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COMPANY ANALYSIS

The stock price has been found to depend on the intrinsic value of the company’s share to the extent of
about 50% as per many research studies. Some of the shares of companies may be blue chip stock or
growth stocks, which are expanding and diversifying and their growth rates are higher than the market
averages. Many investors, who are particularly averse to risk, prefer income stocks. These stocks are
expected to give consistent dividends and with a good record of income distribution. It is important to
analyze the financial data of the company to assess its functioning and credibility.

Elements of Financial Analysis

Financial analysis is analysis of financial statements of a company to assess its financial health and
soundness of its management. “financial Statement Analysis” involves a study of the financial statements
of a company to ascertain its prevailing state of affairs and the reasons therefore. Such a study would
enable the public and investors to ascertain whether one company is more profitable than the other and
also to state the causes and factors that are probably responsible for this.

Analysis and Interpretation: the analysis of financial statements includes:

a. Comparison of the financial statements

b. Ratio analysis of two to five years.
c. Fund flow analysis
d. Trend analysis

Ratio Analysis

Ratio is a statistical yardstick that provides a measure of relationship between any two variables. It can be
effectively used as a toll of management along with fund flow statements and trend analysis for
interpretation of the financial statements.
Ratios may be classified as:
a. Revenue statement ratios: gross profit ratio, operating ratio, expense ratio, net profit ratio.
b. Balance sheet ratios: current ratio, debt equity ratio, asset equity ratio, liquidity ratio.

Use and Limitations of Financial Ratios

Attention should be given to the following issues when using financial ratios:
• A reference point is needed. To to be meaningful, most ratios must be compared to historical
values of the same firm, the firm's forecasts, or ratios of similar firms.
• Most ratios by themselves are not highly meaningful. They should be viewed as indicators, with
several of them combined to paint a picture of the firm's situation.
• Year-end values may not be representative. Certain account balances that are used to calculate
ratios may increase or decrease at the end of the accounting period because of seasonal factors.
Such changes may distort the value of the ratio. Average values should be used when they are
available.
• Ratios are subject to the limitations of accounting methods. Different accounting choices may
result in significantly different ratio values.

Fund Flow Analysis

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The balance sheet of a company reveals its financial ststus at a point of time. The operation of business
involves the conversion of cash into non-cash assets which are recovered back into cash form. The
statement showing sources and uses of funds is properly kn own as Fund Flow Statements.

The changes representing the sources of funds in the business may be issue of debentures, increase in net
worth, addition to funds, reserves and surplus, retention of earnings.

Changes showing the uses of funds include

a. Additions to assets
b. Addition to investments.
c. Decrease in liabilities by paying off loans and creditors.
d. Decrease in net worth by incurring losses, withdrawal of funds from business, etc.

Cash Flow Statements

Cash Flow statement is an essential tool for short term financial analysis an planning.

Its main advantages are as follows:

(i) Planning and Co-ordination of Financial Operations. Cash Flow Statement is useful is evaluating
Financial policies and current cash position. Since cash is the basis for carrying on operations, the Cash
Flow Statement prepared on an estimated basis for the next accounting period will enable the
management to plan and co-ordinate the financial operations probably. The management comes to know
how much cash is needed in the future and at what time and how can it be arranged-how much internally
and how much from outside. It is especially useful in preparing cash budgets.
(ii) A Control Device. Cash Flow statement is also a control device for the management. A comparison of
cash flow statement of previous year with the budget for that year would indicate to what extent the
resources of the enterprise were raised an applied according to the plan. Thus a comparison of original
forecast with actual results may highlights trends of movement that might otherwise go undetected.
(iii) Useful to internal Financial Management. Since it gives a clear picture of cash inflow from
operations (and not income flow of operation), it is, therefore, very useful to internal financial
management in considering the possibility of retiring ling-term debts, in planning replacement of plant
facilities or in formulating dividend policies.
(iv) Profit and Cash Positions. It enables the management to account for situation when business has
earned huge profits yet run without money or when it has suffered a loss and still has plenty of money at
the bank.
(v) Short-term Financial Decisions. Cash Flow Statement helps the management in taking short-term
financial decisions. Suppose, if firm wants to know its state of solvency after one month from to date, it is
possible only from Cash Flow analysis and not from Fund Flow Statement. Shorter the period, greater is
the importance of Cash Flow Statement.
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FUNDAMENTAL ANALYSIS
Influence of the Economy

Companies are a part of the industrial and business sector, which in turn is a part of the overall economy.
Thus the performance of a company depends on the performance of the economy in the first place. If the
economy is in recession or stagnation, ceteris paribus, the performance of companies will be bed in
general, with some exceptions however. On the other hand, if the economy is booming, incomes are
rising and the demand is good, then the industries and the companies in general may be prosperous, with
some exception however.

In the Indian economy, the matters to be considered in the first place are the behavior of the monsoon and
the performance of agriculture. As agriculture is the mainstay of the 70% of the population and
contributes nearly 35% of the output of the economy, it is important for the assessment and forecast of
industrial performance. If the monsoon is good and agricultural income rise, the demand for industrial
products and services will be good and industry propsers.

