Company Analysis

Fundamental analysis is a scientific way of analysis. It deals the in depth analysis of the company’s fundamental criteria such as sales of the company, promoter record, plough back and reserves, book values per share, breakeven point, operating profit, interest burden, gross profit, net profit, return on net worth and still we can go deep to analyse at the required level. In general the fundamental analyst tries to evaluate the intrinsic worth of the company. In addition to that the fundamental analyst evaluate the government policy, industry turnaround situations, company growth situations, product demand, market capitalisation to find out the under priced company in a stock market. Whenever buying a company we have to see first the promoter, product demand, dynamic management, size of the company, growth prospects, well diversified, free from labour problems, competitive and environment friendly. These are the things where can verify easily. The real fundamental analysis of a company depends on evaluation of following important criteria.

1. Equity Size.

02. Sales Turnover.

03. Breakeven Point.

04. Book Value.

05. Reserves.

06. Operating Profit Margin (O P M).

07. Interest.

08. Gross Profit Margin (G P M).

09. Net Profit (N P).

10. Earning Per Share (E P S).

11. Dividend to Yield Ratio.

12. Price Earning Ratio (P E ratio).

13. Market Capitalisation.

14. Return on Net Worth (R O N W)

15. Debt to Equity ratio.

a. In investment point of view the equity capital plays an important role in the profit of the investors. When the equity capital is large then the capital required for dividends is large considerably and so companies of large equity capital generally pay lower dividends. However there are exceptions of companies like Reliance Industries, Hindustan Lever and some multinational companies. Even in those companies also their high dividend seems not attractive because of high share price ruling in the market.

b. Dividends are given only for its face value. There are no questions about the market price of the share.

But dividend to Market value works out to 5 divided by 10 and then multiplied by 200 is equal to 2.5% When the company issues 50% dividend it yields only 2.5% for an investor who is holding shares at 200 rupees as buying price. In a low equity company it is highly profitable to an investor both for capital gains and dividend. As the number of shareholders, say in other words profit dividers is minimum, the company can give a sizable percentage of dividends when it is going good. An equity from 2 to 20 crores will be attractive for investments. When going higher equity an investor may follow a thumb rule say sales versus equity ratio. A company can be considered good or blue chip status if it is having sales more than 5 times of its equity holdings.

c. At the same time don’t buy closely held companies which are having low equity say below 2 crores. It is difficult to follow such companies and rarely one can get information in stock market.

Finance is the heart of the company and sales turnover is the blood supplied to the heart. There are two sides of the company (1) Production (2) Sales. It is easy to produce but difficult to market and compete to increase the sales. When an investor enters a company first he should know the sales turnover. We can shortlist the companies in several groups as below based on sales. Generally a company with higher sales is a good company. But taking the sales for equity ratio can easily do the exact comparison. For example take a company is having 50 crore equity and 200 crore sales. Another one company is having 5 crore equity and 100 crore sales. Though the first company is having 200 crore sales the sales to equity ratio seems only 4, whereas for the latter the sales to equity ratio seems 100 divided by 5 is equal to 20. So it is easily understood that the second mentioned company is having 20 times sales to that its equity. So sales to equity ratio will give a better picture here. Generally a company, which has sales of 5 times or more to that of its equity, is called as Blue Chip Company.

When the sales turnover is 5 to 10 times or more high than its equity capital and consistent record maintained in sales and profits then it is called a blue chip company. Generally the merit of a blue-chip company is that it is already well-stabilised sales network and marketing infrastructure. Most of the blue chips companies have a sizable plough back reserves and it can withstand the minor depressions of the business cycle. In a nutshell it is white elephant in the market and always the prices rule high in the stock market.

If the company sales turnover is low, but it is showing high operating profit and net profit then it is an emerging blue chip. It is Likely to come up as a blue chip in near future.

When a company’s sales turnover is in increasing trend, but yet no profit and coming out of red by reducing the accumulated losses it is called on ‘Turnaround Company’. Example: T V S Suzuki share was quoting around 25 to 30 rupees in 1990. Its sales went more than 200 crores. But there was an accumulated loss of 5 to 10 crores. As a consultant I recommended the company based on Turnaround and cyclic analysis the brokers were reluctant to deal huge of items saying that the company is in loss. There was different news floating in newspapers. First news is that the company is in loss; moped sales low. Other news is in Economic Times “T V S Suzuki – A fast come back trail”. The article was published with more than half a page of stories. It is difficult to understand a turnaround company. At last more than 50 our clients bought T V S-Suzuki and later in 3 years the company share prices zoomed.

Padmini Polymer, Cerelacs Data Recently (in 1999), Rossel Industries have gone more than 20 times. Some went high and fell then.

