May 15, 2012

MF0010 [Security Analysis and Portfolio Management] Set2 Q2

Q2. How is company analysis useful in determining the intrinsic value of a security?


Ans:


Once the economic forecast and industry analysis has been completed,the fundamental analyst focuses on choosing the best positioned company in the chosen industry. Selecting a company involves an analysis of the company s management, the company s financial statements ‟ ‟ and the key drivers for future growth. The analyst is looking for companies with the best management, strong financials, great prospects, and that are undervalued by the market. While doing the analysis, it is to be remembered that the past is irrelevant, what you are looking at are future results.

Some areas of focus for company analysis are discussed below:


Business and financial risk

The return required by investors is proportional to the perceived risk associated with the company. The risk can be measured as variability of the company‟s after-tax cash flows. It is often useful to break down the company‟s risk into two components: business risk and financial risk.

Business risk is uncertainty about future operating income (EBIT), i.e., how well can you predict operating income. It does not include financing effects. Business risk is risk attributable to the composition of the company’s assets. Factors affecting business risk include: (a) sensitivity of company sales to general economic conditions; (b) industry conditions including degree and size of competition, indust ry growth prospects, and the company ability to affect its selling and input prices; and, (c) company characteristics including size of the company, management, and operating leverage.

Operating leverage is the use of fixed operating costs as opposed to variable operating costs. A company with relatively high fixed operating costs will experience more variable operating income if sales change. If most costs are fixed and hence do not decline when demand falls, then the company has high operating leverage.

Financial risk is the variability or uncertainty of a company’s earnings per share (EPS) and the increased probability of insolvency that arises when a company uses financial leverage. Financial leverage is the use of fixedcost sources of financing (debt, preferred stock) rather than variable-cost sources (common stock). Financial risk is the additional risk concentrated on common stockholders as a result of financial leverage.

Financial statement analysis
Analyzing a company’s historical financial statements and financial ratios can provide end users with useful information for estimating the magnitude of future cash flows (earnings and dividends) and the risk inherent in these estimates. These estimates can then be used to assign a value to a company’s assets and liabilities. Through financial statements, analysts determine the financial health and strength of companies. The analysts rely on three statements: Income statement, Balance sheet and the Statement of cash flows. The major tools for analysis are the ratio analysis and growth rates. The income statement provides us with information about the company’s revenues and expenses over some previous time period (usually quarterly, semiannually, and annually).


It indicates a company’s ability to g enerate profits. The key variables to watch are revenues, gross profit margins, operating profit margins, net profit margins and earnings per share (EPS). The analyst especially wants to evaluate the quality of the company’s earnings. Under generally accepted accounting principles, companies are allowed fairly wide latitude on how they recognize revenues and handle “extraordinary” income and expenses. Many companies “manage” or “smooth” earnings, believing that it adds to the stability of the stock price over time. The analysts need to watch for such manipulations, as it may signal problems. Analysts also look for where the earnings are coming from increased sales, or decreased expenses.


Sales can increase forever, but costs can only be cut up to a limit. Generally, when costs are cut to increase profits, it is looked at only as a temporary boost. The balance sheet is a list of a company s assets ‟ (what a company owns), liabilities (what the company owes), and shareholders’ equity (the portion of the company that is owned by investors) at a point in time. It helps determine a company‟s financial soundness by revealing how much of its assets are financed by debt and how much are financed by capital investments. The key variables to watch on the balance sheet are cash, accounts receivable, inventories, and long-term debt. An interesting quote to remember while analyzing balance sheet comes from Benjamin Graham in his book Security Analysis: “liabilities are real but the assets are of questionable value.”


Finally, the cash flow statement shows investors how much revenue a company has generated, making adjustments for non-cash expenses such as depreciation. The cash flow statement explains how the company has performed in managing inflows and outflows of cash and better represents the company‟s ability to pay bills, creditors, and finance growth. The statement of cash flows is far more difficult to manipulate than the income statement, and can help to gauge the quality of earnings.

Financial ratios are commonly used to analyze a company’s financial performance. A single ratio on its own provides very little information unless it is compared to another ratio (or other ratios). Analysts examine how these ratios are evolving through time. This enables them to compare the company’s most recent performance with its performance in earlier periods. In addition, a company’s ratios should be compared with the ratios of similar companies or industry averages. This comparison is a popular method of determining how well a company is performing in relation to its competitors. 


Financial ratios fall into five categories:
Liquidity: The current ratio, quick ratio and cash ratio all fall into this category. They help us to see if the company is able to meet its short term obligations.

