Equity Research: A Fundamental Analyst Framework
Prof. Gangineni... | October 13,2014 12:34 pm IST
Information is the plank on which financial markets operate. Traders with better information and forecasting ability will have an edge in the market place.
Thus, the need for equity research and sophisticated financial modeling in today’s buoyant financial markets. This article attempts to give a framework for the analyst on fundamental factors for analyzing companies.
1. Historical Performance
• Detailed financial analysis of last three years' and latest available quarterly numbers with a view to get a complete understanding of the P&L structure; capital structure; financial ratios; foreign exchange exposure; key products & RM and their price trends; capacity utilization levels; input-output ratios; effective tax rates and likely changes; segment analysis. The key is to get a grip on the business model and list down all parameters that are relevant for financial fore-casting and judging the quality of business and management.
2. Industry Outlook
• Growth drivers.
• Expected growth rates.
• Government regulation - understand the issues that will affect valuations.
• Risk factors.
3. Competitive Position
• Company’s position in the industry.
• Why makes it better than others - technology, brand, size, efficiency, management, location, etc.?
• Financial comparison.
• Growth plans of competitors.
4. Financial Forecasting
• Key assumptions.
• Capital espenditure required.
• How will Capital expenditure be funded - internal accruals, debt, equity, etc.?
• Suitable to the industry, DCF valuation where possible.
• Relative valuations.
6. Sensitivity Analysis
• Vulnerability to fluctuations in sales realization and raw material price spurts should be captured to take a call on the risks.
7. Future Triggers That Can Impact Valuations
• Large orders.
• Fund raising.
• Commencement of production.
• Value unlocking through de-merger, etc..
• Expectation of Bonus, Stock split, etc..
• Strong earnings.
• New product launches.
• Due dates of conversion of warrants/FCCBs/other convertible instruments.
8. Capital History & Shareholding Pattern
• Promoter holding.
• Outstanding warrants/convertible instruments.
• Institutional investors.
• Changes in shareholding & capital structure, both past and likely.
9. Investment Argument
• Why should the value of the stock go up?
10. What Can Go Wrong?
• List all factors that adversely affect the investment outlook.
The analyst has to take all factors into consideration and arrive at a probabilistic estimate of the company’s stock price. Analyst will continuously upgrade or down grade his estimates depending on evolving conditions of Economy, Industry and Company plans.