The objective of fundamental security analysis is to appraise the intrinsic value of a security.The intrinsic value is the true economic worth of a financial asset.The fundamentalist maintain that at any point of time every share has an intrinsic value which should in principle be equal to the present value of the future stream of income from that share discounted at an appropriate risk related rate of interest.
The fundamentalist attempt to estimate the real worth of a security by considering.The real worth of a security by considering the earning potential of a firm which in turn will depend on investment environment factor such as state and growth of national economy,monetary policies of the reserve bank of India corporate laws environment and the factor relating to the specific Industry such as state of product and the growth potential of the industry.
It will depend to a large extent,on the firm’s competitiveness,its quality of management operational efficiency profitability,capital structure and dividend policy.
Fundamental analysis has consist with three factor.
First we consider economy analysis.
1)Economy analysis-An investment in the equity of any company is likely to be more profitable if the economy is strong and prosperous,so the expectation of the growth of the economy is favorable for the stock market.
Not all industries grow at the same rate,do all companies. The growth of a company or an industry depend basically on its ability to satisfy human wants through production of goods or performance of service.
Investment climate in an economy can be observed from the GNP and its components.GNP stand for gross national product,the broadest measure of economic activity used to determine where the national economy is where it has been and where it has been and where it is going.
Monetary and financial conditions are reflecting these demand supply gaps as well as the onset of a durable pick-up in aggregate spending.Banks non-food credit is beginning to dip after expanding abuse 30 percent for three years in succession.Driving up money supply and squeezing overall liquidity.The growth of bank.Credit has favored retail lending particular housing real estate trade,transport and professional service and non-banking financial companies sector which were not significant in the credit market.
Leading,coincidental and lagging Indexes.
The economic indicator are grouped into leading indexes to help in analysis and for casting.The coincidal indicator include GNP in constant or “real” terms,corporate profits,industrial production unemployment and the producer price index.There are many coincidental indexes,but these are the most common.The indicator tell us what is happening in the economy,but they do forecast the future.
The leading indicator tell us what to expect in the future.Some of the popular leading indexes are fiscal policy.Monetary policy,GNP deflator productivity,consumer spending, residential construction and stock prices as measured by the RBI etc.
The lagging indicators turn after the movement in the coincidental indicators.The best-know lagging indicator is the prime rate,which usually turns down a few months or quarters after a turn down in the economy.
Commercial paper rates, capital,expenditure the inventory sales,ratio retail sales and the consumer price index are other important lagging indicator.
Significance and Interpretation of the economic Indicators.
The investor makes an analysis of the economy primarily to determine an investment strategy,It is not necessary to make their own economic forecasts.The primary responsibility is to identity the trends in the economy and adjust the investment position accordingly many of the published forecasts are excellent and provide the necessary perspective.
The variance for analysis have their own significance.The GNP is nominal and real terms is a useful economic indicator.
2) Industry analysis
The industries that contribute to the output of the major segment of the economy vary in their growth rate and in their overall contribution to economic activity some have growth more rapidly than GNP and offer the expectation of continued growth other have maintained a growth comparable to that of the GNP.A flow have been unable to expand and have declined in economic.
Significance seeking industries that are expected to grow at faster than the “real rate of GNP for the future seems to be a logical starting position.
In a broad sense an industry might be considered a community of interests.This concept would reflect the idea of a group of people coming together because they do a certain type of work or produce a similar type of production.Such group would include agriculture as well as manufacturing,mining and merchandising.
The classification of an industry is important when we analyze its growth.Each industry takes the share of the GNP with every other industry .Thus,the manufacturing industry compete with agriculture, transaction and public utilities.
This inter industry competition is important and within each major industry classification.The product or service-oriented segments compete for share GNP.
A second reason for a domination in the industry growth rate is the nature of the technological change itself.The basic types of major technological changes help to produce an old product more cheaply or a completely new product on mass basis.
A high priced commodity or service is changed a low priced one making it available to a large market.