Efficiency: The efficiency ratios tell us how effectively management is using the firm’s assets to generate sales. Inventory turnover, accounts receivable turnover, days sales outstanding, fixed asset turnover, and total asset turnover all fall into this category.

Leverage: Leverage ratios indicate the amount of debt that a firm has. Examples are the „debt ratio‟ and „debt to equity ratio‟. A large amount of debt is good only as long as sales are increasing, but terrible if sales decline. Some debt is good, but too much can be disastrous.

Coverage: Examples of coverage ratios include the “times interest earned ratio and the” fixed charge coverage “ratio”. They are most important to creditors, but whatever is important to creditors is important to shareholders too.

Profitability: Investors tend to focus the most on profitability ratios. Examples include the gross profit margin, operating profit margin, net profit margin, return on assets and return on equity. 

There are two key uses of financial ratios:
Trend analysis – This involves looking for trends over time in ratios. For example, we would like to see that the inventory turnover ratio is rising. Normally, at least five years of data should be used for trend analysis.

Comparison to industry averages – If we assume that, on an average, the firm’s competitors are doing things right, then it makes sense to make these comparisons. This comparison can also help to identify areas of relative strengths and weaknesses for the company.

Growth rates
The growth rates of various variables are important for financial statement analysis. The key variables to calculate growth rates are revenues, operating profits, and free cash flow.

Business plan
The business plan, model or concept forms the foundation upon which everything else is built. If the plan, model or concepts do not work, there is little hope for the business. For a new business, the questions that fundamental analyst asks are: Does its business make sense? Is it feasible? Is there a market? Can a profit be made? For an established business, the questions may be: Is the company's direction clearly defined? Is the company a leader in the market? Can the company maintain leadership?

Management
In order to execute a business plan, a company requires top-quality management. Investors might look at management to assess their capabilities, strengths and weaknesses. Even the best-laid plans in the most dynamic industries can go to waste with bad management. Alternatively even strong management can make for extraordinary success in a mature industry. Some of the questions that the fundamental analyst asks include: How talented is the management team? Do they have a track record? How long have they worked together? Can management deliver on its promises? If management is a problem, it is sometimes best not to invest.

No comments:

