13.1 – What to expect?
Having set the context in the previous chapter, we will now develop a methodology for conducting a ‘limited resource’ equity research. The reason why I call it ‘limited resource’ is because you and I, as a retail investor, have access to just a few resources to conduct equity research. These resources are – internet, company annual report, and MS Excel. Whilst an Institution has access to human resource (analyst), access to company management, financial database (such as Bloomberg, Reuters, Factset etc.), industry reports etc. So my objective here is to demonstrate how one can better understand a company and its business with the limited resources at hand. Of course, we will do this exercise keeping the end objective in perspective, i.e., deciding whether to buy or not to buy a stock.
As mentioned in the previous chapter, we will structure the equity research process in 3 stages-
- Understanding the Business
- Application of the checklist
- Intrinsic Value estimation (Valuation) to understand the fair price of the stock
Each stage mentioned above has several steps within it. One must understand that there is no shortcut to this, and one must not compromise any of these steps.
13.2 – Stock Price vs Business Fundamentals
When we take up a company for research, the first step is to understand the business as much as possible. People often miss this crucial step and go directly into the stock price analysis. Well, just analyzing the stock price is great if you have a short term perspective. However, for long term investments, understanding the business is essential.
Why is it important you may wonder? Well, the reason is simple: the more you know the company, the higher is your conviction to stay put with the investment, especially during bad times (aka bear markets). Remember, during bear markets, the prices react and not the business fundamentals. Understanding the company and its business well gives you the required conviction to reason why it makes sense to stay invested in the stock even though the market may think otherwise. They say bear markets creates value, so if you have a high conviction on the company, you should consider buying into the stock during bear markets and not really selling the stock. Needless to say, this is highly counter-intuitive, and it takes years of investment practice to internalize this fact.
Anyway, moving ahead the best source to get information related to the business is the company’s website and its annual report. We need to study at least the last 5-year annual report to understand how it is evolving across business cycles.
13.3 – Understanding the Business
As a first step towards understanding the business, we need to make a list of questions we need to find answers to. Do note, the answers to all these questions can be found out by reading through the company’s annual report and website.
Here are a bunch of questions that I think helps us in our quest to understand the business. I have discussed the rationale behind each question.
| Sl No | Question | The rationale behind the question |
|---|---|---|
| 1 | What does the company do? | To get a basic understanding of the business |
| 2 | Who are its promoters? What are their backgrounds? | To know the people behind the business. Sanity check to eliminate criminal background, intense political affiliation etc |
| 3 | What do they manufacture (in case it is a manufacturing company)? | To know their products better, helps us get a sense of the product’s demand-supply dynamics |
| 4 | How many plants do they have and where are they located? | To get a sense of their geographic presence. Also at times, their plants could be located in a prime location, and the value of such location could go off-balance sheet, making the company highly undervalued |
| 5 | Are they running the plant in full capacity? | Gives us an idea on their operational abilities, demand for their products, and their positioning for future demand |
| 6 | What kind of raw material is required? | Helps us understand the dependency of the company. For example, the raw material could be regulated by Govt (like Coal) or the raw material needs to be imported either of which needs further investigation |
| 7 | Who are the company’s clients or end-users? | By knowing the client base, we can get a sense of the sales cycle and efforts required to sell the company’s products |
| 8 | Who are their competitors? | Helps in knowing the competitors. Too many competing companies means margin pressure. In such a case, the company has to do something innovative. Margins are higher if the company operates in – monopoly, duopoly, or oligopoly market structure |
| 9 | Who are the major shareholders of the company? | Besides the promoter and promoter group, it helps to know who else owns the company’s shares. If a highly successful investor holds the shares in the company, then it could be a good sign |
| 10 | Do they plan to launch any new products? | Gives a sense of how ambitious and innovative the company is. While at the same time a company launching products outside their domain raises some red flags – is the company losing focus? |
| 11 | Do they plan to expand to different countries? | Same rationale as above |
| 12 | What is the revenue mix? Which product sells the most? | Helps us understand which segment (and therefore, the product) is contributing the most to revenue. This in turns helps us understand the drivers for future revenue growth |
| 13 | Do they operate under a heavy regulatory environment? | This is both good and bad – Good because it acts a natural barrier from new competition to enter the market, bad because they are limited with choices when it comes to being innovative in the industry |
| 14 | Who are their bankers, auditors? | Good to know, and to rule out the possibility of the companies associated with scandalous agencies |
| 15 | How many employees do they have? Does the company have labour issues? | Gives us a sense of how labour-intensive the company’s operations are. Also, if the company requires a lot of people with a niche skillset, then this could be another red flag |
| 16 | What are the entry barriers for new participants to enter the industry? | Helps us understand how easy or difficult it is for new companies to enter the market and eat away the margins |
| 17 | Is the company manufacturing products that can be easily replicated in a country with cheap labour? | If yes, the company may be sitting on a time bomb – think about companies manufacturing computer hardware, mobile handsets, garments etc |
| 18 | Does the company have too many subsidiaries? | If yes, you need to question why? Is it away for the company to siphon off funds? |
These questions are thought starters for understanding any company. In finding answers, you will automatically start posting new questions for which you will have to find answers to. It does not matter which company you are looking at if you follow this Q&A framework. I’m very confident your understanding of the company would drastically increase. This is because the Q&A process requires you to read and dig out so much information about the company that you will start getting a greater understanding of the company.
Remember, this is the first step in the equity research process. If you find red flags (or something not right about the company) while discovering the answers, I would advise you to drop researching the company further irrespective of how attractive the business looks. In case of a red flag, there is no point proceeding to stage 2 of equity research.
From my experience, I can tell you that stage 1 of equity research, i.e. ‘Understanding the Company’ takes about 15 hours. After going through this process, I usually try to summarize my thoughts on a single sheet of paper which would encapsulate all the important things I have discovered about the company. This information sheet has to be crisp and to the point. If I’m unable to achieve this, then it is clear that I do not know enough about the company. After going through stage 1, I proceed to stage 2 of equity research, which is “Application of Checklist”. Please do bear in mind the equity research stages are sequential and should follow the same order.
We will now proceed to stage 2 of equity research. The best way to understand stage 2 is by actually implementing the checklist on a company.
We have worked with Amara Raja Batteries Limited (ARBL) throughout this module. Hence I guess it makes sense to go ahead and evaluate the checklist on the same company. Do remember, the company may differ, but the equity research framework remains the same.
As we proceed, a word of caution at this point – the discussion going forward will mainly revolve around ARBL as we will understand this company better. The idea here is not to showcase how good or bad ARBL is but instead illustrate a framework of what I perceive as a ‘fairly adequate’ equity research process.
13.4 – Application of checklist
Stage 1 of the equity research process helps us understand how, what, who, and why. It helps us develop a holistic view of the company. However, as they say – the proof of the pudding is in the eating; so no matter how attractive the business looks, the numbers of the company should also look attractive.
The objective of the 2nd stage of equity research’s objective is to help us comprehend the numbers and actually evaluate if both the nature of the business and the business’s financial performance complement each other. If they do not complement each other, then clearly the company will not qualify as an investible grade.
We looked at the checklist in the previous chapter; I’ll reproduce the same here for quick reference.
| Sl No | Variable | Comment | What does it signify |
|---|---|---|---|
| 1 | Net Profit Growth | In line with the gross profit growth | Revenue growth should be in line with the profit growth |
| 2 | EPS | EPS should be consistent with the Net Profits | If a company is diluting its equity, then it is not good for its shareholders |
| 3 | Gross Profit Margin (GPM) | > 20% | Higher the margin, higher is the evidence of a sustainable moat |
| 4 | Debt Level | The company should not be highly leveraged | High debt means the company is operating on high leverage. Plus the finance cost eats away the earnings |
| 5 | Inventory | Applicable for manufacturing companies | A growing inventory, along with a growing PAT margin is a good sign. Always check the inventory number of days |
| 6 | Sales vs Receivables | Sales backed by receivables is not a great sign | This signifies that the company is just pushing its products to show revenue growth |
| 7 | Cash flow from operations | Has to be positive | If the company is not generating cash from operations, then it indicates operating stress |
| 8 | Return on Equity | >25% | Higher the ROE, better it is for the investor, however, make sure you check the debt levels along with this |
Let us go ahead and evaluate each of the checklist items on Amara Raja Batteries and see what the numbers are suggesting. First, we will look into the P&L items – Gross Profit, Net Profit, and EPS of the company.
Revenue & Pat Growth
The first sign of a company that may qualify as the investable grade is the rate at which it is growing. To evaluate the growth of the company, we need to check the revenue and PAT growth. We will evaluate growth from two perspectives –
- Year on Year growth – this will give us a sense of progress the company makes every year. Do note; industries do go through cyclical shifts. From that perspective, if a company has a flat growth, it is ok. However, just make sure you check the competition and ensure the growth is a flat industry-wide.
- Compounded Annual Growth Rate (CAGR) – The CAGR gives us a sense of how the company is evolving and growing across business cycles. A good, investable grade company is usually the first company to overcome the shifts in business cycles. This will eventually reflect in a healthy CAGR.
I prefer to invest in growing (Revenue and PAT) companies over and above 15% on a CAGR basis.
