Fundamental analysis of stocks/ company

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Fundamental
Analysis
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Definition:
Fundamental analysis (FA) is a method of measuring a security's intrinsic value
by examining related economic and financial factors. Fundamental analysts
study anything that can affect the security's value, from macroeconomic factors
such as the state of the economy and industry conditions to microeconomic
factors like the effectiveness of the company's management.
The end goal is to arrive at a number that an investor can compare with a
security's current price in order to see whether the security is undervalued or
overvalued.

Financial Ratios
Profitability Ratios
Leverage Ratios
Valuation Ratios
Operating Ratios

Profitability Ratios
The Profitability ratios help the analyst measure the profitability of the company.
The ratios convey how well the company is able to perform in terms of
generating profits. Profitability of a company also signals the competitiveness of
the management. As the profits are needed for business expansion and to pay
dividends to its shareholders a company’s profitability is an important
consideration for the shareholders.

In Details
EBITDA Margin (Operating Profit Margin)
PAT Margin
Return on Equity (ROE)
Return on Asset (ROA)
Return on Capital Employed (ROCE)

EBITDA Margin:
EBITDA = [Operating Revenues – Operating Expense]
EBIDTA Margin = EBITDA / [Total Revenue – Other Income]

PAT (Profit After Tax) Margin:
PAT Margin = [PAT/Total Revenues]

Return on Equity (RoE):
RoE shows the efficiency of the company in terms of generating profits to its
shareholders.
RoE can be calculated as: [Net Profit / Shareholders Equity* 100]

Return on Asset (RoA):
Return on Assets (RoA) evaluates the effectiveness of the entity’s ability to use
the assets to create profits. A well managed entity limits investments in non
productive assets. Hence RoA indicates the management’s efficiency at deploying
its assets.
RoA = [Net income + interest*(1-tax rate)] / Total Average Assets

Return on Capital Employed (ROCE):
The Return on Capital employed indicates the profitability of the company taking
into consideration the overall capital it employs.
ROCE = [Profit before Interest & Taxes / Overall Capital Employed]

Leverage Ratios
The Leverage ratios also referred to as solvency ratios/ gearing ratios measures
the company’s ability (in the long term) to sustain its day to day operations.
Leverage ratios measure the extent to which the company uses the debt to
finance growth. Remember for the company to sustain its operations, it has to
pay its bills and obligations. Solvency ratios help us understand the company’s
long term sustainability, keeping its obligation in perspective.

In Detail:
Interest Coverage Ratio
Debt to Equity Ratio
Debt to Asset Ratio
Financial Leverage Ratio

Interest Coverage Ratio:
The interest coverage ratio is also referred to as debt service ratio or the debt
service coverage ratio. The interest coverage ratio helps us understand how
much the company is earning relative to the interest burden of the company.
This ratio helps us interpret how easily a company can pay its interest payments.
The formula to calculate the interest coverage ratio:
[Earnings before Interest and Tax / Interest Payment]

Debt to Equity Ratio:
A value of 1 on this ratio indicates an equal amount of debt and equity capital.
Higher debt to equity (more than 1) indicates higher leverage and hence one
needs to be careful. Lower than 1 indicates a relatively bigger equity base with
respect to the debt.
[Total Debt/Total Equity]

Debt to Asset Ratio:
This ratio helps us understand the asset financing pattern of the company. It
conveys to us how much of the total assets are financed through debt capital.
Total Debt / Total Assets

Financial Leverage Ratio
The financial leverage ratio gives us an indication, to what extent the assets are
supported by equity.
Average Total Asset / Average Total Equity

Valuation ratios
The Valuation ratios compare the stock price of the company with either the
profitability of the company or the overall value of company to get a sense of
how cheap or expensive the stock is trading. Thus this ratio helps us in analysing
whether the current share price of the company is perceived as high or low. In
simpler words, the valuation ratio compares the cost of a security with the perks
of owning the stock.

In Detail
Price to Sales (P/S) Ratio
Price to Book Value (P/BV) Ratio and
Price to Earnings (P/E) Ratio

Price to Sales (P/S) Ratio
This ratio compares the stock price of the company with the company’s sales per
share.
Price to sales ratio = Current Share Price / Sales per Share

Price to Book Value (P/BV) Ratio
A high ratio could indicate the firm is overvalued relative to the equity/ book
value of the company. A low ratio could indicate the company is undervalued
relative to the equity/ book value of the company.
Price / BV
BV = [Share Capital + Reserves (excluding revaluation reserves) / Total Number
of shares]

Price to Earning (P/E) Ratio
The P/E of a stock is calculated by dividing the current stock price by the
Earning Per share (EPS).
P/E indicates how expensive or cheap the stock is trading at. Never buy stocks
that are trading at high valuations.

Operating Ratios
The Operating Ratios, also called the ‘Activity Ratios’ measures the efficiency at
which a business can convert its assets (both current and noncurrent) into
revenues. This ratio helps us understand how efficient the management of the
company is. For this reason, Operating Ratios are sometimes called the
‘Management Ratios’.

In Detail
Fixed Assets Turnover Ratio
Working Capital Turnover Ratio
Total Assets Turnover Ratio
Inventory Turnover Ratio

Fixed Assets Turnover
The ratio measures the extent of the revenue generated in comparison to its
investment in fixed assets.
Fixed Assets Turnover = Operating Revenues / Total Average Asset

Working Capital Turnover
If the working capital is a positive number, it implies that the company has
working capital surplus and can easily manage its day to day operations.
Working Capital = Current Assets – Current Liabilities
Working Capital Turnover = [Revenue / Average Working Capital]

Total Assets Turnover
It indicates the company’s capability to generate revenues with the given amount
of assets.
Total Asset Turnover = Operating Revenue / Average Total Assets

Inventory Turnover Ratio
If the product is really popular the inventory turnover would be high.
Inventory Turnover = [Cost of Goods Sold / Average Inventory]

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