Post a Comment

Labels

1st Sem (common) Subjects (150) 1st Sem BBA (10) 2nd Sem (common) Subjects (70) 2nd Sem BBA (10) 3rd Sem Banking Management (30) 3rd Sem BBA (8) 3rd Sem core/common subjects (37) 3rd Sem Environmental Management (2) 3rd Sem Event Management (8) 3rd Sem Finance Management (113) 3rd Sem HEALTH SERVICE MANAGEMENT (HSM/HCS) (65) 3rd Sem Human Resource Management (98) 3rd Sem Information Systems Management (8) 3rd Sem International Business (34) 3rd Sem Marketing Management (129) 3rd Sem Operations Management (8) 3rd Sem Project Management (103) 3rd Sem Retail Operations Management (8) 3rd Sem Supply Chain Management (SCM) (16) 3rd Sem Total Quality Management (TQM) (16) 4th Sem Banking Management (38) 4th Sem core/common subjects (65) 4th Sem Event Management (8) 4th Sem Finance Management (8) 4th Sem HEALTH SERVICE MANAGEMENT (HSM/HCS) (21) 4th Sem Human Resource Management (104) 4th Sem Information Systems Management (8) 4th Sem International Business (12) 4th Sem Marketing Management (8) 4th Sem Operations Management (37) 4th Sem Project Management (56) 4th Sem Retail Operations Management (8) 4th Sem Supply Chain Management (SCM) (8) 4th Sem Total Quality Management (TQM) (8) BBA101 - Communication Skills (2) BBA101 Set1 (1) BBA101 Set2 (1) BBA102 - Organization Behaviour (2) BBA102 Set1 (1) BBA102 Set2 (1) BBA103 - Business Environment (2) BBA103 Set1 (1) BBA103 Set2 (1) BBA104 - Quantitative Techniques in Business (2) BBA104 Set1 (1) BBA104 Set2 (1) BBA105 - Computer Fundamentals (2) BBA105 Set1 (1) BBA105 Set2 (1) BBA201 - Research Methods (2) BBA201 Set1 (1) BBA201 Set2 (1) BBA202 - Business Strategy (2) BBA202 Set1 (1) BBA202 Set2 (1) BBA203 - Financial Accounting (2) BBA203 Set1 (1) BBA203 Set2 (1) BBA204 - Marketing Management (2) BBA204 Set1 (1) BBA204 Set2 (1) BBA205 - Management Information Systems (2) BBA205 Set1 (1) BBA205 Set2 (1) BBA301 - Legal and Regulatory Framework (2) BBA301 Set1 (1) BBA301 Set2 (1) BBA302 - Human Resource Management (2) BBA302 Set1 (1) BBA302 Set2 (1) BBA303 - Quality Management (2) BBA303 Set1 (1) BBA303 Set2 (1) BBA304 - Advertising and sales (2) BBA304 Set1 (1) BBA304 Set2 (1) Differences between Managers and Leaders (1) EM0001 - Fundamentals of Environment (2) EM0001 Set1 (1) EM0001 Set2 (1) ET0001 - Human resource management for events (2) ET0001 Set1 (1) ET0001 Set2 (1) ET0002 - Corporate Event Project Management (2) ET0002 Set1 (1) ET0002 Set2 (1) ET0003 - Event marketing and management (2) ET0003 Set1 (1) ET0003 Set2 (1) ET0004 - Event Finance Management (2) ET0004 Set1 (1) ET0004 Set2 (1) ET0006 - Event Risk Management (2) ET0006 Set1 (1) ET0006 Set2 (1) ET0007 - Entrepreneurship (2) ET0007 Set1 (1) ET0007 Set2 (1) ET0008 - Special Events (2) ET0008 Set1 (1) ET0008 Set2 (1) ET0009 - Event Management for Tourism (2) ET0009 Set1 (1) ET0009 Set2 (1) IB0010 - International Financial Management (9) IB0010 Set1 (7) IB0010 Set2 (2) IB0011 - International Marketing (9) IB0011 Set1 (2) IB0011 Set2 (7) IB0012 - Management of Multinational Corporations (8) IB0012 Set1 (7) IB0012 Set2 (1) IB0013 - Export-Import Management (8) IB0013 Set1 (7) IB0013 Set2 (1) IB0015 - Foreign Trade of India (6) IB0015 Set1 (3) IB0015 Set2 (3) IB0016 - International Logistics and Distribution Management (2) IB0016 Set1 (1) IB0016 Set2 (1) IB0017 - International Business Environment and International Law (2) IB0017 Set1 (1) IB0017 Set2 (1) IB0018 - Export Import Finance (2) IB0018 Set1 (1) IB0018 Set2 (1) MA0036 - Financial Systems and Commercial Banking (14) MA0036 Set1 (7) MA0036 Set2 (7) MA0037 - Banking Related Laws and Practices (12) MA0037 Set1 (6) MA0037 Set2 (6) MA0038 - Banking Operations (2) MA0038 Set1 (1) MA0038 Set2 (1) MA0039 - Retail Banking (2) MA0039 Set1 (1) MA0039 Set2 (1) MA0040 (1) MA0041 - Merchant Banking and Financial Services (5) MA0041 