Let us see how ARBL fares here…
| FY 09 -10 | FY 10-11 | FY 11-12 | FY 12 -13 | FY 13 – 14 | |
|---|---|---|---|---|---|
| Revenue (INR Crs) | 1481 | 1769 | 2392 | 3005 | 3482 |
| Revenue Growth | 19.4% | 35.3% | 25.6% | 15.9% | |
| PAT (INR Crs) | 167 | 148 | 215 | 287 | 367 |
| PAT Growth | (11.3%) | 45.2% | 33.3% | 27.8% |
The 5-year CAGR revenue growth is 18.6%, and the 5-year CAGR PAT growth is 17.01%. These are an interesting set of numbers; they qualify as a healthy set of numbers. However, we still need to evaluate the other numbers on the checklist.
Earnings per Share (EPS)
The earnings per share represent the profitability on a per-share basis. The EPS and PAT growing at a similar rate indicate that the company does not dilute the earnings by issuing new shares, which is good for the existing shareholders. One can think of this as a reflection of the company’s management’s capabilities.
| FV Rs.1 | FY 09 -10 | FY 10-11 | FY 11-12 | FY 12 -13 | FY 13 – 14 |
|---|---|---|---|---|---|
| EPS (In INR) | 19.56 | 17.34 | 12.59 | 16.78 | 21.51 |
| Share Cap(INR Crs) | 17.08 | 17.08 | 17.08 | 17.08 | 17.08 |
| EPS Growth | – | -11.35% | – 27.39% | 33.28% | 28.18% |
The 5 year EPS CAGR stands at 1.90% for the FY14.
Gross Profit margins
Gross profit margins, expressed as a percentage is calculated as a –
Gross Profits / Net Sales
Where,
Gross Profits = [Net Sales – Cost of Goods Sold]
Cost of goods sold is the cost involved in making the finished good; we had discussed this calculation while understanding the inventory turnover ratio. Let us proceed to check how ARBL’s Gross Profit margins have evolved over the years.
| In INR Crs, unless indicated. | FY 09-10 | FY 10-11 | FY 11-12 | FY 12 -13 | FY 13 – 14 |
|---|---|---|---|---|---|
| Net Sales | 1464 | 1757 | 2359 | 2944 | 3404 |
| COGS | 1014 | 1266 | 1682 | 2159 | 2450 |
| Gross Profits | 450 | 491 | 677 | 785 | 954 |
| Gross Profit Margins | 30.7% | 27.9% | 28.7% | 26.7% | 28.0% |
Clearly, the Gross Profit Margins (GPM) looks very impressive. The checklist mandates a minimum GPM of 20%. ARBL has much more than the minimum GPM requirement. This implies a couple of things –
- ARBL enjoys a premium spot in the market structure. This may be because of the absence of competition in the sector, which enables a few companies to enjoy higher margins
- Good operational efficiency, which in turn is a reflection of management’s capabilities
Debt level – Balance Sheet check
The first three points in the checklist were mainly related to the company’s Profit & Loss statement. We will now look through a few Balance sheet items. One of the most important line items that we need to look at on the Balance Sheet is the Debt. An increasingly high level of debt indicates a high degree of financial leverage. Growth at the cost of financial leverage is quite dangerous. Also do remember, a large debt on balance sheets means a large financial cost charge. This eats into the retained earnings of the firm.
Here is how the debt stands for ARBL –
Debt( INR Crs) Evaluation –
| FY 09-10 | FY 10-11 | FY 11-12 | FY 12 -13 | FY 13 – 14 | |
|---|---|---|---|---|---|
| Debt | 91.19 | 95.04 | 84.07 | 87.17 | 84.28 |
| EBIT | 261 | 223 | 321 | 431 | 541 |
| Debt/EBIT (%) | 35% | 42.61% | 26.19% | 20.22% | 15.57% |
The debt seems to have stabilized around 85Crs. In fact, it is encouraging to see that the debt has come down in comparison to FY 09-10. Besides checking for the interest coverage ratio (which we have discussed previously), I also like to check the debt as a per cent of ‘Earnings before interest and taxes’ (EBIT). This just gives a quick perspective on how the company is managing its finance. We can see that the Debt/EBIT ratio has consistently reduced.
I personally think ARBL has done a good job here by managing its debt level efficiently.
Inventory Check
Checking for the inventory data makes sense only if the company under consideration is a manufacturing company. Scrutinizing the inventory data helps us in multiple ways –
- Raising inventory with raising PAT indicates are signs of a growing company
- A stable inventory number of days indicates management’s operational efficiency to some extent
Let us see how ARBL fares on the inventory data –
| FY 09-10 | FY 10-11 | FY 11-12 | FY 12 -13 | FY 13 – 14 | |
|---|---|---|---|---|---|
| Inventory (INR Crs) | 217.6 | 284.7 | 266.6 | 292.9 | 335.0 |
| Inventory Days | 68 | 72 | 60 | 47 | 47 |
| PAT (INR Crs) | 167 | 148 | 215 | 287 | 367 |
The inventory number of days is more or less stable. In fact, it does show some sign of a slight decline. Do note; we have discussed the calculation of the inventory number of days in the previous chapter. Both the inventory and PAT are showing a similar growth sign which is again a good sign.
Sales vs Receivables
We now look at the sales number in conjunction with the receivables of the company. A sale backed by receivables is not an encouraging sign. It signifies credit sales, and therefore many questions arise out of it. For instance – are the company sales personal force selling products on credit? Is the company offering attractive (but not sustainable) credit to suppliers to push sales?
| FY 09-10 | FY 10-11 | FY 11-12 | FY 12 -13 | FY 13 – 14 | |
|---|---|---|---|---|---|
| Net Sales(INR Crs) | 1464 | 1758 | 2360 | 2944 | 3403 |
| Receivables (INR Crs) | 242.3 | 305.7 | 319.7 | 380.7 | 452.6 |
| Receivables as a% of Net Sales | 16.5% | 17.4% | 13.5% | 12.9% | 13.3% |
The company has shown stability here. From the table above we can conclude a large part of their sales is not really backed back receivables, which is quite encouraging. In fact, just like the inventory number of days, the receivables as % of net sales has also shown signs of a decline, which is quite impressive.
Cash flow from Operations
In fact, this is one of the most important checks one needs to run before deciding to invest in a company. The company should generate cash flows from operations; this is, in fact, where the proof of the pudding lies. A company which is draining cash from operations raises some sort of red flag.
| In INR Cr | FY 09-10 | FY 10-11 | FY 11-12 | FY 12 -13 | FY 13 – 14 |
|---|---|---|---|---|---|
| Cash flow from Operations | 214.2 | 86.1 | 298.4 | 335.4 | 278.7 |
The cash flow from operations through a bit volatile has remained positive throughout the last 5 years. This only means ARBL’s core business operations are generating cash and therefore, can be considered successful.
Return on Equity
We have discussed at length about Return on Equity in chapter 9 of this module. I will encourage you to go through it again if you wish to refresh. Return on Equity (ROE) measures in percentage the return generated by the company keeping the shareholder’s equity in perspective. In a sense, ROE measures how successful the company’s promoters are for having invested their own funds in the company.
Here is how ARBL’s ROE has fared for the last 5 years –
| In INR Cars | FY 09-10 | FY 10-11 | FY 11-12 | FY 12 -13 | FY 13 – 14 |
|---|---|---|---|---|---|
| PAT | 167 | 148 | 215 | 287 | 367 |
| Shareholders’ Equity | 543.6 | 645.7 | 823.5 | 1059.8 | 1362.7 |
| ROE | 30.7% | 22.9% | 26.1% | 27.1% | 27.0% |
These numbers are awe-inspiring. I personally like to invest in companies that have an ROE of over 20%. Do remember, in case of ARBL, the debt is quite low. Hence the good set of return on equity numbers is not backed by excessive financial leverage, which is again highly desirable.
Conclusion
Remember, we are in stage 2 of equity research. I see ARBL qualifying quite well on almost all the required parameters in stage 2. As an equity research analyst, you have to view the output of stage 2 in conjunction with your finding from stage 1 (which deals with understanding the business). If you can develop a comfortable opinion (based on facts) after these 2 stages, the business surely appears to have investable grade attributes and therefore worth investing.
However, before you buy the stock, you need to ensure the price is right. This is exactly what we do in stage 3 of equity research.
Key takeaways from this chapter
- ‘Limited Resource’ Equity Research can be performed in 3 stages
- Understanding the Business
- Application of the checklist
- Valuations
- The objective of stage 1, i.e. understanding the business requires us to gather all business information. The best way to go about this is the Q&A way
- In the Q&A way, we begin with posting some simple and straightforward questions for which we find answers
- By the time we finish stage 1, we should be through with all the information related to the business
- Most of the answers required in stage 1 are present in the company’s annual report and website
- Do you remember while researching the company in stage 1, if there is something not very convincing about the company, it is often a good idea to stop researching further
- You need to get convinced (based on facts) about the company in stage 1. This is how you will develop a strong conviction to stay put during bear markets
- Stage 2 of Equity Research requires you to evaluate the performance of the company on various counts.
- You will proceed to stage 3 only after the company clears in stage 1 & 2.
Sir,
Very informative
When is next chapter being uploaded ?
Shortly, maybe in a day or 2 🙂
In gross profit margin calculations, i think COGS figure seems to have been considered instead of Net Sales Figure while computing the GP Ratio. GP Ratio is much lesser (more than 10%) in all cases although above norm.
Sorry, dint quite get that. Can you kindly elaborate?
GP Ratio= GP Margin/Net Sales.
