shareholders Equity to Total Capital
= Equity Capital + Reserves
Fixed Assets + Working Capital
b) Funded Debt to Net Working Capital
= Funded Debt.
Net Working Capital
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Efficiency Ratios
Efficiency ratios are useful for measuring the companys managerial efforts in
managing inventories, production process, credit and effectiveness of marketing and
sales force
These are useful in judging the overall performance of the company
These ratios indicate the managerial capabilities in effectively utilizing the assets of
the company
The following are the important efficiency ratios:
Average Collection Period
Stock Turnover
Total Assets Turnover
Net Working Capital Turnover
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a) Average Collection Period
= Receivables x 360
Net Sales
a) Stock Turnover
= Cost of Goods Sold
Average Stock
a) Total Assets Turnover
= Net Sales .
Total Assets
a) Net Working Capital Turnover
= Net Sales .
Net Working Capital
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Ratios relating to Equity Shareholders/Stock Market
These ratios are of primary interest to the companys shareholders.
a) Earnings Per Share (E.P.S)
= NPAT Preference Dividend
Number of Equity Shares
b) Dividend Per Share (D.P.S)
= Total Equity Dividend
Number of Equity Shares
c) Dividend Yield
= Dividend per Share x 100
Market Price per Share
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d) Book Value per Share
= Equity Share Capital + Reserves & Surplus
Number of Equity Shares
e) Price Earning Ratio (P/E Ratio)
= Market Price Per Share
Earnings Per Share
f) Capital Gearing Ratio
= Preference Capital + Debentures + Term Loans
Equity Share Capital + Reserves
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Technical Analysis Fundamental Analysis
It mainly seeks to predict short-term price
movementsIt tries to analyze long-term values
Its focus is mainly on internal market data,
particularly price and volume data
Its focus is mainly on fundamental factors relating
to the economy, the industry and the firm
Technical analysis appeals mostly to short-term
traders
Fundamental analysis appeals primarily to long-
term investors
Technical analyst looks only backward Fundamental analyst looks forward as well asbackward
Technical analyst thinks that stock market
behavior is 10%logical and 90% psychological
Fundamental analyst thinks that stock market
behavior is 90%logical and 10% psychological
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