Fundamental Analysis PART I

8/8/2019 Fundamental Analysis PART I

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FUNDAMENTAL ANALYSIS

( Understanding the Broad Picture )

PART-1

Prof. Seema Chakrabarti


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Economies and MarketsEconomies and Markets

A strong relationship exists between the economyA strong relationship exists between the economyand the stock marketand the stock market

Security markets reflect what is going on in anSecurity markets reflect what is going on in aneconomy because the value of an investment iseconomy because the value of an investment isdetermined bydetermined by

its expected cash flowsits expected cash flowsrequired rate of returnrequired rate of return


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Economic Activity andEconomic Activity and

Security MarketsSecurity MarketsStock Market As A Leading IndicatorStock Market As A Leading Indicator

Stock prices reflect expectations of Stock prices reflect expectations of earnings, dividends, and interest ratesearnings, dividends, and interest ratesStock market reacts to various leadingStock market reacts to various leadingindicator seriesindicator seriesStock prices consistently turn before theStock prices consistently turn before theeconomy doeseconomy does


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E - I - C FRAMEWORK

ER HAVE FO HA OCK RICE CHA GE CA BE

A RIB E O HE FO OWI G FAC OR :

y ECONOMY-WIDE FACTORS : 30-35 PERCENT y INDUSTRY FACTORS : 15-20 PERCENT y COMPANY FACTORS : 30-35 PERCENT y

OT HERS FACTORS : 15-25 PERCENT BASED ON T HE A BOVE E VIDENCE, A COMMONLY AD VOCATEDPROCEDURE OF FUNDAMENTAL ANALYSIS IN VOL VES A T HREE-STEP EXAMINATION, W HIC H CALLS FOR :

y UNDERSTANDIN G OF T HE MACRO-ECONOMICENVIRONMENTAND DE VELOPMENTS

y ANALYSIN G THE PROSPECTS OF T HE INDUSTRY TO W HIC H THE FIRM BELON GS

y ASSESSIN G THE PROJECTED PERFORMANCE OF T HECOMPANY .


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T E LO AL ECONOMY

In a globalised business environment, the top down

analysis of the prospects of a firm must begin with the

global economy. The global economy has a bearing on the

export prospects of the firm, the competition it faces from

international competitors, and the profitability of its

overseas investors.


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T E LO AL ECONOMY

W ILE MONITORIN T E LO AL ECONOMY EAR INMIND T E FOLLOWIN

Although the economies of most countries

are linked, economic performance varieswidely across countries at any time.

From time to time countries may experienceturmoil due to a complex interplay between

political and economic factors.The exchange rate is a key factoraffecting the international competitivenessof a countrys industries.


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Central overnment Policies

The overnment employs two broadclasses of macroeconomic policies, viz.demand side policies and supply side policies.

Traditionally, The Focus Was Mostly OnFiscal And Monetary Policies, The TwoMajor Tools Of Demand-side Economics.From 1980s Onward, owever, Supply-sideEconomics as Received A Lot Of Attention.


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FISCAL POLICY

Fiscal policy is concerned with the spending

and tax initiatives of the government . It is themost direct tool to stimulate or dampen theeconomy.

An increase in government spending stimulatesthe demand for goods and services, whereas adecrease deflates the demand for goods andservices.

y the same token, a decrease in tax ratesincreases the consumption of goods andservices and an increase in tax rates decreasesthe consumption of goods and services.


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MONETARY POLICY

Monetary policy is concerned with the manipulation of moneysupply in the economy. Monetary policy affects the economymainly through its impact on interest rates.

T E MAIN TOOLS OF MONETARY POLICY ARE

Open Market Operation

ank Rate

Reserve RequirementsDirect Credit Controls


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Monetary Variables, theMonetary Variables, theEconomy, and Stock PricesEconomy, and Stock Prices

M oney supply and the economyM oney supply and the economy

M oney supply and stock pricesM oney supply and stock prices

Excess liquidity and stock pricesExcess liquidity and stock prices


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Money Supply and the EconomyMoney Supply and the Economy

Declines in the rate of growth of the moneyDeclines in the rate of growth of the moneysupply have preceded business contraction.supply have preceded business contraction.

Increases in the rate of growth of theIncreases in the rate of growth of themoney supply have preceded economicmoney supply have preceded economicexpansions.expansions.


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Money Supply and Stock PricesMoney Supply and Stock PricesExc ess LiquidityExc ess Liquidity

Excess liquidity causesExcess liquidity causes interest ratesinterest rates to fall.to fall.

Fall in the interest rates leads toFall in the interest rates leads to encouragingencouraginginvestment climate.investment climate.

Encouraging investment climate leads toEncouraging investment climate leads toincreased economic activity and capacityincreased economic activity and capacitybuilding and restructuringbuilding and restructuring. .

Economic activity leads toEconomic activity leads to improvement in theimprovement in thestock prices.stock prices.