However, it seems COGS fig. have been taken into account instead of Net Sales Fig. (in each year)
Hey thanks for pointing this out. Clearly an error from my side. Have rectified the same.
Karthik,
Is it possible for you to explain on how to write research report/paper?
Are you looking at writing these reports from a career perspective?
Don’t know. But yeah.. It’s my dream to write a Professional Research Report/Paper on my own..
Hope this is possible one day.
Going by your credibility & forte in this financial world, need your help in accomplishing this objective
It is just a matter of practice of identifying good opportunities..you will soon realize a report is just a formality 🙂
Yup.. But in today’s world a lot of emphasis is placed on the presentation. Hence, it is essential that identification of good opportunity being translated into proper presentation.
I would love to make a career in this… Is it possible?
Sure why not. There are many firms that require research analyst. Getting yourself a CFA certification is a good start.
very informative and summrize tutorials.hats off for your honest efforts to aware peoples
Thanks, glad you liked it 🙂
Nice to go through user friendly simple explanation. Great effort by Zerodha and u.
Thanks, glad you liked them 🙂
Great info Karthik garu.
Thank you for making us to understand these difficult subjects nd procedures very easily.
Most welcome GK garu 🙂
Sir,
For FY11 the operating cash flow was low compared to previous year, even though other numbers like sales, Ebit etc remains strong in FY11. what does that imply what can effect the operating cash flow of a company but still that company can be “Investment Grade”..
Regards
Suneeth
Operating cash flow is also dependent on how well the costs are controlled by the company and therefore the margins. So a strong sales does not really translate to great operating numbers. Also, there will be business cycles which can alter the cash flow in operations…this needs to be studied as well.
Image
When I calculating CAGR all CAGR comes different from annual report Why?Like as Business Growth 18.60%,Shareholder Value Accretion 17.07% .
Yogesh – Thanks for pointing this. We are in the process of re-editing the whole module. I guess there has been some mistake while exporting these numbers to excel. For now, please ignore the calculations and only look at the central idea. Also, please do continue to point out any errors you spot. Thanks.
When is Stage 3 going to be explained ?
Not sure which stage 3 you are talking about, can you please be specify?
You mentioned that it is a three stage process.
You already explained Stage 1 and Stage 2.
So, far I haven’t read further; so was wondering what about Stage 3
As mentioned in the previous chapter, we will structure the equity research process in 3 stages-
Understanding the Business
Application of the checklist
Intrinsic Value estimation (Valuation) to understand the fair price of the stock
The Third Stage: Intrinsic Value estimation (Valuation) to understand the fair price of the stock
Oh, I’ve discussed this here – http://zerodha.com/varsity/chapter/equity-research-part-2/
Let me check, I must have messed up with the stages etc.
Hi Karthik , All your lessons are Very Informative and simple to understand.
I have a question on how to perform FA to compare the performance of PSU or Private banks. What all aspects of a bank business we need to evaluate ?
Banks are a little tricky to understand. To begin with look at – Book Value, Net Interest Income, NPA etc.
In your investment due diligence process , you mentioned macros only for domestic scenarios .
How to deal with Global Macros in the due diligence process ?
Example : Present Stock Market Meltdown !!!!!
Good point this one :). Honestly global macros is something that is very difficult to get a grasp on. Requires one to understand Sovereign economic balances and the interconnectivity with other countries. This is much difficult than understanding companies. I don’t think I can do justice to this topic here. But on the contrary, irrespective of what happens fundamentally strong companies always survive the toughest economic conditions!
Are there automated tools available in Zerodha for calculating DCF of any Stock ? Please elaborate
Nope, not at this stage.
Hi,
To check debt level of the stock, should we take short term and long term borrowing or only short term borrowing?
Both short and long term.
plz explain this, how come prime location price can go off balance?
“To get a sense of their geographic presence. Also at times their plants could be located in a prime location, and the value of such location could go off balance sheet, making the company highly undervalued”
Well, cant think of an example for you right now, but please do be aware that such a thing could happen…maybe transfer to a subsidiary.
Are they running the plant in full capacity?
How to find this from annual report. Please explain from ARBL example
Read the management discussion and analysis section in the annual report, the management will usually share information on this.
“Who are their bankers, auditors?”
As a retail investor how to know who is a good auditor or not and those auditors have any malafide intention or not /
Hard to answer given the fact PWC were the auditors of Satyam. But yes, you will get the name in the annual report….auditors have to sign off below the financial statements.
“What are the entry barriers for new participants to enter the industry?”
where to find this information, for example for batterry companies where i can I find this information?
Industry association reports or by primary research which you will have to conduct.
“Is the company manufacturing products that can be easily replicated in a country with cheap labor?
If yes, the company maybe sitting on a time bomb – think about companies manufacturing computer hardware, mobile handsets, garments etc”
I am not clear with this statment…can you please elaborate to explain
So if you are a company manufacturing toys in India….then t’row cheap imports from China may harm your business.
hi..
I am currently working on a bank stock, PNB. how can i calculate the gross profit margin and debt of the stock as it is not directly given in the annual report. do they use other terms for the same?
Yes, banks have a slightly different balance sheet, therefore a bit tricky to analyse. Guess I may not be the right person to talk about banking stocks.
What should be the ideal/maximum Price to Earnings to be considered while choosing a stock?
No such thing as an ideal PE…..but, I generally tend to be more averse of buying stocks with 30+ PEs.
30x? Wow! Even if we are considering the purchase for long term? (15-20 years or more)
🙂
ऊपर आपने gross profit margin का, inventory days का, receivables का, cash flow का “Snapshots” लिए हैं ना, वो किधर से लिये हैं? (Source of the snapshots?)
Sir,
What do you mean by PAT & PAT growth , kindly explain ?
PAT is nothing but the profits after all the deductions. Pat growth is the rate at which PAT is growing.
Sir you have mentioned that the equity research stages are sequential, but what if I find that the Stage II Equity Research is not convincing enough ? That means I would be spending 15 hours researching about a company which I would not prefer to invest.
Its fine, as long as you have valid reasons to reject the stock 🙂
Okay 🙂 Thanks a lot sir, by the way I am not getting your replies in my mail like I used to get before, what should I do?
The settings have been changed deliberately, will check what can be done. Thanks.
How did you arrive at the debt in debt to EBIT level table?
I must have picked it up from the AR.
Hi Karthik,
Debt/Ebit % is coming 719% for Tata Chemical 2015-2016, Debt=8263.68 cr, EBIT=1148.8 , am i comprehending correct?
Regards,
MSP
Somehow these numbers do not make sense. I think you are missing the conversions somewhere. Please look into that.
Hi Karthik,
I have rechecked the numbers, just to avoid confusion, if we take plain profit before tax 1271 cr, Debt 8263 cr, still its coming 650.9 %, tata chemical report link is http://www.tatachemicals.com/upload/content_pdf/tata-chemicals_AR_15_16.pdf.
Please suggest.
Regards,
MSP
Its better you treat this a multiple rather than a percentage.
Hi Karthik,
Thanks, in that case, its coming 6.50, what does this mean?
Regards,
MSP
Its a multiple of 6.5 times!
Hi Karthik,
This means Tata Chemicals Debt is more than 6.5 times of the profit they are generating, which i guess is a bad sign for the company.
Am i right ?
Regards,
MSP
Yup.
Hi Karthik,
If that is the case, why people are investing in Tata chemicals?
Regards,
MSP
Markets are forward looking. Perhaps, they expect a better future.
How do we find out the amount of dividend paid out if it is expressed in terms of percentage ? (Eg:Infosys March 2016 div. payout was 40.72% , is it 40.72% of the face value ?)
Moneycontrol has this information listed under dividends. Check this – http://www.moneycontrol.com/company-facts/infosys/dividends/IT#IT
Hi Karthik,
a small doubt, what is meant by SHIFTS IN BUSINESS CYCLE and another doubt is what is CAPPEX CYCLE. Please through some light on this sir.
Thanks&Regards
Shift in business cycle indicates the way business is conducted – for example companies in commodity business. Hindalco’s profits depend on the prices of Aluminium and copper…if the prices increase so would the margins of Hindalco…if they decrease, so would Hindalco’s margin.
Capex cycle refers to capital investment made by the company.
Sir, what should be the lower limit for Market Capitalization for starting to evaluate a company.
I mean, Market Cap should be greater than _____. (to avoid scams and find legit comapnies)
Nothing of that sort really.
While calculating PEG (Price to Earnings to Growth rate) which growth rate should we consider? Is it EPS (CAGR of last 5 years or so) or Revenue (CAGR of last 5 years or so)? Or is it based on the forecast the company proposes in the annual report?
You will have to take the EPS.
Would that work for ‘Turnarounds’ or ‘Cyclics’?
Yes, it would.
Sorry, Just to be sure that I understood it right – you meant EPS TTM to be considered or EPS CAGR of 5 years?
PE/G requires a growth rate at the denominator…hence EPS TTM does not make sense.
You can decide if you want to take the last 5 or 7 year EPS CAGR OR you want to take the expected EPS growth going forward. Both the options are acceptable.
Yes, I agree with you. Ben Graham says not to believe in forward EPS growth as it’s not achieved and forecasts are always wrong 🙂 That leaves 5 to 7 years CAGR as the only choice – the more the better I guess – to iron out all uncertainties.
Yup, that makes sense!