Conclusion: Sales turnover is a heartbeat of the company. No sales will result no beat. It is the point where the company’s status is evolved. A better formula is sales/equity ratio for easy analysis.

The breakeven point indicates the level of activity where all costs are fully recovered. It is a no-profit, no-loss situation. If a company’s breakeven point is 40% then it means it will survive with 40% production load in no-loss condition. The breakeven is point is the level of survival. A company can be run above the breakeven point and it is the responsibility of the management to cross that level shortly after their gestation period. Gestation period is the time required for a new company till the commercial production starts. The breakeven point is usually expressed in terms of a certain value of sales

Book value generally indicates the Value of funds used as working capital. In other words book value indicates what each share of a company is worth according to the books of accounts of the company. The company’s books of accounts maintain a record of what the company owns (assets), and what if owes to its creditors. (Liabilities) First we should know the shareholders’ fund. Then we can get the Book Value

If a company Shares’ face value is equal to 10 rupees then book value is equal to 60 rupees i.e. Say book value is 6 times greater than the Face Value. It is an easy evaluation calculated per share basis. Book Value is a historical record based on the original prices at which assets of the company were first purchased. It does not reflect the current market value of the assets of the company. Therefore book value per share has limited usage as a guide for evaluating the market value or price of a company’s shares. It can. At best, give you a rough idea of what your shares should be worth. The market prices of shares are generally much higher then what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under priced. This is one of the way to compare the market price is over priced or under priced.

The profit of the company is divided for two purposes. The company generally does not show interest to distribute all the profits. Instead it will transfer a portion of profit as reserves. Remaining portion shall be distributed in the dividends. These figures are displayed in the balance sheets every year with accumulated total. Reserves are important for a company to utilise in growth, expansion, and diversification activities. The companies will take back the reserves for normal working when the time of depression and loss making occurrences. Reserves also evaluated as a comparison given below.

Reserve ratio = Reserves divided by equity if reserves is 25 crores and equity is 5 crores, and then we can say the reserve ratio is 5. As a rule of thumb, a company that has 2 or 3 times of free reserves of its equity then it is in a position to make a liberal bonus issue. This retained profits are belong to the shareholders and they are called as ‘shareholders’ Funds’. Generally a blue chip company will have a high reserve.

Operating profit is a value derived by deducting total expenditure (overhead costs). It is the profit calculated before interest, depreciation, and tax deductions. Operating Profit (O P) is equal to (Sales minus Total Expenditures) (O P M) Operating Profit Margin is calculated from OP as a percentage of sales. O P M = O P divided by sales and then multiplied by 100 is equals to O P M expressed as percentage of sales. A company should have a high O P M say 40% to 60% otherwise it should be technologically advanced of it may be in the outdated technology. Some industry group has high O P M and others generally high sales Vs low O P M patterns. Industries like Textile, Fertilisers, and Steel have low O P M and Travel Agencies;

Information technology companies have high O P M. Higher O P is the expression of low cost production.

Gross Profit is the derived from sale after deducting overhead charges and interest. G P is equal to Sales minus (Total expenditure plus interest) G P is equal to O P minus Interest G P usually refers to profit before depreciation and taxes. G P M (gross profit margin) is calculated G P as a percentage of sales. G P M = G P divided by sales then multiplies by 100 is equal to G P M as a percentage of sales

Net Profit is the distributable profit available as surplus. Net profit is the bottom line for every business the source both of today’s rewards dividends – tomorrows’ rewards like bonus shares for its equity holders. Net profit is the profit derived after deducting interest depreciation and taxes.

There is no use for having a zero yielding companies in one’s portfolio. A profit making company transfers a certain percentage of its net profits to reserves while the balances are paid out as dividends to shareholders. The payout ratio indicates the percentage of earnings paid in the form of dividends to shareholders. Many investors show a marked preference for a company with an attractive payout ratio. On the other hand, a company, which does not plough back, enough profits into reserves cannot impress into growth. A proper balance should be struck between the current need for dividends and future need of funds for growth. A dividend warrant is the most important part as equity investor books forward every year. Dividend issued from net profits. Some companies prefer to pay interim dividends and final dividends. A higher dividend paying company is investor attractive one. Investors are not really interested in dividends but in the relationship that dividends bear to

the market price of the company’s share. The relationship is best expressed by the ratio called ‘yield’. Yield = Dividend per share multiplied by 100 divided by Market price per share Yield indicates the percentage of return that one can expect by the way of dividends on the investment made at the prevailing market price. Generally finance companies’ are yield oriented.

The Price Earning Ratio expresses to relationship between the market price and its earning per share. P E = Market Price divided by E.P.S. If P E ratio is 10 it means an investor pays 10 times price than its annual earnings. If one assumes E P S is constant it will take 10 years to recover the price by way of earning dividends from the company. But really it is not so. The company’s E P S changes from time to time. P E ratio is the reflection of market opinion of earning capacity and future business prospects of the company. Generally E P S will vary steadily. But P E ratio will fluctuate 3 to 50 times high, which often creates confusion to investors.