Secondly, India has a mixed economy, where the public sector plays a vital role. The Government being
the biggest investor and spender, the trends in public investment and expenditure would indicate the
likely performance of the Indian economy. Concomitant with this, the government budget policy, tax
levies and government borrowing programme along with the extent of deficit financing will have a major
influence on the performance of the Indian economy, as these influence the demand and income of the
people. The changes in excise and customs duties, corporate taxes, etc. are all relevant to assess the trends
in the economy as they have an impact on the industry and the companies.

Thirdly, the monetary policy and trends in money supply which mainly depend on the government’s
budget policy, its borrowing from the public and credit from the banks and the RBI, have a major impact
on the industrial growth through the cost and availability of credit, the profit margins of the companies
etc. The monetary situation along with the budgetary policy influences the movement in price level
(inflation) and interest rates. The tight money position, increasing budget deficits and RBI creation of
currency lead to an inflationary spiral. Although some interest rates in the organized financial system are
now freed, the bazaar rates in the unorganized market do reflect the availability of funds in the free
markets. So interest rates in the free markets and the degree of inflation do have a major influence on the
economy and the performance of the industries. Although a mild inflation is good for business
psychology, higher degrees of inflation, particularly in two digits, will defeat all business planning, lead
to cost escalation sand squeeze on profit margins. These will adversely affect the performance of industry
and companies.

Fourthly, the general business conditions in the form of business cycles or the level of business activity to
influence the demand for industrial products and the performance of the industry. In India, there are no
business cycles but outputs do fluctuate depending upon the state of the economy, performance of
agriculture, availability of power and other infrastructural outputs, imported inputs and a host of other
factors. These factors do influence the costs and profit margins of companies from both demand and
supply sides. The business earnings and profits are affected by such changes in business conditions.
Fifthly, the economic and political stability in the form of stable and long-term economic policies and a
stable political system with no uncertainty would also be necessary for a good performance of the
economy in general and of companies in particular

The Government regulations being all-pervasive in India, the government policy has to be known in
advance in all its aspects and there should be no uncertainty about the political system as economic and
political factors are interlinked. Political uncertainties and adverse changes in government policy do
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adversely affect industrial growth. Government policy relating to projects, clearance for foreign
collaboration and foreign investment, price and distribution controls, and listing requirements on stock
exchanges and a host of other matters like import restrictions do affect the performance of companies.
The foreign exchange position and the balance of payments situation at any time would also indicate the
rigors of government policy with regard to imports, exports, foreign investment and related matters.
All the above factors of the economy influence the corporate performance and the industry in general. In
any investment analysis, a broad picture of these factors and a forecast of the growth of the economy and
of industry would be necessary to decide when to invest and what to invest in. At any stage in the
economy, there are some industries which are growing while others are declining. The performance of
companies will depend among other things upon the state of the industry as a whole and the economy. If
the industry is propserous, the companies, within the industries may also be propserous although a few
may be in a bad shape.

The performance of a company is thus a function not only of the industry and of the economy, but more
importantly, on its own performance. The shape price of the company is empirically found to depend up
to 50% on the performance of the industry and economy. The economic and political situation in the
country has thus a bearing on the prospects of the company. There are different phases in the economy
such as boom, depression, recession, etc. The performance of the economy in India is not cyclical as in
the case of developed countries exhibiting business cycles, as the Indian economy depends basically on
the monsoon and the growth rate of agriculture. Besides, with a huge public sector in our mixed economy,
the performance of the five-year plan, yearly public investment, government expenditure and a host of
other factors influence the economy, industry and company. Thus one important factors the fiscal policy
which incorporates government expenditure and taxation, borrowing, deficit financing, etc. and which
influence both the public and private sectors in the economy.

The industrial growth in general and of infrastructural industries in particular influences the corporate
performance. As referred to earlier at any stage in the economy there are some indutries growing fast
while orders are declining. The performance of companies will depend among other things upon testate of
the industry as a whole. If the industry is prosperous, the companies, within the industries may also be
prosperous, if the economy is also doing well. The performance of a company is tusk a function of the
industry and of the economy in addition to its own performance .As referred to earlier, the share price of
the company is empirically found to depend up to 50% on the performance of the industry and economy.
The economic and political situation in the country has thus a bearing on the prospects of the company.
The industries in different stages of growth are shown below:-Even in industries of above average
growth, there may be some companies of poor growth or no growth at all. The fundamentals of the
company will explain this. The Market Price (MP) is a function of intrinsic factors to the extent of about
½ of it and the rest is accounted by the expectations, psychological and sentimental factors, as shown
below. In the above context, any particular industry can be studied with a view to assess the problems,
prospects, etc. of the company in the industry.