Best topic ever covered. Most useful of newbies and experienced people can take as refreshment training. Best 😀
Glad you think so 🙂
Hi, I had a question regarding diluting the company’s equity, in this example I can see that the company is growing it’s PAT at a CAGR of 17% while EPS CAGR is only 1.9%. So does that mean the company is diluting it’s equity and it’s a bad sign for Minority shareholder’s
Yes, too much equity dilution is a not a great sign.
Is there any module coming up on Financial Modelling? Do you teach Financial Modelling?
Yes, we plan to do that sometime soon.
so will it be live classes or a module….do you currently teach modelling?
Module – it will be in the same format as other content.
Sounds Great…Learning a lot from your website….you guys are doing a wonderful job 🙂
Thanks for the kind words, Romil 🙂
Dear Karthik
It is found that all equities of NSE are not tradable in Zerodha platform.Eg. I tried yesterday 22-05-17 to trade SHAKTIPUMP, but I found it was blocked by zerodha.What is the reasons of suck blocking ?. How can i get the total list of such blocked equities of NSE and BSE. Please help
Regards,
Sunanda
Can you check again, Sunanda?
I just loaded the stock on my market watch and it seems to be working fine!
Sir can u tell me how u got the eps of 19.65(should be 167/17.08=9.77) and 17.34(148/17.08=8.66) for the year FY10 and FY11 respectively under EPS explanation. The other 3 years values are correct but , how u got the above mentioned values.
You basically divide the earnings over the total number of outstanding shares. Let me look into this.
Sir, pl check and update, I think you made a mistake.
Sure, will do. Thanks.
What a great work ! So easy to understand that I have a doubt only in this chapter.
To get a sense of their geographic presence. Also at times their plants could be located in a prime location, and the value of such location could go off balance sheet, making the company highly undervalued.
Please clarify .let’s take example of Bhushan steel .it’s plant in Shahibabad is at prime location .if prime location here means somewhere in posh locality ?or prime location means like Orissa plant where raw material like ore ,zinc is available easily ,coal is there so cheap is power generation ?
Second Question balance sheet vala part.
Thanks again for educating us !
Prime location can be any valuable piece of land which the company owns. It could be the value of the land itself or proximity to resources.
Happy reading 🙂
For stage 2 of the research, we apply only some of the financial ratios that you taught us in the previous chapter. For example, in Stage 2, ratios like the P/E ratio and such are not included. Which of the other ratios should we be looking at?
We will take these up in detail when we deal with Financial Modelling.
I wonder why AMARA RAJA remained flat even with such great fundamentals for last 3 years?
That’s the mysterious ways in which markets work 🙂
Haha! Anyways, thanks for the brilliant work which you are doing. Coming from a non-finance background this makes me feel a little more confident to analyze markets.
Good luck, Naveen!
All the very best.
How to calculate inventory days?
Inventory number of days = 365/Inventory Turnover.
Sir,
Like this module,can you explain in a separate module,how to find turnaround companies and multibagger. Really your expiation about the fundamental analysis is very easy to understand to anyone.
Will try and do that, Roji. Meanwhile, I’d suggest you take a look at this video – https://www.youtube.com/watch?v=JRNEH8eJ6jg
Thank you sir for your quick reply…
Cheers!
Thank you for the info.
For calculating debt you have taken only long term borrowings and short term borrowings.
Why are trade payables and provisions(short term and long term) not added to calculate debt?
Short term is mainly Çurrent in nature, meaning they will be serviced within the financial year, hence we need not have to consider this. However, to get a sense of the short-term debt condition, we can look at the working capital condition of the company.
Thanks for the input.
Hi Mr Karthik/Zerodha Team,
There appears to be a minor error in EBIT calculation for FY 13-14 for “Debt level- Balance Sheet Check”. As per my working it is as follows:
Total Revenue less: Other Income (3482.17- 45.51)=3,436.66 (A)
Total Expenses less: Finance Cost (2941.62-0.72)=2940.9 (B)
EBIT=(A)-(B)=3436.66-2940.9=495.76
As per your working, 541 has been considered.
Thanks for pointing, let me check this.
Hi Karthik,
Now I am comfortable in doing the fundamental analysis after reading your materials. Thanks a lot for that. God bless you.
My doubt here is that, there are some companies which are fundamentally strong. But the price movement does not start suddenly. How to determine the perfect time for buying such stocks.
I found out one company called APIS India. From my analysis I found out that it’s a very good company. But it’s not being traded in BSE or NSE now. So, I don’t know when will it start trading and that time I would not be knowing. So please mention how can I track all such companies.
You cannot really time the market, Deepak, no one can 🙂
If the company is not trading, then maybe there is no liquidity at all. Are you sure this company is fundamentally strong?
I recently started going through these modules…but I have been an investor for two years or so.
I really like the fresh perspectives offered here. BTW, I work with Factset and when I saw this name
mentioned here I was surprised. I didn’t know that Factset is known to Indian investors 🙂
As a software engineer, I wrote codes for technical and fundamental analysis, that’s how I developed
interest in stock market. Anyways, reading the theory part after doing practical is “fresh perspective” 🙂
Happy reading, Ranjan!
Hope you continue to like the stuff here.
Great insights based on the financials docs! This has made the fundamental analysis a cakewalk of sorts 🙂
One query though – The CAGR calculated in the “Revenue & PAT” section is not correct for the given data. It is assumed that the period is 5 years although its only a 4 year period. Hence, the CAGR (if we take 4 years) will come higher than the ones mentioned above. The above values will come only if we take the start and end values from this data but ASSUME the growth has happened in 5 years!
Correct me if I’m missing something…
Thanks
Not really Uday. This is 5 year data, so you need to consider 5 years as the time period.
Formula is (3482/1482)^(1/5)-1
=18.6%
Hi Karthik,
Thanks for the prompt response!
I would beg to differ on this particular thing and urge you to have a look once again deeply.
Although it’s a 5 years data by looking purely at the number of data points, still this is a 4 year period only – from FY 09-10 to FY 13-14. Hence, we need to take “4” as the time period for calculating CAGR.
The periods for growth precisely are:
1 – FY09-10 to FY10-11
2 – FY10-11 to FY11-12
3 – FY11-12 to FY12-13
4 – FY12-13 to FY13-14
So, we can see that although we have 5 data points (1482 to 3482) but we are growing the revenue for only 4 years (periods here), and hence, it makes sense to take CAGR as {(3482/1482)^(1/4) – 1} which will be a higher value than the one we’ve received above!
Nevertheless, this write up is awesome & I would recommend it to anyone wanting to deep dive into fundamental analysis.
Cheers :):)
Uday, another way to look at this is as below –
1) Number reported on 31st March ’10
2) Number reported on 31st March ’11
3) Number reported on 31st March ’12
4) Number reported on 31st March ’13
5) Number reported on 31st March ’14
So 5 different numbers across 5 different years.
Whatever angle we view it from, pl find the calculation (in excel) taking 18.646% as the CAGR… If we start calculating step-wise from 1481, reported on 31st March ’10, then we would get to 3482 on 31st March ’15 and not on 31st March ’14…
I can share the excel calculation if we can discuss further over email..
CAGR
1) Number reported on 31st March ’10 1481.00 18.65%
2) Number reported on 31st March ’11 1757.15 18.65%
3) Number reported on 31st March ’12 2084.80 18.65%
4) Number reported on 31st March ’13 2473.54 18.65%
5) Number reported on 31st March ’14 2934.76 18.65%
We’ve reached only till 2934.76 here on 31st March ’14… If we go one more year ahead, we get the desired value:
6) Number reported on 31st March ’15 3481.99
Cheers:):)
Cheers 🙂
In screener small case kindly clarify weightage / priority should be given in which order for the following parameters for selection of a particular stock :
1) Return on Equity.
2) Return on Assets.
3) Return on Net Profit Margin.
4) Return on Investment .
5) Return on operating profit margin.
You need to speak to folks from Smallcase for this.
Sir
How do we check, the company is running the plant with full capacity?
Check for the capacity utilization number, usually, the company publishes these numbers in the annual report.
Hello sir
How r u?
As I was going through of your module,i observed in FY 10-11 to FY 11-12 the EPS shrank from 17.34 to 12.59 but the PAT grew impressively. So how would u justify this? why EPS shrank though PAT was in a uptrend?
Maybe the number of shares increased? Perhaps due to a corporate action?
Is it reasonable to buy a stock which has P/E = 26% ?
Certainly, as long as you can justify why you are buying at such valuations.
Hello Sir!
Should the Revenue CAGR and PAT CAGR rates be somewhat matching / in line with each other.
Ideally yes, but I suspect this is not a common occurrence. Even otherwise, its ok, nothing to worry about I guess.
Ok.
Adding to my question, should I take Revenue or PAT CAGR 5 years in FCF growth rate while using the DCF model.
I’d suggest you take the PAT.
HI Karthik Sir,
Your modules are really good and very useful. Thanks for sharing your knowledge.
Happy learning!
Dear Sir,
While calcuating EPS, how should I get total number of shares. For example, if total share capital is 6 Crs. and face value is Rs. 2/-, then Total Number of Shares = 6 / 2 i.e. 30,000,000 (30 Cr shares). Am i correct?
Correction….
6 / 2 i.e. 30,000,000 (30 Cr shares). Not 30 Cr but 3 Cr shares.
Thats right.
That would be 3 Cr shares outstanding.
Hi Karthik ! In your 9th point you have mention “Besides the promoter and promoter group, it helps to know who else owns the shares of the company. If a highly successful investor holds the shares in the company then it could be a good sign” Which I don’t think is true.
