FUNDAMENTAL ANALYSIS : PART - 2

My intention of posting the methods of fundamental analysis is that I want every person who reads my posts to become capable of analyzing the Company’s performance on a longer term horizon viz. one or two years earlier and future expectations.

1. If a company is capital intensive, in the initial years it may incur heavy losses but if the products may not entail any huge operational expenses in future, the profitability would keep growing year after year. So, in the first few years of inception, if there are continued losses, the investors should not runaway. In this category, you may see the examples of Bharti Airtel, Noida Toll etc. Once their initial costs are taken care of, the cash registers will keep ringing.

2. If the company has come out of black into red and sustains the profitability, you have to look at the following few ratios : equations etc.

Earning per share (eps) : It is net profit divided by number of equity shares of a company.

P.E. Ratio : It is share price in the market divided by eps

Sales to Net profit ratio : It is the percentage of net profit in relation to Sales. If it is very less, it implies that the company is incurring huge expenses. On a safe side, if this ratio is above 25% on a sustained basis, we can safely enter.

3. After the company has run for several years, it may start declaring dividends and transfer some funds from profits to reserves. So, in the company’s financials, you will hear of a term Book Value. This is made up of Share capital plus reserves divided by number of shares. Higher the book value, stronger is the fundamental health of a company. If the book value is very huge, the company management may decide to convert some of the reserves into capital (called capitalization of reserves) and issue bonus (free) shares to shareholders.

4. For comparing a share price to book value, analysts use a ratio called price to book value ratio. There is no hard and fast yard stick, but if the price is less than book value, and the company is consistently making profits/paying dividends, one can safely accumulate the scrip. If the price is very high as compared to book value, then there is imminent risk and the share price may be rising due to reasons other than fundamental.

5. Market capitalization : It is the number of shares traded multiplied by the outstanding shares. When the promoter’s holding is very heavy and the share price is very less, the market capitilisation will be low. The companies have been categorized into three categories viz. big companies with large market capitalization (large cap), Medium level market capitalization (Midcap) and small level market capitalization (Smallcap). It is a bit unsafe to invest in small cap companies, unless the investor knows the details of the company.

I am sure, by the time I finish posting all my lessons, many readers would be able to do their own analysis and invest. I repeat, my analysis is meant for long term investing. (Further posts will follow).