There is an opinion in between investor community that high P E ratio companies have low risk. We cannot fully rely on that. In fundamental analysis when a company’s earning increases then P E ratio come down. A fundamental analyst then says it is under priced. He compares the same with the industry average P E. Say if an industry (aggregate) P E ratio is 40 and the particular company P E ratio 5 then the analyst say that the company is 40 divided by 5 is equal to 8 times under priced. But in real sense there is no condition for 8 times appreciation. Generally P E ratio above 3 and below 15 may give a better safe investment opportunity. One may add more for track record promoters like Tatas, Birlas, and Ambanis.

Conclusion: Generally high PE ratio industry is low risky. PE ratio is the measure of confidence of investors to that particular industry. So select a high PE ratio industry and select a low PE ratio company in the group so that you can get a under priced company in that group.

It is the profit calculated per share basis when we see the net profit and growth in profit it will be vague. But one can get a clear idea if we say what is the earning per equity share. Earning Per Share (E P S) is equal to Profit after Tax divided by the Total number of shares issued. In order to get a clear idea of what this ratio tells, let us assume one possess 100 shares of face value of rupees 10 each in Oswal Agro Mills Limited. Suppose Oswal Agro Mills earns Rs.60 crores as net profit and its equity shares is say 120 crores (say 12 crore number of shares say 120 crore rupees divided by 10 is equal to 12. Then E P S is equal to 60 divided by 12 is equal to 5 Rupees per share.

Suppose it pay 2 rupees, as dividend then 4 rupees remaining will be transferred to reserves. Even though the dividend is 2 rupees per share, because of E P S 6 rupees and remaining available with the company as reserves the investor would get benefit due to market prices of the share go up. Suppose an investor had bought share in Ganesh Benzo Plast Ltd. At twice the amount their face value, say at 20 rupees per share. Then an E P S of 6 rupees per share, which would mean a 30%, returns on his investment of which 10% (say 2 rupees per share) is dividend and 20% (Rs.4/- Per share) the plough back. Under ideal conditions, plough back should slash of the prices of shares by 20%, say to 20 rupees from24 rupees per share. Therefore, irrespective of what share price you buy a particular company’s shares at its E P S will provided you with an invaluable tool for calculating the returns on your investment.

Conclusion: Higher EPS reflects the company’s growth in earnings at net level and attracts more buyers.

The market capitalisation means an evaluation derived by multiplying total volume of shares by its market price. Number of equity share multiplied by Market price is equal to Market capitalisation. It is more useful when calculating on industry basis. For we have to take all or active companies of a particular industry and multiply the aggregate volume of shares average market price of shares. Market Capitalisation of an Industry is equal to Aggregate number of shares multiplied by Industry Average Market Price. When buyers rush, then the market capitalisation attracts a particular industry starts increase. This, we can compare monthly or fortnightly basis. The highest market capitalisation industry is really the one, which attracted largest number of investors. There is no necessity to buy, number one Industry. But we can select top 25 out of 400 industry groups approximately, mentioned in various business and investment magazines.

Conclusion: Increasing trend and top ranking market capitalisation is the attractive position

Return on net worth is slightly differing in calculating and comparing the net profit. For example say if a company is having 100 crores equity capital and earned 75 crores simply we can say earning per share is equal to 75 divided by100 is equal to 75%. At the same time if the company is having 650 crores reserves actually it will use (650 plus 100) 750 crores for its business activities. So we can get more clear idea about return when comparing with the total capital employed. Say Earning Per Share = 75 divided by 100 = 7.50 or 75% Return on Net Worth = 75 / (100+650) =0.1 = 10% Actually the company return one net worth seems very low but to E P S seems attractive. In all companies we have to compare both and to find out the real earnings by the company. In old companies with huge reserves R O N W will very normally. But some new companies also maintain some debts to project higher E P S. So a better conclusion can be arrived based on R O N W i.e., profits earned for the total capital deployed or utilised.

Net worth consists of equity capital, reserves and borrowed funds consisting of long term and short-term debt. For a profit making, tax paying company some debt in the capital structure in advantageous because interest on debt is a tax-deductible expense. Generally companies try to maximise their EPS by a suitable mix of debt and net worth. However too much debt is risky and in recession times it may lead for closure.

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1. How do you define a company’s profitability? Whether E P S, Net profit, returns on net worth, O P M and or with what?

3. What is the specialty or distinction of fundamental analysis than technical analysis?

4. Compare the PE ration of the industry and a individual company of the same group industry. At what condition you prefer to buy a company in the industry group?

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