Can you tell me why Rakesh jhunjhunwala holds stake of DB realty the very same company whose promoters were linked with 2g spectrum scandal?
I know you have mention the possibility of it happening but they’re many more examples.
Yes, not always true. You should only look at this as a supplementary angle. End of it, what really matters is the value of the business.
okay!
Welcome!
Sir,
I am a beginner in stock market. and try to understand its basics through varsity. In understanding the business section, where should i go to read and find the answers of all those questions? Is it available in annual report of company or should i refer some other sources also??
And thank you for these excellent modules.
Yes, usually the annual report will contain all the answers, especially in the ‘Management Discussion & Analysis’ section. Do check it out.
Ok i will read the annual report.
And what should I see in annual result ,consolidated or standalone result? Which is more sacred??
I’d always prefer consolidated, Prakhar.
I have read near about all your articles
And thanku very much for this immense knowledge
I think there is no website available which explain the harsh road of share matket inthis sweet and smooth way
Thanks so much for the kind words, keep learning 🙂
Hello Karthik.
I would like to thank you for sharing such beautiful piece of information in the most simplest form.
Well I was going through the same process of checklist for STRIDS SHASUN PVT LTD.
While calculating the Net profit growth, I got stuck at the P/L statement for this company.
We need both REVENUE and PAT for at least 5 years to compare right?
While checking the PAT i see PAT from discontinued operations, may I know as to what I should consider for PAT Growth calculation, as the P/L statement has both PAT for the current year and PAT from Discontinued Operations.
Will be waiting for your reply.
Thank you.
This is a tricky situation and under such circumstance valuation based on traditional approach becomes really difficult. You will have to pay a lot more attention to MD&A and figure out the prospects. Maybe dig deeper into quarterly results as well.
Thank you for your timely reply Kartik.
The company every year generates huge profits from the sale of discontinued assets.
Is it a good sign or a bad sign?
I read in the prospectus that they don’t want to build a 100 year old company, they just want to grow and then sell the company for profits. The company in 2013 made huge profits by selling one of their subsidiaries and it has around 37 subsidiaries, I find the company bit risky as the management is only concerned to grow the company as quickly as possible to sell. No chance for long term investment.
This depends on how much percentage this would be wrt to the overall profits. If it is a large part, then you need to worry about it. I’m curious to know which company this is. I’d be worried about the management if they are making such statements 🙂
Greeting,
It’s a very informative blog. I am getting a little confused between the consolidated financial statements and standalone financial statements. Which ones do we have to consider for doing all the calculations and analysis.
I’d suggest you look at consolidated financial statements, Sameer.
Hi 🙂
So according to the write up above while doing equity research we follow following steps:
Understanding the Business
Application of the checklist
Intrinsic Value estimation (Valuation) to understand the fair price of the stock
So let’s say I am evaluating Company ABC and it has a competitor Company XYZ. So for comparison with competitor can I skip to step 2 of checklist to see if financial numbers are looking good, or I need to do comparison on the basis of step 1 as well ?
Thanks.
There are times when you figure out the competing company is much better than the one you chose to look into in the first place. So in case, you decide to skip step 2, you may miss on an opportunity 🙂
Hi, I was going through qualitative analysis of Hero Motocorp Limited. I was evaluating
Who are their bankers, auditors?
In the AR 2017-18 it is mentioned that their Statutory Auditors are BSR & Co. LLP (KPMG). I didn’t find any red flags against them.
Also they have PWC as one of their internal audit partners. PWC were audit partners for Satyam Computers just before the scam broke out, and in 2018 they have been banned from auditing for 2 years in India. Will this be a red flag even though PWC is a well established firm ? How much relevance do you give to such information and what is your preferred technique for digging such information out ?
Arun, the bankers and auditor information will be there in the AR. Look for it in the initial few pages.
No, PWC was involved in Satyam, but that does not mean they would be running a scam with every company 🙂
Hi
Thank you so much for your quick reply every time
How can I know bankers or financial institution is a good or bad ?
Plz give me some example
Book value is one metric that matters apart from NPA. I’d suggest you do some research on these parameters.
Hi sir
My question was
How can I judge this bankers r good or bad ?
End of the day they are banks like ICICI, HDFC, SBI etc..how do you judge them?
Hi
Means not much important to know who r they bankers ?
M I right ?
It is good to know, but I’m not sure if it adds any value to the research.
As Reliance also has many subsidairies so would it be good ti invest in reliance and by the ways you are doing a terrific job!
I’m not a big fan of Reliance stock, Ram 🙂
Respected sir,
Am facing the difficulty in calculations of CAGR
In Revenue and PAT Growth section, you have given 5 year CAGR Revenue Growth as 18.6% & 5 year CAGR PAT Growth as 17.01%. Whereas my calculations are giving negative result for same calculation. Please guide us.
Regards
Mahesh, I think you may have missed the brackets. Can you please double check?
Thanks sir !
Got it correct this time.
Again, is there any way around to get doubts cleared while in applying the theory? Since it wont be always possible to reach this website frequently.
Regards
Mahesh, unfortunately, there is no other way. Btw, I usually respond to queries within 24hrs, if not sooner 🙂
Good luck!
sir,
is it possible to pick a multi-bagger stock with the limited resource?
All you need is an annual report, which is freely available!
Hi sir
BLS international consolidated net profit 49 Cr .standalone 3.10 Cr and companys top management’s person salary is 13.5 Laks annualy .
Too much high salary is bad but what is indicate a too much low salary ?
Maybe he has shareholding via which he receives a great dividend payout. Please check that as well.
Hi sir
No not that type here
Two question
1.what low salary indication ?
2.i saw on zee business manpasand beverages management pay low salaries to CFO ,cs etc. Acoorading to zee it’s suspicious .what’s your view about this type of matter?
You cannot isolate salary alone, Amit. Salary could be just one part of the overall earnings. You need to see the dividend income as well.
sir,
what should be the 5 year EPS CAGR of a good company.
There is no fixed number for this. The CAGR can be as small as 5%, but within the industry, if this is the best then obviously we are looking at the best company in the industry.
Is everything that is listed under stage 1 can be checked by reading the annual report?
Yes, the annual report contains all the information you’d need.
How can a company dilute it’s earnings by issuing new shares? Please elaborate this.
When new shares are issued, the number of outstanding shares increases, when the outstanding share increase the profits are distributed amongst more shareholders, hence the dilution.
Also at times their plants could be located in a prime location, and the value of such location could go off balance sheet, making the company highly undervalued.
Can you please elaborate the above.
That means the real value of the land may not really be included in the balance sheet. Hence the valuation model may not accurately depict the true value of the company.
sir could you tell me please that what should first we check qualitative analysis or quantitaive?
There is no prescribed sequence for this. However, I’d suggest you start with qualitative aspects.
thanks for your valuable suggestion big bro…
Cheers!
Sir,Where is the Revene of ARBL for FY 09/10 mentioned in the financial statements ?
The very first line in the P&L statement is the revenue number.
Thanks Sirji
I have another query about EPS Calculation of FY 09/10 ,FY 10/11,FY 11/12,
If we calculate the EPS by the 10 years Financials of ARBL why the are different ?Pls correct me if i am wrong
EPS is based on the current year earning, Akshay. I’m not sure if I’m missing something here.
Hey Kartik…!!! Wonderful job..
Learning finance was never easy , but you framed it in a much simpler manner and I am finding it really interesting. Thanks a lot.
Happy to note that, Manav!
Good luck and happy reading.
Dear sir, Wishing you my best regards for teaching FINANANCE in
such a crystal clear manner, with hope to get your another sessions, thanking you
Glad to note that, Prakash!
Happy learning 🙂
Hi Karthik,
When can we expect the 11th module on Financial modeling?
Hopefully this year, Ram.
Thanks.
Hello sir
I’m pretty convinced by the fundamentals, financial ratios and the growth of these companies, and I think for their market they have monopoly and their future is bright.
-Colgate-Palmolive (India) Ltd
-Hindustan Unilever Ltd
BUT their p/e ratio is very high , like 64 for Hindustan Unilever and 44.6 for colgate-palmolive.
Help please discuss whether they are a good option or not.
Arpit, markets have always assigned higher PEs to multinational companies. So this boils down to the growth you foresee for these companies and their current growth multiples. In case of a mismatch, then you will have to wait for an appropriate time to buy in.
Sir
@Karthik
Where can we get the fundamental data for equity research like ROE, EPS , GPM etc? Is there any resource available where we can get these all the basic information about stock.
All these are available in Stock report+ (https://stockreports.zerodha.com/), but then its a paid feature by Zerodha. Check screener.in or even tijori finance for free versions.
Hi Karthik Sir,
What do we mean by “Promoters have pledged 70% of their holding”. Is it good or bad?
It means that the promoters has pledged their shares to raise more money. This is like pawning your gold to cash.
Thanks for the clarification…!
Welcome!
Sir,will it be better to set the threshold revenue and pat growth based on the industry i.e revenue growth and pat growth to be best among its competitors rather than fixing absolute number of 15% CAGR which you have done.Because i think 15% is very rare and it causes many fundamnetally strong companies to eliminated from our priority?For example,I have calculated the revenue growth of stocks in FMCG (nifty FMCG) today…of these FMCG stocks the highest growth was observed to be Britania with 7.89 CAGR. And the average CAGR of all these FMCG stocks is around 4% CAGR.Does that mean britania has passed the revenue growth parameter from our checklist or it did not pass because of its growth less than the the threshold of 15%?How should we interpret?