Set1 (3) MA0041 Set2 (2) MA0042 - Treasury Management (14) MA0042 Set1 (7) MA0042 Set2 (7) MA0043 - Corporate Banking (9) MA0043 Set1 (5) MA0043 Set2 (4) MA0044 - Institutional Banking (10) MA0044 Set1 (8) MA0044 Set2 (2) MB0038 - Management Process and Organization Behavior (24) MB0038 Set1 (16) MB0038 Set2 (9) MB0039 - Business Communication (24) MB0039 Set1 (15) MB0039 Set2 (9) MB0040 - STATISTICS FOR MANAGEMENT (24) MB0040 Set1 (15) MB0040 Set2 (9) MB0041 - Financial Management and Accounting (24) MB0041 Set1 (15) MB0041 Set2 (9) MB0042 - Managerial Economics (30) MB0042 Set1 (15) MB0042 Set2 (15) MB0043 - Human Resource Management (24) MB0043 Set1 (15) MB0043 Set2 (9) MB0044 - PRODUCTION and OPERATIONS MANAGEMENT (16) MB0044 Set1 (8) MB0044 Set2 (8) MB0045 - Financial Management (9) MB0045 Set1 (7) MB0045 Set2 (2) MB0046 - Marketing Management (10) MB0046 Set1 (8) MB0046 Set2 (2) MB0047 - MANAGEMENT INFORMATION SYSTEMS (15) MB0047 Set1 (8) MB0047 Set2 (7) MB0048 - OPERATIONS RESEARCH (10) MB0048 Set1 (8) MB0048 Set2 (2) MB0049 - Project Management (10) MB0049 Set1 (8) MB0049 Set2 (2) MB0050 - Research Methodology (20) MB0050 Set1 (10) MB0050 Set2 (10) MB0051 - Legal Aspects of Business (17) MB0051 Set1 (13) MB0051 Set2 (4) MB0052 - Strategic Management and Business Policy (30) MB0052 Set1 (15) MB0052 Set2 (15) MB0053 - International Business Management (35) MB0053 Set1 (19) MB0053 Set2 (16) MF0010 - Security Analysis and Portfolio Management (39) MF0010 Set1 (21) MF0010 Set2 (18) MF0011 - Mergers and Acquisitions (24) MF0011 Set1 (14) MF0011 Set2 (10) MF0012 - Taxation Management (25) MF0012 Set1 (16) MF0012 Set2 (9) MF0013 - Internal Audit and Control (25) MF0013 Set1 (16) MF0013 Set2 (9) MF0014 (1) MF0015 - International Financial Management (2) MF0015 Set1 (1) MF0015 Set2 (1) MF0016 - Treasury Management (2) MF0016 Set1 (1) MF0016 Set2 (1) MF0017 - Merchant Banking and Financial Services (2) MF0017 Set1 (1) MF0017 Set2 (1) MF0018 - Insurance and Risk Management (2) MF0018 Set1 (1) MF0018 Set2 (1) MH0051 - Health Administration (15) MH0051 Set1 (5) MH0051 Set2 (10) MH0052 - Hospital Organisation Operations and Planning (26) MH0052 Set1 (12) MH0052 Set2 (14) MH0053 - Hospital and Healthcare Information Management (11) MH0053 Set1 (3) MH0053 Set2 (8) MH0054 - Finance Economics and Planning in HCS (13) MH0054 Set1 (10) MH0054 Set2 (3) MH0055 (1) MH0056 - Public Relations and Marketing for Healthcare Organisation (6) MH0056 Set1 (3) MH0056 Set2 (3) MH0057 - Management of Healthcare Human Resources (5) MH0057 Set1 (2) MH0057 Set2 (3) MH0058 - Legal Aspects in Healthcare Administration (5) MH0058 Set1 (3) MH0058 Set2 (2) MH0059 - Quality Management in HCS (5) MH0059 Set1 (3) MH0059 Set2 (2) MI0014 (1) MI0033 - Software Engineering (2) MI0033 Set1 (1) MI0033 Set2 (1) MI0034 - Database Management System (2) MI0034 Set1 (1) MI0034 Set2 (1) MI0035 - Computer Network (2) MI0035 Set1 (1) MI0035 Set2 (1) MI0036 - BUSINESS INTELLIGENCE TOOLS (2) MI0036 Set1 (1) MI0036 Set2 (1) MI0038 - Enterprise Resource Planning (2) MI0038 Set1 (1) MI0038 Set2 (1) MI0039 - eCommerce (2) MI0039 Set1 (1) MI0039 Set2 (1) MI0040 - Technology Management (2) MI0040 Set1 (1) MI0040 Set2 (1) MI0041 - Java and Web Design (2) MI0041 Set1 (1) MI0041 Set2 (1) MK0010 - Sales Distribution and Supply Chain Management (33) MK0010 Set1 (17) MK0010 Set2 (16) MK0011 - Consumer Behaviour (31) MK0011 Set1 (16) MK0011 Set2 (15) MK0012 - Retail Marketing (42) MK0012 Set1 (20) MK0012 Set2 (22) MK0013 - Market Research (23) MK0013 Set1 (12) MK0013 Set2 (11) MK0014 (1) MK0015 - Service Marketing And Customer Relationship Management (2) MK0015 Set1 (1) MK0015 Set2 (1) MK0016 - Advertising Management and Sales Promotion (2) MK0016 Set1 (1) MK0016 Set2 (1) MK0017 - eMarketing (2) MK0017 Set1 (1) MK0017 Set2 (1) MK0018 - International Marketing (2) MK0018 Set1 (1) MK0018 Set2 (1) ML0010 - Warehousing and Supply Chain Management (2) ML0010 Set1 (1) ML0010 Set2 (1) ML0011 - Buying and Merchandising (2) ML0011 Set1 (1) ML0011 Set2 (1) ML0012 - Store Operations (2) ML0012 Set1 (1) ML0012 Set2 (1) ML0013 - Retail IT Management (2) ML0013 Set1 (1) ML0013 Set2 (1) ML0014 (1) ML0015 - Services Marketing and Customer Relationship Management (2) ML0015 Set1 (1) ML0015 Set2 (1) ML0016 - Advertising Management and Sales Promotion (2) ML0016 Set1 (1) ML0016 Set2 (1) ML0017 - Mall Management (2) ML0017 Set1 (1) ML0017 Set2 (1) ML0018 - Project Management in Retail (2) ML0018 Set1 (1) ML0018 Set2 (1) MU0010 - Manpower Planning and Resourcing (31) MU0010 Set1 (16) MU0010 Set2 (15) MU0011 - Management and Organizational Development (20) MU0011 Set1 (10) MU0011 Set2 (10) MU0012 - Employee Relations Management (22) MU0012 Set1 (11) MU0012 Set2 (11) MU0013 - Human Resource Audit (25) MU0013 Set1 (15) MU0013 Set2 (10) MU0014 (1) MU0015 - Compensation Benefits (24) MU0015 Set1 (14) MU0015 Set2 (10) MU0016 - Performance Management and Appraisal (27) MU0016 Set1 (12) MU0016 Set2 (15) MU0017 - Talent Management and Employee Retention (24) MU0017 Set1 (12) MU0017 Set2 (12) MU0018 - Change Management (29) MU0018 Set1 (9) MU0018 Set2 (20) OM0010 - Operations Management (2) OM0010 Set1 (1) OM0010 Set2 (1) OM0011 - Enterprise Resource Planning (2) OM0011 Set1 (1) OM0011 Set2 (1) OM0012 - Supply Chain Management (2) OM0012 Set1 (1) OM0012 Set2 (1) OM0013 - Advanced Production and Operations Management (2) OM0013 Set1 (1) OM0013 Set2 (1) OM0014 (1) OM0015 - Maintenance Management (6) OM0015 Set1 (3) OM0015 Set2 (3) OM0016 - Quality Management (11) OM0016 Set1 (8) OM0016 Set2 (3) OM0017 - Advanced Production and Planning Control (11) OM0017 Set1 (3) OM0017 Set2 (8) OM0018 - Technology Management (9) OM0018 Set1 (7) OM0018 Set2 (2) PM0010 - Introduction to Project Management (26) PM0010 Set1 (14) PM0010 Set2 (12) PM0011 - Project Planning and Scheduling (25) PM0011 Set1 (14) PM0011 Set2 (11) PM0012 - Project Financing and Budgeting (26) PM0012 Set1 (14) PM0012 Set2 (12) PM0013 - Managing Human Resources in Projects (26) PM0013 Set1 (13) PM0013 Set2 (14) PM0014 (1) PM0015 - Quantitative Methods in Project Management (14) PM0015 Set1 (8) PM0015 Set2 (6) PM0016 - Project Risk Management (14) PM0016 Set1 (7) PM0016 Set2 (7) PM0017 - Project Quality Management (14) PM0017 Set1 (7) PM0017 Set2 (7) PM0018 - Contracts Management in Projects (14) PM0018 Set1 (7) PM0018 Set2 (7) Project (1) QM0010 - Foundations of Quality Management (4) QM0010 Set1 (2) QM0010 Set2 (2) QM0011 - Principles and Philosophies of Quality Management (4) QM0011 Set1 (2) QM0011 Set2 (2) QM0012 - Statistical Process Control and Process Capability (4) QM0012 Set1 (2) QM0012 Set2 (2) QM0013 - Quality Management Tools (4) QM0013 Set1 (2) QM0013 Set2 (2) QM0014 (1) QM0015 - ISO/QS 9000 Elements (2) QM0015 Set1 (1) QM0015 Set2 (1) QM0016 - Managing Quality in the Organization (2) QM0016 Set1 (1) QM0016 Set2 (1) QM0017 - Quality Management System (2) QM0017 Set1 (1) QM0017 Set2 (1) QM0018 - Quality Development Methods (2) QM0018 Set1 (1) QM0018 Set2 (1) SC0001 - Supply Chain Management (4) SC0001 Set1 (2) SC0001 Set2 (2) SC0002 - Outsourcing (4) SC0002 Set1 (2) SC0002 Set2 (2) SC0003 - Food Supply Chain Management (4) SC0003 Set1 (2) SC0003 Set2 (2) SC0004 - Inventory Management (4) SC0004 Set1 (2) SC0004 Set2 (2) SC0006 - Global Logistics and Supply Chain Management (2) SC0006 Set1 (1) SC0006 Set2 (1) SC0007 - Category Management in Purchasing (2) SC0007 Set1 (1) SC0007 Set2 (1) SC0008 - Purchasing and Contracting for Projects (2) SC0008 Set1 (1) SC0008 Set2 (1) SC0009 - Supply Chain Cost Management (2) SC0009 Set1 (1) SC0009 Set2 (1) SMU BBA Subjects (1) SMU MBA/PGDBA Subjects (1)

Visitor Count (since Jan 2019)