The examination and evaluation of the relevant information to select the best course of action from among various alternatives. The methods used to analyze securities and make investment decisions fall into two very broad categories: fundamental analysis and technical analysis. Fundamental analysis involves analyzing the characteristics of a company in order to estimate its value. Technical analysis takes a completely different approach; it doesn’t care one bit about the “value” of a company or a commodity. Technicians (sometimes called chartists) are only interested in the price movement in the market.
What is technical analysis? Technical analysis is a method of evaluating securities by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. What is fundamental analysis? Fundamental Analysis involves examining the economic, financial and other qualitative and quantitative factors related to a security in order to determine its intrinsic value.
It attempts to study everything that can affect the security’s value, including macroeconomic factors (like the overall economy and industry conditions) and individually specific factors (like the financial condition and management of companies). Fundamental analysis, which is also known as quantitative analysis, involves delving into a company? s financial statements (such as profit and loss account and balance sheet) in order to study various financial indicators (such as revenues, earnings, liabilities, expenses and assets). Such analysis is usually carried out by analysts, brokers and savvy investors.
Many analysts and investors focus on a single number–net income (or earnings)–to evaluate performance. When investors attempt to forecast the market value of a firm, they frequently rely on earnings. Many institutional investors, analysts and regulators believe earnings are not as relevant as they once were. Due to nonrecurring events, disparities in measuring risk and management’s ability to disguise fundamental earnings problems, other measures beyond net income can assist in predicting future firm earnings. Two Approaches of fundamental analysis
While carrying out fundamental analysis, investors can use either of the following approaches: 1 . Top-down approach: In this approach, an analyst investigates both international and national economic indicators, such as GDP growth rates, energy prices, inflation and interest rates. The 8 search for the best security then trickles down to the analysis of total sales, price levels and foreign competition in a sector in order to identify the best business in the sector. 2. Bottom-up approach: In this approach, an analyst starts the search with specific businesses, irrespective of their industry/region.
How does fundamental analysis works? Fundamental analysis is carried out with the aim of predicting the future performance of a company. It is based on the theory that the market price of a security tends to move towards its ‘real value’ or ‘intrinsic value. ‘ Thus, the intrinsic value of a security being higher than the security? s market value represents a time to buy. If the value of the security is lower than its market price, investors should sell it. The steps involved in fundamental analysis are: 1.
Macroeconomic analysis, which involves considering currencies, commodities and indices. 2. Industry sector analysis, which involves the analysis of companies that are a part of the sector. 3. Situational analysis of a company. 4. Financial analysis of the company. 5. Valuation The valuation of any security is done through the discounted cash flow (DCF) model, which takes into consideration: 1. Dividends received by investors 2. Earnings or cash flows of a company 3. Debt, which is calculated by using the debt to equity ratio and the current ratio (current assets/current liabilities)
Fundamental Analysis Tools These are the most popular tools of fundamental analysis. Earnings per Share – EPS Price to Earnings Ratio – P/E 9 Projected Earnings Growth – PEG Price to Sales – P/S Price to Book – P/B Dividend Payout Ratio Dividend Yield Book Value Return on Equity Ratio analysis Financial ratios are tools for interpreting financial statements to provide a basis for valuing securities and appraising financial and management performance. A good financial analyst will build in financial ratio calculations extensively in a financial modeling exercise to enable robust analysis.
Financial ratios allow a financial analyst to: Standardize information from financial statements across multiple financial years to allow comparison of a firm? s performance over time in a financial model. Standardize information from financial statements from different companies to allow apples to apples comparison between firms of differing size in a financial model. Measure key relationships by relating inputs (costs) with outputs (benefits) and facilitates comparison of these relationships over time and across firms in a financial model.
In general, there are 4 kinds of financial ratios that a financial analyst will use most frequently, these are: Performance ratios Working capital ratios Liquidity ratios Solvency ratios These 4 financial ratios allow a good financial analyst to quickly and efficiently address the following questions or concerns: 10 Performance ratios What return is the company making on its capital investment? What are its profit margins? Working capital ratios How quickly are debts paid? How many times is inventory turned? Liquidity ratios Can the company continue to pay its liabilities and debts?
Solvency ratios (Longer term) What is the level of debt in relation to other assets and to equity? Is the level of interest payable out of profits? WHY ONLY FUNDAMENTAL ANALYSIS Long-term Trends Fundamental analysis is good for long-term investments based on long-term trends, very long-term. The ability to identify and predict long-term economic, demographic, technological or consumer trends can benefit patient investors who pick the right industry groups or companies. Value Spotting Sound fundamental analysis will help identify companies that represent a good value. Some of the most legendary investors think long-term and value.
Graham and Dodd, Warren Buffett and John Neff are seen as the champions of value investing. Fundamental analysis can help uncover companies with valuable assets, a strong balance sheet, stable earnings, and staying power. Business insights One of the most obvious, but less tangible, rewards of fundamental analysis is the development of a thorough understanding of the business. After such pains taking research and analysis, an investor will be familiar with the key revenue and profit drivers behind a company. Earnings and earnings expectations can be potent drivers of equity prices. Even some technicians will agree to that. 11
A good understanding can help investors avoid companies that are prone to shortfalls and identify those that continue to deliver. In addition to understanding the business, fundamental analysis allows investors to develop an understanding of the key value drivers and companies within an industry. A stock’s price is heavily influenced by its industry group. By studying these groups, investors can better position themselves to identify opportunities that are high-risk (tech), low-risk (utilities), growth oriented (computer), value driven (oil), non-cyclical (consumer staples), cyclical (transportation) or incomeoriented (high yield).
Knowing Who’s Who Stocks move as a group. By understanding a company’s business, investors can better position themselves to categorize stocks within their relevant industry group. Business can change rapidly and with it the revenue mix of a company. This has happened with many of the pure internet retailers, which were not really internet companies, but plain retailers. Knowing a company’s business and being able to place it in a group can make a huge difference in relative valuations. The charts of the technical analyst may give all kinds of profit alerts, signals and alarms, but there?
s little in the charts that tell us why a group of people make the choices that create the price patterns Objective of the study To analyze economy by using some economic indicators like GDP, and inflation rate etc for the selected period of 5 years. To analyze the industry especially private bank industry for the selected period of 5 years. To carry out financial and non-financial analysis of ICICI bank as a whole for the selected period. DATA SOURCES Secondary data has been collected from various sources to analyze the fundamentals.
The secondary data has been collected from Books ACE equity database Internet-websites 12 PERIOD OF STUDY: The period of study for the analysis is five years from 2006-2010. CHAPTER PLAN It is proposed to divide the project into following chapters. CHAPTER 1: INTRODUCTION TO STUDY This chapter will be introductory in nature covering the relevance of study. CHAPTER 2: CONCEPTUAL FRAMEWORK OF FUNDAMENTAL ANALYSIS This chapter will include a comprehensive study of the concept of Fundamental analysis And its tools.
CHAPTER 3: DATA SOURCE AND RESEARCH METHODOLOGY This chapter will give an inside into source of data and method of undertaking research. CHAPTER 4: DATA ANALYSIS This is the chapter of all observations, inferences, analysis and conclusions that will be made out of the data analysis during the course of study. CHAPTER 5: LIMITATIONS AND SUGGESTIONS All the limitations and stumbling blocks that will be encountered during the study will be discussed in this chapter along with the future scope and suggestions.