Kaushal, I do agree with you on pegging the values to the industry. However, you need to ensure that there is a decent growth across all parameters – revenue, margins etc. I agree it is not really easy to find these, but then that the point about investments, you will have to keep looking for opportunities 🙂
Really very informative and simple to understand concepts for a retail investor. Thank you team Zerodha.
Happy reading, Satya!
When you are calculating the CAGR why are you taking the no of years as 5 rather the no. of years would be 4?
You include the base year as well, Brijesh.
Yes that’s what i m trying to say, starting with base year we are taking the data at the end of the FY .
2009-10 end to 2010-11- 1 year
2010-11 end to 2011-12- 1 year
2011-12 end to 2012-13- 1 year
2012-13 end to 2013-14 – 1 year
Total time period – 4 years
Isn’t it?
1st Apr 2009 – 31st Mar 2010 – 1st year
1st Apr 2010 – 31st Mar 2011 – 2nd year
1st Apr 2011 – 31st Mar 2012 – 3rd year
1st Apr 2012 – 31st Mar 2013 – 4th year
1st Apr 2013 – 31st Mar 2014 – 5th year
Hi Sir,
Please suggest if it’s worth buying shares of a company with negative EPS CAGR growth but above 15% PAT CAGR growth.
What can be the reasons behind a company to have negative EPS CAGR growth and positive PAT CAGR growth?
I’d be a bit hesitant to do that, Pratibha.
Hi Karthik,
First of all thanks a lot for putting together such practical content.
Second, I tried applying the checklist to L&T Finance Holdings. Looks like we would need a different checklist for Banking, Finance etc. Could you suggest such a checklist or direct to the right resource (something as lucid as your content).
Regards
Ashis
Thats right, Ashish. This won’t really work for BFSI companies. I’m not sure, but let me check for content on this online.
Hello Karthik ,
During the result times media houses often mentions slippages in bank’s results. can you explain how to calculate that?
THANKS
This refers to the losses occurring due to the provisioning of banks.
Hi Kartik,
If companies have too many subsidiaries, the company may be siphoning off funds. How many number of subsidiaries would be good enough ?
Its best to look at it the other way i.e. if a company is siphoning off funds, then it is likely to have many subsidies. Not all companies with subsidies siphon off the funds.
How to check promoters/board criminal background and intense political affiliation? Any methods/tools etc to give us quick info on this?
You will have to dig up the internet for this.
Hi Karthik,
under inventory check,
As you mentioned, if Inventory and PAT are growing together, its a good sign. what if there is a great difference between both? like for the data below, what should i incur out of it?
FY 2014-2015 FY 2015-2016 FY 2016-2017 FY 2017-2018 FY 2018-2019
Inventory 953.63 826.07 658.05 740.6 788.87
PAT 130.62 188.63 214.68 219.51 305.92
Decrease in inventory and increase in PAT indicates quick sales for the company, which is a good sign.
Hi Karthik
my question is that when I am doing fundamental analysis of a company now ( march 25th), the annual reports that are available are that of FY 2019. the quarterly reports available is till 31st dec 2019. If i want to check the Debt of the company, the values of “debt, other liabilities, reserves …etc” that are available in Screener.in are different. The values in Annual Statement are different. And there is no mention of debt, liabilities, reserves etc in the Quarterly statement published by the company.
How can i find the current value of above parameters today? Where does the Screener.in sources its data?
thanks
vikram
Vikram, ensure you are checking the consolidated numbers in the annual report. Also, when you are checking AR, there is no need to check any other source. Btw, these debt numbers don’t change frequently, so its safe to assume you have the lastest number.
Dear Sir, First of all thanks for such an amazing content.
I had a query regarding Amara Raja Batteries , from screen.in ,I came to know that the promoter holding has reduced significantly over the years ( 24% in last 3 years ). I think its a red-flag , isn’t it..? Also as I assume that you have been following this company over the years what is the reason for reduced promoter holding..?
I’ve not been following that stock, Prakash. It is really hard to say if the reduced promoter holding is good or not. One needs to read through the context in which it has reduced. For example, Infy has very little promoter holding.
Hello Sir,
I have a few Question.
1. Could you Please explain, Why should we consider only “short term Liabilities” while calculating the DEBT level?
2. What will the “Ideal EPS” CAGR growth for 5yrs? As in this case it is around 1.9% and there is no comment on that particular note.
3. As a Long term Investor which annual report should I used for Equity Research for all the Steps? Whether it is a “Standalone Report” or “Consolidated report” or “Both” ?
1) Short term liabilities also include working capital loans and other borrowings right?
2) Depends on the industry, no ideal ratio as such
3) Consolidated
1. I would agree that Short term liabilities also include working capital loans and other borrowings but What about “Long Term Liabilities” while calculating the Debt Level. Because most of companies have huge Long Term Liabilities?
Yes, long term liabilities has all the big debt component. You need to consider this as well.
Hi.
Do stock splits have a similar effect on EPS and subsequetly P/E ratio, as of issuing new shares?
In the long term, stock splits should be peceived as good thing or bad thing?
Thanks.
EPS yes, because the denominator in EPS is the number of shares. Not for PE though. A stock split does not matter in the longer term.
Sir,
It’s an amazing tutorial on FA. I have not seen any other FA tutorial on Internet including paid one, which is so elaborated like this one. Thanks a lot sir.
Eagerly waiting for the Financial Modelling course. Could you please tell when it is coming on this platform?
Thanks and regards
I’m eager to write it as well, hopefully sometime before mid of this year 🙂
Hi,
Can you please explain to me where i am getting it wrong
COGS- In the example I can see figure of 2450 for 2013-14 while in Financial report its 2941.
Link to report : https://www.bseindia.com/bseplus/annualreport/500008/5000080314.pdf
Also,
To calculate CAGR,
Excel formula is =( End year/Start Year )^(1/Number of years )-1, Right?
So here aren’t we supposed to take number of years as 4 instead of 5 because practically we are calculating for 4 years only
But if we take 4 answer differs from the one in example.
In example (considered 5 years) = 18.65 years
As per 4 years it comes to = 23.83%.
Please clarify Thankyou!
Consider the years ‘completed’, this is the accurate way to do it.
Great fan of you sir!!.sir,please add some more fundamental analysis of different companies like banking sector as it’s analysis is somewhat different
Thanks for the kind words, Mahesh. Yes, we will add these chapters at some point.
Good afternoon sir,
Thank you so much for such insightful modules. I have a doubt of how do we identify whether plant is operating at full capacity or not?
Rupam, easiest way is to look for the management’s statement on capacity utilization, which they’d state in the MD&A section of the Annual Report.
Sir any special course or website through which i can go more deep into financial markets, specially equity market or mutual funds?
This is the right place, what exactly are you looking for?
sir, during FY 11-12, the PAT of the company increased but the EPS went down so there must be diluting in shares i.e issuance of new shares?
Yup, thats right.
Already loving what you taught me sir! I want to enter into financial markets, i want to dig more into it!
Happy learning, Mohit!
I must thank you for the kind of courses you have design and the lucid way the things are explained. I never thought I would ever be able to get hang of the things.
I had a question on this topic. Is there any tolerance level we should consider while evaluating a company? I mean not every company can be good in all the points mentioned in the check list. Is there any points which are more critical to look at from long term perspective and some might be something which we may tolerate to some extent. Would you suggest some guideline related to that?
Thanks!!
Ritwik, this is a very tricky spot. Personally I’ve turned a blind eye to a few of the things and its turned ok. For example, management has political exposure…you just live with that fact. So these things should be evaluated on a case to case basis and considered only if you are comfortable.
While calculating metrics Earnings per Share (EPS) i have observed that for TCS share capital has increased in FY19 which in turn affects the EPS .i,e EPS has decreased . In that case how to analyze this metrics?
Thanks
It just means that there is an equity dilution (are you sure about this wrt TCS), and therefore the EPS has dropped. You need to understand why there is a dilution and the management reasoning for the same.
Hi,
I wanted to ask that we should use the checklist above only for equity research part 2 for checking the financials or do we have to compare valuation ratios or other financial parameters while researching a stock.
Thanks,
Aditya
You can use the checklist for pretty much every critical aspect of equity research.
Hello sir,
What is meaning of diluting companies equities ?
Why do companies dilute equities
Thanks
Suppose you are 100% owner of the company, you want to raise funds, you give a part of your shareholding to raise the funds. This is called dilution.
Hello sir,
A) Like GPM more than 20%
ROE more than 20%
P/E less than 30%
what is number for ideal Debt / EBIT
B) I am confused between co relation of Inventory, Inventory days, PAT
Inventory should increase
Inventory days decrease
PAT increase
Mi right
There is no ideal ratio, this depends on the sector really. Inventory can increase due to higher sales, does not mean inventory days also increases. So no correlation.
Thanks sir,
How to know company is diluting its shares?
How does it affect investors
Regarding inventory and PAT
Is this right combination
Inventory should increase
Inventory days decrease
PAT increase
The company will announce its intention beforehand that they want to raise money by dilution. When diluted, the profitability reduces. The rest depends on the company and the sector it is operating in.