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Money Supply and Stock PricesMoney Supply and Stock Prices

Tight li qu idity Tight li qu idity

Tight liquidity leads to less money being availableTight liquidity leads to less money being availablefor the industryfor the industry

Causes increase in the interest ratesCauses increase in the interest rates

Discourages investment climate and affectsDiscourages investment climate and affectseconomic activityeconomic activity

Leads to negative sentiments in the market Leads to negative sentiments in the market


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Also . Also .Increase in money supply puts more money inIncrease in money supply puts more money inthe hands of consumersthe hands of consumers

Stimulates increased spendingStimulates increased spending

Businesses increase productionBusinesses increase production

Raises demand for labor and capital goodsRaises demand for labor and capital goods

Capital markets improveCapital markets improve


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And And

If output growth reaches capacity limits pricesIf output growth reaches capacity limits pricesbegin to risebegin to rise

Expect inflationExpect inflation

Lenders increase the lending ratesLenders increase the lending rates

Interest rates risesInterest rates rises

Stock market turns negativeStock market turns negative


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I nflation, I nterest Rates, andI nflation, I nterest Rates, andSecurity PricesSecurity Prices

I nflation and interest ratesI nflation and interest ratesgenerally move togethergenerally move togetherinvestors are not good at predicting inflationinvestors are not good at predicting inflation

I nflation rates and bond pricesI nflation rates and bond pricesnegative relationshipnegative relationshipmore effect on longer term bondsmore effect on longer term bonds

I nterest rates and stock pricesI nterest rates and stock pricesnot direct and not consistent not direct and not consistent

effect varies over timeeffect varies over time


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Cyclical Indicator Approach toCyclical Indicator Approach to

understand the Economyunderstand the EconomyThis approach contends that the aggregateThis approach contends that the aggregateeconomy expands and contracts ineconomy expands and contracts in

discernable periodsdiscernable periods

Cyclical indicator categories:Cyclical indicator categories:

leading indicatorsleading indicatorscoincident indicatorscoincident indicatorslagging indicatorslagging indicators


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Cyclical Indicator CategoriesCyclical Indicator Categories

Leading indicatorsLeading indicators Economic series that Economic series that usually reach peaks or troughs beforeusually reach peaks or troughs before

corresponding peaks or troughs in aggregatecorresponding peaks or troughs in aggregateeconomy activityeconomy activity

C oincident indicatorsC oincident indicators Economic series that Economic series that have peaks and troughs that roughly coincide withhave peaks and troughs that roughly coincide withthe peaks and troughs in the business cyclethe peaks and troughs in the business cycle


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Cyclical Indicator CategoriesCyclical Indicator Categories

Lagging indicatorsLagging indicators Economic series that Economic series that experience their peaks and troughs after those of experience their peaks and troughs after those of

the aggregate economythe aggregate economy

O ther seriesO ther series Economic series that do not fallEconomic series that do not fallinto one of the three main groupsinto one of the three main groups


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Lead IndicatorsLead Indicators

M anufacturers order book M anufacturers order book Capital goods order book Capital goods order book Index of stocksIndex of stocksM oney SupplyM oney SupplyInterest Rate SpreadsInterest Rate SpreadsConsumers Business Confidence IndexConsumers Business Confidence IndexUnemployment rateUnemployment rate


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Lag indicatorsLag indicators

Credit expansionCredit expansionBank PLR Bank PLR Inventories to salesInventories to sales


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MACRO ECONOMIC ANALYSIS

E MACROECONOMY IS E O ERALL ECONOMIC

EN IRONMEN IN IC ALL IRMS O ERA E E EYARIA LES COMMONLY SE O ESCRI E E S A E O EMACROECONOMY ARE

y GROWTH RATE OF GROSS DOMESTIC PRODUCTy INDUSTRIAL GROWTH RATEy AGRICULTURE AND MONSOONSy SAVINGS AND INVESTMENTSy GOVERNMENT BUDGET AND DEFICITy PRICE LEVEL AND INFLATIONy INTEREST RATESy BALANCE OF PAYMENT, FOREX RESERVES, AND EXCHANGE

RATEy INFRASTRUCTURAL FACILITIES AND ARRANGEMENTSy SENTIMENTS


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Industry AnalysisIndustry Analysis App roaches to industry analysis: App roaches to industry analysis:

Sensitivity to business cycleSensitivity to business cycle

Study of structure & characteristics of the industryStudy of structure & characteristics of the industry

Industry Life cycleIndustry Life cycle

Profit po tential o f industries : P o rter m o delPro fit po tential o f industries : P o rter m o del


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Industry AnalysisIndustry AnalysisSENS ITI VITY TO BUS I NESS CYCL Eis determ in ed by:

Sensiti vity of Sale s Opera tin g Leverage s Fin an ci al Leverage

Study of structure & characteristics of theStudy of structure & characteristics of theindustryindustryStructure of the industry & nature of competitionStructure of the industry & nature of competitionNature & prospects of demandNature & prospects of demandCost, Efficiency & ProfitabilityCost, Efficiency & ProfitabilityTechnology & ResearchTechnology & Research


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INDUSTRY ANALYSISINDUSTRY LIFE CYCLE ANALYSIS

PIONEERIN STA E

RAPID ROWT STA E MATURITY & STA ILIZN STA E DECLINE STA E

PROFIT POTENTIAL OF INDUSTRIES FORCES DRI IN COMPETITION PORTER MODEL

POTENTIALENTRANTS

TREAT OF NEW ENTRANTSAR AININ INDUSTRY AR AININ

SUPPLIERS RI ALRY UYERSPOWER OF AMON POWER OFSUPPLIERS FIRMS UYERS

T REAT OFSU STITUTEPRODUCTS

SU STITUTES


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INDUSTRY ANALYSISINDUSTRY LIFE CYCLE ANALYSIS

PIONEERIN STA E

RAPID ROWT STA E MATURITY & STA ILIZN STA E DECLINE STA E

PROFIT POTENTIAL OF INDUSTRIES FORCES DRI IN COMPETITION PORTER MODEL

POTENTIALENTRANTS

TREAT OF NEW ENTRANTSAR AININ INDUSTRY AR AININ

SUPPLIERS RI ALRY UYERSPOWER OF AMON POWER OFSUPPLIERS FIRMS UYERS

T REAT OFSU STITUTEPRODUCTS

SU STITUTES

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Fundamental Analysis PART I

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