A third factor that tend to limit the growth of an industry is competitive pressure from other industries.The industry that first experienced a technological change may be restrained by the development of a new industry,competing directly for raw material and thus tending to raise costs for the original industry and limit its expansion potential.Sometime ,new industries are directly competitive with the old product or original product.
Fourth and final factor that might reduce the rate of growth of an industry is a decrease decreased population growth.In order for a product to expand its output at an increasing rate,per capita output would have to grow at an increasing rate.For this to occur,consumers would have to spend more of their income.
The consumer’s income does not increase as fast as the growth of the product,because the economy grows more slowly than an industry experiencing rapid growth, and so it is unlikely that the industry’s growth rate can be sustained.
Investment classification of industries
- The discussion upto this point has been about the economic classification of industries.Investment services provide basic industry information more closely related to our needs and concentrate more on companies within the industry.If an industry appears yo offer attractive future benefit,we can easily translate this into the probability that a company’s equity will allow us to share in the industry’s prosperity.
Selecting an Expanding Industry
An understanding of the growth pattern of an industry and of the stages of growth pioneering,expansion and stagnation as well as the sign of obsolescence, should help us reach a solution to the problem of where to invest.the investor should select industries that are in the expansion stage of the growth cycle and should concentrate on these areas.Except for special circumstances brought about by individual portfolio needs,an investor should not invest in industries in the pioneering stage unless he or she is prepared to accept a great deal of speculative risk,comparable to that assumed by the innovator or speculator
The specific market and economic environment may enhance the performance of a company for a period of time,it is ultimately the firm’s own capabilities that will judge its performance over a long period of time .
A)Marketing first variable that influences future earning in terms of both quality and quantity is the marketing results of the firm in comparison to industry.This in turn is determined by the share of the company in the industry,growth of its sales and stability of sales.A company in a strong competitive position will provide greater earning with more certainty.
1.Sales:The rupee amount of annual sales and its share market help to determine a company’s relative competitive position within the industry and how successful it has been RI meeting competition.Here to rank the company, the companies should be comparable in like product groups
2.Growth in sales:The annual growth in sales is equally if not more important than the amount of sale in determining the competitive position of the company.Expanding annual sales and adequate financing firm will be in a better position to earn money.
3.Stability of sales:Stability of sales will provide stable earning for a firm,other things of plant .Aggregate sales of various industries vary in their degree of stability and company’s sales should have same pattern as that of the industry.
B)Accounting policies:There is a risk of faulty Interpretation of corporate earnings and consequent bad judgement in purchasing,keeping or selling stock.
1)Inventory pricing:i)Cost or market value methods in which case inventory is priced at lower of average cost of inventory or the market price.
ii)First in first out,method in which the inventory is priced at the cost of last purchase and the cost of goods first acquired are adjusted in cost of sales.
iii)Last in first out method is just opposite of the FIFO method.Here cost of inventory is on basis of first purchase and last purchase and last purchase cost is adjusted in cost of sales.
2)Depreciation methods:The depreciation for wear and tear of the machinery and so reduction in value of assets is provided as fixed expenses.The change providing provision for depreciation will thus affect net income and also affect net income and also affect the valuation of the assets.
3)Non-operating Income:Non-operating income such as dividend income,interest,etc,generally occur to the firms.To avoid error of judgement these incomes should be studied.In certain accounting period the non-operating income for reason such as gains or losses due to sale of fixed asset of the comoany.
C)Profitability-We are interested in income amount stability a growth of these earning particularly the amount and when they will be recieved.This rest on the assumptions that the profitability the relationship between the sales and earning,will remain constant to study the relationship if expenses and sales,one needs to study the trends of the profitability ratios, namely, gross profit margin,net profit margin,earning power return on equity and earning per share.
D)Dividend policy:In most of the cases it is observed that the management tries to have a stable dividend policy and increase the dividend only when they expect they will be able to maintain the higher rate of dividend in future.