The industry data are to be examined from the point of view of the product-mix, raw materials,
components, pricing cost of production, etc., profit margins and related data juxtaposed with those of the
company. The capacity utilization of the industry in general and of the company in question within the
industry is to be compared. The demand and supply, the market conditions and the share of the company
in the market are to be studied before making a projection of its future growth, keeping the industry
prospects in mind. The future profitability can be assessed from the half yearly and annual reports, press
releases, AGM’s reports, market reports, management interviews and Industry and Commerce
Association’s publications. The share of the company in which investment is sought is to be analyzed in
terms of the fundamentals of the company in the background of the industry’s performance. The decision
to buy has to be on the basis of whether the price of the share is proper and the future profitability is good
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based on a rational forecast for the future. We have to consider the quantifiable factors and qualitative to
consider the capital efficiency and the sales turnover and the profitability margins. The quantifiable data
are based on financial statement Analysis. The qualitative factors are:
a. Management efficiency,
b. Rating of promoters,
c. Rating of collaborators,
d. Uniqueness of the product,
e. Location of government policy and patronage, etc.

The industrial position not only depends upon the economic growth but on the nature of the industry
itself. Within the industry the factors which have to be taken into account are the product-mix, the various
outputs, nature of the products, inputs and raw materials, installed capacity of the industry -utilization of
capacity - the market nature of the inputs, their domestic availability and the problems of the industry in
general. The pricing and the Government controls on prices, distribution, etc., controls on imports and tax
policy, excise and customs duties etc. would influence the cost of production and the profit margins of the
industry, as also the prospects of growth. In the area of market, the demand for the products produced and
the prospects for exports, protection or tariff preferences, etc. influence the prospects of the industry. In
many industries, the raw materials and other inputs and their availability domestically, particularly of
electricity, have a major influence on the market from the point of view of supply. Labour conditions in
the industry should also be looked into and have a bearing on growth prospects. In the company analysis,
the financial highlights of the companies, which are influenced by the industry and the economy are the
capacity utilization, demand, cost and profit margins. The state of the capital market and the capacity to
raise capital from the market not only depend on the performance of the companies but of the economy
and the industry as well. The fundamentals of the company are to be analyzed in terms of its financial
structure, leverage, liquidity and profitability, financial viability, etc. The information for this purpose is
to be secured from the annual reports of the company, balance sheets, press reports, AGM’s reports
management’s press releases and the publications of the Industry and Commerce Associations.

The most important variable influencing the company’s performance is management, namely, the quality,
capability, popularity and integrity of the management. Generally, the rating of the promoters and
management has to be looked into through their plans, financial management, growth orientation,
expansion plans, tax planning, R & D, technology, etc. The popularity of the management is known from
their track record, retention policy, distribution of dividends and bonus, etc. The honesty and integrity of
the management can be seen from the shareholding pattern and the availability of floating stock and the
liquidity of shares of the company. In the area of financial management, companies ‘financial structure,
retention policy, dividend record, bonus policy and liquidity ratios, etc. are to be looked into. The market
capitalization of a share is to be compared with the book value and the intrinsic worth of the company.
The share has to be examined to know whether it is properly priced and reflects its true intrinsic value.
The P/E ratio and earnings per share, book value, etc. are to be looked into in this context. Only shares
which are underpriced are to be generally purchased, provided they have the potential for growth and
capital appreciation. In the above context, any particular industry can be studied with a view to assess the
problems, prospects, etc. of the company in the industry. The industry data are to be examined from the
point of view of the installed capacity and its utilization, raw materials, components, pricing, cost of
production, etc., profit margins and related data juxtaposed with those of the company. The capacity
utilization of the industry in general and of the company in question within the industry is to be
compared.
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The demand and supply, the market conditions and the share of the company in the market are to be
studied before making a projection of its future growth, keeping the industry prospects in mind. The
future profitability can be assessed from the half-yearly and annual reports, press releases, AGM’s
reports, market reports, management interviews and Industry and Commerce Association’s publications.
The stock of the company in which investment is sought is to be analyzed in terms of the fundamentals of
the company in the background of the industry’s performance. The decision to buy has to be on the basis
of whether the price of the share is proper and the future profitability is good based on a rational forecast
for the future. To examine the financial highlights, we have to consider among other things, the capital
efficiency and the sales turnover and the profitability margins. For this purpose, the following
components may be taken into account. Normally, a company uses capital efficiently by having a high
turnover of equity. Similarly, the use of capital is efficient if there is a high sales turnover to gross block.
The company may have only a small profit margin but if the sales turnover is high, the profits will also be
high. Gross profits-to-sales ratio measures the profit margins. In this context, the growth of gross block,
sales, equity, and gross profits are to be analyzed in respect of each company within the industry. On this
basis, these ratios of companies within the industry are to be compared with the industry’s overall
operating performance in respect of the variables referred to earlier. The gross profit (GP)is also to be
examined in relation to the market capitalization. The riskless return is 12% and a reasonable return is
15%.Depreciation, taxes, etc. may account for another 15%. A total return in the form of gross profit of
not less than 30% is, therefore, to be expected from any company to start with. If a company in any
industry is less profitable than that, it is not worth the purchase. Similarly, gross profit to gross block and
the dividend policy, earning per share and bonus payouts are all to be examined from the point of view of
the future prospects of the company in the background of industry performance and possible capital
appreciation of the shares.