Thanks
In certain companies, for eg PGHL
Revenue CAGR (%)
10 Years 6.02
5 years -0.43
3 Years – 5.07 Years
PAT CAGR (%)
10 Years 29.05
5 years 80.96
3 years 119.66
REVENUE CAGR for 3 and, 5 years are negative but PAT CAGR for 3 and 5 years are positive (that also significantly) how to interpret ?
The growth can be -ve, but the profitability can be +ve. This means they are not growing in sales, but mainintian status quo.
Sir, while considering CAGR, for how many years cagr is good to consider means of 3 years, 5years or 10years
At least 5 to 7 years.
hello karthik,
as per checklist debt/ebit% shows a company highly leveraged as per earnings before interest and tax but as per debt/equity ratio is less than 1 making it virtually debtfree .so while taking investment decision what should be given more preference.
kindly guide.
Do take the Debt/Equity ratio.
hello karthik as per check list
if debt/ebit% shows a company highly leveraged as per earnings before int and tax and at same time as per debt/equity ratio is low say for eg 0.001 making it virtually debt free .so what has to be given more preference .
This is a great article, infact the entire module is great and very informative.
I had one doubt, what sources to refer to when doing the industry analysis?
Samuel, you should checkout Tijori Finance and Screener.in, both are great resources.
Most satisfying lesson in the entire module. Learning all about financial statements and financial ratios and finally falling into equity research was the most satisfying part !!!!
Happy learning, Pooja 🙂
Good day,
I’m a bit confuse, when you are referring to the ROE Dupont Model: Net Profit/Net Sales x Net Sales/Total Average Asset x Total Average Asset/Shareholders Equity. Net Sales in the formula is actually Operating Revenues am I correct?
Also on the Computation of Gross Profit Margin: Gross Margin/ Net Sales, the Net Sales is actually the Net Sales of Product. Is this also same with the Net Profit Margin?
Yup, that’s operating margins. You ignore the other income and take in only the revenues from operations.
Thank you so much for the reply.
Hi Karthik,
Thank you so much for this fundamental analysis module. However I have one question related to qualitative analysis, where we get details like plant capacity, type of raw materials, whether plants are running at full capacity.. I am doing analysis for Ashok Leyland and I am not able to find these details. I got the location of plants and cost of goods(In depth details diff. raw materials have not been provided in schedules/notes either) from AR and their official website.
Hoping with a favorable reply.
Thanks and Regards,
Arpit
Arpit, this information has to be available in the AR, either in the tabular format or in the test description under the MD&A section.
Thank you so much for your response, I will look into AR and MD&A section.
Sure. Good luck.
Dear Sir,
May I kindly request you to please explain the reason for FY12 EPS resulting in negative inspite of Revenue and PAT for FY12 being positive.
What about the expenses?
The table mentions the major shareholders of a company. From the description, it is clear that we need to look for non-promoter shareholders. However, this information is not easily available online. Do you suggest any particular way to figure this out?
All the large shareholders are mentioned in the annual report Rahul.
Share capital in the table is mentioned as 17.08 crs but balance sheet says 170.8crs. Same goes with most of the values in the table here. Do we divide by 10 to simplify the numbers? Can you explain why are we doing it?
Its 17.08Cr or million balance sheet?
Sir when I calculated checklist going through all year annual reports and finding the trend
Sitting and calculating on book is very difficuly
Please suggest is there any other way ?
seeing every year annual report and writing them on book and calculating where the numbers too are in lakhs,Indian ruppes
You can use screener available online for this right?
Ok sir, Sir when is financial modelling module coming on varsity?
Sometime this year 🙂
surely it is very very worth to study. karthick sir you did great job.
Happy reading!
I really like your module its very helpful and valuable for me
Happy reading!
Hello Sir,
4)How many plants do they have and where are they located? (Question)
To get a sense of their geographic presence.
Also at times, their plants could be located in a prime location, and the value of such location could go off-balance sheet, making the company highly undervalued (The rationale behind the question)
In the above what does the statement mean ” the value of such location could go off-balance sheet, making the company highly undervalued”?
Can you please help me undetstand.
Thank you..
As in the company may own prime land, which could be highly valuable and not really come under the balance sheet. Although, I think the chances of this happening is low 🙂
While studying the annual reports, it is important to calculate all the financial ratios or just checklist ratios ?
AS much as you can. Remember, these ratios etc are means to find the answers you are looking for, so ensure you dig for these ratios till you get all your answers 🙂
So right now PE of Nifty 50 is 40-41% is that mean valuations are very high and it’s not a good time to invest.
What should we do if our planning has to invest in index fund or index shares thorugh SIP.
The good part of SIP is that that you don’t have to worry about things like PE. You invest an amount in a disciplined way over many years, and the timing part is automatically taken care of.
Hey! For ARBL, the PAT has increased while the share capital has remained constant since 2009. But the EPS in your calculations show a decline and then an increase. I think the EPS for FY 09-10 and 10-11 have been miscalculated. Please look into it. Thanks!
Thanks, Sherin. Let me check.
Sir, regarding understanding the business. There are a bunch of question for which we need to find answers. If you could add a column in the table “Where it can be found” and provide the reference points in the annual report of the company it would be more helpful and it helps us to have it as a reference whenever we do equity research in a different company.
for eg: “How many plants do they have and where are they located” question, you could add to the column like, This can be found under the heading “Locations” in the annual report.
Most of the answers to such questions can be found in the Director’s report and the Management Discussion and Analysis.
Sir hope you are aware of company IRFC
Sir how to do stage 2 for such nbfc companies
Their main operation is leasing to MoR because of more of trade receivables receivables on future their cashflow are negative how to value such company and how to compare valuation ratios when there are no peers and I can’t see the trend
Sir finally when is next module coming
Thank you😊
Chandu, I’m not too comfortable doing DCF on NBFC/Banks. This sector requires valuations techniques other than DCF. I’m not too familiar with it.
Sir I’m degree student have chapter called valuation of shares In that methods like Net asset value method,Yield method I have done that based on sums shall I apply same for valuing this company
Yes, you can give that a try. If not for anything, it will be a great learning experience.
Hello sir,
1) I prefer to invest in growing (Revenue and PAT) companies over and above 15% on a CAGR basis. Means?? I guess every year Revenue and PAT should grow by 15% YEAR ON YEAR. Please correct me
2) Debt level – I am not able to find debt heading (in balance sheet) in site like rate star. Where find debt value in rate star.
3.) For calculation which debt should be taken current or non current
4) Is receivable means sundry debtors
1) When you measure the growth on say 10-year basis, CAGR should be 15% or higher.
2) Look at the balance sheet, its usually called debt or borrowings
3) Non-current
4) Yeah
Sorry sir, regarding Q2, I could find these heading,
Non-Current Liabilities
Secured Loans
Unsecured Loans
Long Term Provisions
Current Liabilities
Trade Payables
Other Current Liabilities
Short Term Borrowings
Short Term Provisions
Have explained these in the module itself right?
Thanks sir,
But I could find the debt or borrowing in above headings.
Among the above heading which could be consider as debt or the borrowings for the calculation debt/ ebit
Then maybe there is no debt in the company?
Sir PAT and revenue are positive for 5 years and its increasing but growth rate is volatile say from 34% growth rate it comes to 1% or negative but overall cagr is 10%. What one must do in that situation.My question is overall CAGR is good but growth rates are volatile and negative but trend is up of last 5 years
Thats too much volatility in earnings, Bharath. I’d ignore the CAGR and inspect why this is happening. Maybe there is a cyclical component?
Sir I found 2016 2017 cash flows are very high but from 2018 to 20 due to change in accounting policy IND AS cash flows are decreased what to do here sir shall I take same
Yes, you will have to go with the same.
Could anyone tell me why we should not invest in a company with an intense political affiliation?
Because let us just say that while a certain car battery manufacturing company is now in a slight hump due to the lockdown, it’s share if bought around 2008 and sold now(2018 for maximum gains)would have yielded an excellent return. But on the other hand…Let’s just say that the man who is the MD, the Vice-Chairman and also the founder’s son is a part of the Lok Sabha and belongs to a certain company, and his mother, the person after the company, quite sweetly in my opinion is named after and who is also the founder and chairman’s wife, belongs to the same party. What do you think about this Karthik?
The only reason to avoid companies with political affiliation is to ensure that the company is not growing due to political favours. After all, we want companies that are growing because of their operations and not due to other factors.
Hello Sir,
How is Free Cash flows and Profit after tax related??
Harish, will be discussing this and a lot more topics in the new module on Financial Modelling. Request you to please check that module.
Hello Sir,
When exactly would the complete module on Financial modelling get released. Will you please teach us how to value a bank/nbfc/insurance/holding company?
It will take sometime, Harsih. We just started it.
Hello Sir,
Will you teach us how to value a bank/nbfc/insurance/holding company?
I wont be able to do that, Harish.
Sir How do we research on the company that is just listed like nazara technologies.
Check their DHRP filed with SEBI at the time of IPO. It will have all the relevant historical data useful for research.
Hi Sir , A little doubt for me why you didn’t include the revenue from services in gross profit margin?
Have I missed that? If yes, my bad, it should have been included.
Hey! what if a company has a controversy, but it also involves the government such that they didn’t intend problems? Example the adani green energy company along with the Rajasthani govt. controversy over solar parks on farmers’ lands.
Depends on you as an investor if you want to invest your money in companies that are muddled in controversies or look for opportunities elsewhere.
sir just a personal question, did you invest in arbl in 2014. if yes are you still holding on it.
