Fundamentals of Investing

ByNitasha Shankar

Senior Vice President – ResearchYES Securities India Ltd.

Strictly Confidential.1

Criteria for picking stocks

• Using time frame: Short term -less than 1 year Long term - more than 1 year

• Methodology: Technical Analysis Fundamental Analysis

• Using theories Value investing – pick stocks with high intrinsic value at cheap

valuations Growth investing – picking stocks that are capable of high growth Momentum investing – Picking stocks in industries/sectors that are

currently seeing a positive sentiment.

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One could invest using any of these criteria but the bottom line is the same

– expectation of returns on investment.

Time Frame

Long Term: Investing is all about buying a stock at a discount to its determinable intrinsic value. That value could come from adopting a niche business model or by building a competitive advantage or any other such unique strategies. Ways to identify stocks – uses fundamental analysis to pick stocks based on underlying fundamentals and numbers.

Short Term: While long term investing is one of the proven ways to earn superior returns in capital markets; however it cannot be ruled out that there exist short term opportunities for making quick returns. The caveat here is that these returns are lower and much more riskier. Nevertheless short term opportunities do exist for those who know where to look for them. Ways to identify stocks – uses technical analysis to pick stocks using

charts and trends.

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Both have their pros and cons but investing for long term yields can help earn higher returns

As long term investing can yield higher returns, it is akin to buying a house.

Buying a stock = Buying a House?

Buying a HouseSurvey the location.

Buying a StockStudy the industry.

5Investing in stock is like investing in a home. So it is critical

TO DO YOUR HOMEWORK

Foundation & layout of the house. Financial numbers, profitability & ratios.

Facilities & services provided in premises.

Comparison with peers – what makes them better/worse.

Cost of acquisition Valuations at which stock is available.

Loan facilities available. Does it have too much debt? Can it pay it back and service it?

Nearby schooling/market facilities.

What do vendors and/or customers have to say about the company?

Background check on the builder Background check on the promoter.

-contd.

Buying a House Buying a Stock

6Scales are weighed in favor of equities – What’s holding you back?

Point to Remember

Low HighTransparency

Low HighPrice Volatility

Low HighLiquidity

High-onetime Multiple optionsBudget

Family IndividualDecision maker

Newspapers, ads, word of mouth

Newspapers, company reports,

websites like moneycontrol,

researchbytes, etc.

Source of information

How long should you hold it?Theoretically if you buy a fundamentally sound stock, then why sell it?Practically you need to keep in mind the following:

The reason why you liked the stock – is it still intact Is there any material change in the business model Is there any adverse news related to the company Is there a massive change in strategy Do you really need the money?

Our Suggestion : Always prudent to book some profits by following a disciplined approach. When stock has given your target returns – then book profits.

7Buy when ‘Mr. Market’ is Sad Sell when ‘Mr. Market’ is Happy

Basic things to look at in a stock

Numbers & Ratios: All about the numbers – sales growth, margins, profits, loan levels, capability to pay back these

loans. Ratios – Returns on equity, EBITDA margins, Returns on capital employed, etc. Dividends – a steady source of income

Source: Company annual reports & financials, BSE, NSE, Moneycontrol, etc. Management Quality: Is there any negative information on promoter, is he/she involved in

unrelated business as that could divert attention & focus, what is the past track record, does he have a succession line in place?Source: News articles, message boards on websites, management interviews, company investor presentations, etc. IMPORTANT – DON’T BELIEVE ALL RUMORS but DON’T IGNORE THEM EITHER.ALSO NOT NECESSARY TO REACT TO EVERY NEWS ITEM

Industry and macro outlook: Which industry is the company operating in? What are the steps it has taken to beat its competition or do better than the industry?Source: Company presentations, past track record of numbers, annual reports, peer reports, etc.

Valuations:– “Price is what you pay; value is what you get” – BuffettBuying at cheap valuations helps maximise gains.Source: Financial websites like moneycontrol, researchbytes, etc. Or use ratios like Price to Earnings, Price to Book, etc.

8It may take time but the end results are worth the effort.

Typical tools for valuing a company

Strictly Confidential.9

Valuation Methods

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• Assign a multiple to the company’s operating metric• Multiple based on historic comparable or peer

comparisonMultiple

based

• When a company is unlisted, one needs to look for a comparable transaction that has taken place in the past.

• Valuation based on similarities.• Premium/Discount assigned based on the differences

Precedent Transaction

• Project the company's future unlevered cash flows and calculate the present value of those cash flows and the terminal value using an appropriate cost of capital and terminal value methodology

DCF Analysis

• Individual segments valued as separate assets.• Total value of enterprise is the sum-of-parts or SOTP

SOTP Analysis

Multiple based

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• Commonly used for companies with front loaded capex

• EBITDA a proxy for cash flows• Multiple usually in the range of 6x to 18 x

EV/EBITDA

• Ideal for companies with low depreciation but larger quantities of debt

• Usually in the range of 10 x to 25 xEV/EBIT

• Ideal for companies in the initial stages of operations when profitability is negative.

• Often in the range of 1x to 3 xEV/Sales

Multiple based – contd.

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• Most commonly used metric• Equates net value to the earnings potential• Usually in the range of 10 x to 30 x.

P/E

• Takes into account future growth.• Ideal for companies seeing or expected to see

exponential growth• Usually in the range of 0.5 x to 3x

PEG

• Equates value to the company’s assets• Ideal for banks and financial institutions • Not ideal when most assets are intangible in nature • Often in the range of 1x to 4 x

Price to Book

Typical DCF

Typical DCF – contd.

Capital Markets: How the stock prices and the overall markets move

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• “Markets for buying and selling equity and debt instruments” – Investopedia

• These instruments are collectively called securities.

• Includes both primary markets, i.e., where securities are sold for the first time to investors; and the secondary markets, where subsequent dealing takes place.

• These markets provide the platform for interaction between savers and investors.

• Channelizes capital (funds) from capital suppliers to capital users.

Capital Markets

• Theoretically prices are a function of demand and supply.

• In the capital markets, two broad factors drive prices:

• Emotions

• Fundamentals

• As such we can categorize all factors that influence prices in these 2 broad categories.

• Within these categories, there are several factors that drive prices in the capital markets.

How do the prices move?

1. Sentiments

2. Expectations

3. Momentum

4. Valuations

5. Macro Factors

Major Factors influencing price movement

Sentiments – all about emotions

Sentiments – all about emotions

Expectations – on what the “street” expects

Momentum – what others are doing

VOLUMES

PRICE

SUZLON – PRICES RUNNING UP AS VOLUMES STARTED TO BUILD LEADING TO HIGHER PRICES AND HIGHER VOLUMES

Momentum – what others are doing

VOLUMES

PRICE

NBCC – PRICES RUNNING UP AS VOLUMES STARTED TO BUILD LEADING TO HIGHER PRICES AND HIGHER VOLUMES

Valuations

“Price is what you pay, Value is what you get” - Warren Buffett

Valuations – the long term driver for markets

Valuations – the long term driver for markets

Valuation driven by earnings which is driven by?

Macro Factors

•Government Stability•Macroeconomic factors like economic growth, income growth, investments in the economy, deficit position, etc.•Economic Policies•Monetary and Fiscal Policies•Movement in the exchange rate•External Factors like geopolitical issues, etc.

Thank You