I did way before 2014 and sold it few yrs ago as I needed money for something else.
Karthik, The Face Value of Amara Raja Battery till 2012 was Rs 2. So when calculating the number of outstanding shares in FY 09-10 and FY 10-11 do we need to keep the Face value of Rs 2 or Re 1(current F.V)?
The EPS for FY10 and FY11 you have considered 19.56 and 17.34 respectively. But while I am calculating of my own (PAT/Outstanding Shares) its coming 9.78 and 8.67 respectively. Even in screener.in it’s showing 9.78 and 8.67. Is that a typo? If not can u explain why the difference?
If you are doing this today, then you will have to consider today’s face value. For historical calculation, use the historical values. As far as the difference is concerned, is that in the historical context?
Yeah, when I am calculating the historical data using historical calculations, your data seems correct. I got confused looking at screener.in. Also, the change in face value indicates a stock split that happened in past. As you told that issuing new shares by company by diluting the earnings isn’t good, but this low CAGR in EPS is due to a stock split. How can stock split be bad?
Splits and bonuses are not bad, these are corporate actions. The valuation of the company does not really change with these corporate actions.
How do we actually get to know or get to analyse about the future prospects of the industry/sector to which the company belongs?
That depends on how well you know the industry and the emerging trends and its prospects. The more you study, the better would be your knowledge about the industry.
Sir can you tell the steps by which we can write Equity research reports ?
As I want to pursue career in Equity research
There are many different ways in which you can write, Jigar…right from 1 pager to a detailed report. Will probably put up a note on this sometime.
Hi Karthik,
Thanx for all your clear explanations. I have started analyzing a stock in Fashion Industry. Here,the profit were consistently increasing for the past 5 years except last year(might be due to the pandemic).Can you please tell me whether I can proceed with the futher analysis.
Yes, why not. Revenue is just one aspect of the analysis.
While calculating the CAGR, you have considered no of years as 5. In my humble opinion, it should be 4 years (Hence CAGR will increase in your tables).
For examples in Revenue & Pat Growth paragraph, It took ARBL 4 years to achieve revenue of 3482 crores from 1481 crores. Another way to look at it is 1481 crores revenue is in the 0th year.
The formula states that we have to take the starting year, ending year, and raise it by the number of years in between.
Exactly my point, the number of years in between are 4 and not 5 in my opinion. In that case the CAGR revenue growth for ARBL would be 23.8%.
Am I counting the years wrong?
But you need to include the starting and ending year also right?
I guess you should not consider amount in the first year because that is the amount invested to get the returns after 4 years. Hence when you show 5 figures, 1st one is the invested amount and hence the nper = 4 in RRI formula.
I have also cross checked my theory on Tickertape.
Hmm, ok. Let me relook at this.
Can you please advise about the discount rate one should consider now when saving rate is at 3.5% and FD rate is at 5 – 5.5%. I guess the cost of capital now a days is around 6.5%. Should I consider discount rate as 6.5%?
Yeah, you can consider around 6.5%. Generally, the 10-year GOI bond is an indicator of the discount rate.
Ok thanks and thank you for taking the time out and responding to our queries.
Happy reading!
Hi sir for 5years CAGR revenue growth and CAGR PAT am getting the following answer but how did you get 18.6% and 17.01% ??
(1,481÷3,482)^(1÷5)−1 = 15.71
(187÷367)^(1÷5)−12.61
The 5-year CAGR revenue growth is 18.6%, and the 5-year CAGR PAT growth is 17.01%.
Sorry Mr karthik I got the answer thank you thank you for your great work.
Glad you did 🙂
Hello Karthik,
Thanks for educating newbie investor community on various aspects of investment/trading etc. Just quick observation, EPS for 09/10 and 10/11 is calculated incorrectly. It should be 9.78 and 8.67, can you please relook into this. It should be in sync with PAT CAGR as share capital/volume is constant for the given period.
As, thanks Yogesh. I will check through this again.
When i read the Annual report of any bank. In the P & L section, I do not see any tax expense. I see only “Less : Minorities interest” why is that? Please explain.
Bank P&Ls are a little different. I’d suggest you read the schedule notes associated with the line item, Vineeth.
Today I show zerodha varsity in my phone to college friends and ask them to pay some money as i buy these by paying money .And they ready to pay for it. 😂
But after share the link for free. As the motive of zerodha to educate freely.
Lol 🙂
But thanks for sharing the link and helping in spread the knowledge 🙂
Hi sir.How to get/collect the mentioned details in stage 1 about a company?
You can check websites like Tijori Finance for this.
Hi Karthik,
could you elaborate this statement “The earnings per share represent the profitability on a per-share basis. The EPS and PAT growing at a similar rate indicate that the company does not dilute the earnings by issuing new shares, which is good for the existing shareholders. One can think of this as a reflection of the company’s management’s capabilities.”
Even if company is diluting the earnings by issuing the new shares, investor will be having more no of share (as bonus shares or splt). Could you please explain the above statement with an example ?
Regards
So if there is dilution, the profitability per share reduces, right? If PAT is 200 and total number of shares is 20, then EPS is 200/20 = 10. But if there is dilution, and the number of shares is now 40, then, EPS is 5. So higher the number of shares, lower the EPS.
Hi Karthik,
while doing the Inventory check of a chemical company for (2018- 22) I can see that inventory days increased from 86 in 2021 to 229 days in 2022 but pat is increased 20% so what inference we can take here ?
Maybe the company has pricing power here? They increased the price of the goods they are selling?
so even that’s also a positive. right ?
Sorry, I lost context. Whats positive?
Correct. So I have two questions on this
– First Why a company will try to lower it’s EPS (higher EPS is a good thing) by diluting it’s no shares
– second, If I have 10 shares of this company and company’s shares are diluted * 2 and it makes my shares 20. so if earlier I had eps of 10 that means total earning was 100 and even after diluting eps has come down to 5 still my earning is 20*5=100 same. isn’t it ?
so how diluting is no of shares is impacting our anyalysis ?
1) Dilution can happen on multiple counts – if the company wants to raise more capital, or issue bonus shares, or do a stock split.
2) Dilution shrinks the profitability ratios.
“Sorry, I lost context. Whats positive?” – so when I asked “while doing the Inventory check of a chemical company for (2018- 22) I can see that inventory days increased from 86 in 2021 to 229 days in 2022 but pat is increased 20% so what inference we can take here ?” you told “Maybe the company has pricing power here? They increased the price of the goods they are selling?”.
so that’s what I asked even if they increased the price that’s a positive thing in analysis ?
Oh yes, having pricing power is a good thing for the company 🙂
In interest coverage ration section you mentioned EBIT=EBITDA – Depreciation and amortozation(560-65 =495). But in this chapter you have mentioned it as 541. Is summin wrong with my understanding?
Ah, I need to double-check. But D&A are non-accounting entries, and its best to factor in that while calculating the interest coverage ratio.
Hi Karthik,
Stage1 – point no 9 says “If a highly successful investor holds the shares in the company, then it could be a good sign”
what is highly successful investor?
Sir ji
Revenue and pAT growth
The 5-year CAGR revenue growth is 18.6%, and the 5-year CAGR PAT growth is 17.01%.
How did u calculated 18.6% and 17.01%🤔
Applied the CAGR formula, Punit 🙂
Hi Karthik,
How did you calculate “The 5 year EPS CAGR”? Can you pls explain?
Thanks
Kiran
I’ve shared the formula, Kiran. Please do check the same.
You explained everything very well . thank you for sharing valuable information with us
Happy learning, Arun 🙂
In the ARBL example above for Calculating the CAGR, shouldn’t we use periods as 4 instead of 5. The CAGR with no. of periods as 5 is 18%. The same with no.of periods as 4 is 23%. Kindly, clarify.
You are considering 5 year’s data, so you need to factor it by 5 right?
Hello Karthik sir,
What if a company keeps on diluting its shares and EPS also performing well?
The dilution will impact EPS also right? It gets lower and lower.
How do I calculate 5 year CAGR revenue growth, 5 year CAGR PAT growth? I am new, please help me out.
You need to apply the CAGR formula. Have explained that here – https://zerodha.com/varsity/chapter/measuring-mutual-fund-returns/
Why PAT growth is 17.01% and EPS Growth is only 1.90%? In my understanding, these both should be same. Kindly help with this.
Its possible that the company could have issued bonus shares, splits etc. So any change in the number of shares will reduce the total EPS, even if the PAT is increases.
Sir, can you suggest me a particular website, where i can get all the information of 1st stage research as well as 2nd stage research.
You can check Tijori Finance.
Hi Karthik,
In the section Applying the checklist, you have suggested a Gross Profit Margin (GPM) >20% is good, what about the PAT margin? why I am asking is company might have a good GPM >20% but PAT is like 7%
YOu can have multiple filters, Ramesha. One easy thing to do is to look at sector averages and figure out what is the sector average like and then figure out a suitable percentage in your filters. It could be 7% or 10%, really depends on the sector.
Understood Thank You Karthik
Happy learning 🙂
These are helping so much.
I have one question regarding calculation of CAGR. What if the value in question for the beginning year is negative, while the value for ending year is positive?
How do we calculate the CAGR then? Or do we use other metrics in such cases?
You cant really use a -ve number at the start. But in the investment context, you wont encounter situation right?
What should be an ideal CAGR growth of EPS for a company.
There is no such thing as a idea CAGR or EPS of a company.