Module 3 Fundamental Analysis

Chapter 1

Introduction to Fundamental Analysis

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M3-Ch1title

1.1 – Overview

Fundamental Analysis (FA) is a holistic approach to study a business. When an investor wishes to invest in a business for the long term (say 3 – 5 years) it becomes extremely essential to understand the business from various perspectives. It is critical for an investor to separate the daily short term noise in the stock prices and concentrate on the underlying business performance. Over the long term, the stock prices of a fundamentally strong company tend to appreciate, thereby creating wealth for its investors.

We have many such examples in the Indian market. To name a few, one can think of companies such as Infosys Limited, TCS Limited, Page Industries, Eicher Motors, Bosch India, Nestle India, TTK Prestige etc. Each of these companies have delivered on an average over 20% compounded annual growth return (CAGR) year on year for over 10 years. To give you a perspective, at a 20% CAGR the investor would double his money in roughly about 3.5 years. Higher the CAGR faster is the wealth creation process. Some companies such as Bosch India Limited have delivered close to 30% CAGR. Therefore, you can imagine the magnitude, and the speed at which wealth is created if one would invest in fundamentally strong companies.

Here are long term charts of Bosch India, Eicher Motors, and TCS Limited that can set you thinking about long term wealth creation. Do remember these are just 3 examples amongst the many that you may find in Indian markets.

M3-Ch1-chart1

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M3-Ch1-chart3

At this point you may be of the opinion that I am biased as I am selectively posting charts that look impressive. You may wonder how the long term charts of companies such as Suzlon Energy, Reliance Power, and Sterling Biotech may look? Well here are the long term charts of these companies:

M3-Ch1-chart4

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These are just 3 examples of the wealth destructors amongst the many you may find in the Indian Markets.

The trick has always been to separate the investment grade companies which create wealth from the companies that destroy wealth. All investment grade companies have a few common attributes that sets them apart. Likewise all wealth destructors have a few common traits which is clearly visible to an astute investor.

Fundamental Analysis is the technique that gives you the conviction to invest for a long term by helping you identify these attributes of wealth creating companies.

1.2 – Can I be a fundamental analyst?

Of course you can be. It is a common misconception that only chartered accountants and professionals from a commerce background can be good fundamental analysts. This is not true at all. A fundamental analyst just adds 2 and 2 to ensure it sums up to 4. To become a fundamental analyst you will need few basic skills:

  1. Understanding the basic financial statements
  2. Understand businesses with respect to the industry in which it operates
  3. Basic arithmetic operations such as addition, subtraction, division, and multiplication

The objective of this module on Fundamental Analysis is to ensure that you gain the first two skill sets.

1.3 – I’m happy with Technical Analysis, so why bother about Fundamental Analysis?

Technical Analysis (TA) helps you garner quick short term returns. It helps you time the market for a better entry and exit. However TA is not an effective approach to create wealth. Wealth is created only by making intelligent long term investments. However, both TA & FA must coexist in your market strategy. To give you a perspective, let me reproduce the chart of Eicher Motors:

M3-Ch1-chart7

Let us say a market participant identifies Eicher motors as a fundamentally strong stock to invest, and therefore invests his money in the stock in the year 2006. As you can see the stock made a relatively negligible move between 2006 and 2010. The real move in Eicher Motors started only from 2010. This also means FA based investment in Eicher Motors did not give the investor any meaningful return between 2006 and 2010. The market participant would have been better off taking short term trades during this time. Technical Analysis helps the investor in taking short term trading bets. Hence both TA & FA should coexist as a part of your market strategy. In fact, this leads us to an important capital allocation strategy called “The Core Satellite Strategy”.

Let us say, a market participant has a corpus of Rs.500,000/-. This corpus can be split into two unequal portions, for example the split can be 60 – 40. The 60% of capital which is Rs.300,000/- can be invested for a long term period in fundamentally strong companies. This 60% of the investment makes up the core of the portfolio. One can expect the core portfolio to grow at a rate of at least 12% to 15% CAGR year on year basis.

The balance 40% of the amount, which is Rs.200,000/- can be utilized for active short term trading using Technical Analysis technique on equity, futures, and options. The Satellite portfolio can be expected to yield at least 10% to 12% absolute return on a yearly basis.

Core

1.4 – Tools of FA

The tools required for fundamental analysis are extremely basic, most of which are available for free. Specifically you would need the following:

  1. Annual report of the company – All the information that you need for FA is available in the annual report. You can download the annual report from the company’s website for free
  2. Industry related data – You will need industry data to see how the company under consideration is performing with respect to the industry. Basic data is available for free, and is usually published in the industry’s association website
  3. Access to news – Daily News helps you stay updated on latest developments happening both in the industry and the company you are interested in. A good business news paper or services such as Google Alert can help you stay abreast of the latest news
  4. MS Excel – Although not free, MS Excel can be extremely helpful in fundamental calculations

With just these four tools, one can develop fundamental analysis that can rival institutional research. You can believe me when I say that you don’t need any other tool to do good fundamental research. In fact even at the institutional level the objective is to keep the research simple and logical.


Key takeaways from this chapter

  1. Fundamental Analysis is used to make long term investments
  2. Investment in a company with good fundamentals creates wealth
  3. Using Fundamental Analysis one can separate out an investment grade company from a junk company
  4. All investment grade companies exhibit few common traits. Likewise all junk companies exhibit common traits
  5. Fundamental analysis helps the analysts identify these traits
  6. Both Technical analysis and fundamental analysis should coexist as a part of your market strategy
  7. To become a fundamental analyst, one does not require any special skill. Common sense, basic mathematics, and a bit of business sense is all that is required
  8. A core satellite approach to the capital allocation is a prudent market strategy
  9. The tools required for FA are generally very basic, most of these tools are available for free.

113 comments

  1. Kishor Chaudhari says:

    Versity is good, however most of the charts given are not legible. The coordinate labels appear very small to read, probably on full HD display. Also the charts are marked by circle and arrow but not by word. For example while explaining the candlesticks the word doji, spinning top etc should be written.

    • Karthik Rangappa says:

      Thanks for the feedback, I would agree with you. Most of the images are real time screenshots from live markets, hence the drop in image quality.

  2. […] Introduction to Fundamental Analysis – Zerodha Varsity. […]

  3. Ram23 says:

    Please provide downloadable for taking print and read keep it as a reference guide.

  4. nitin tarvekar says:

    Fundamental analysis is very useful to create our self openion on company strategy .there is given very nice illustration on fa.

  5. Shyamnath P R says:

    Can I Get the soft copy of the modules

  6. Nikhil Zelawat says:

    Good overview covering the positive and negative aspect and comparing with TA which depicts the picture more clearly.

    One query – What is the role of MS Excel as a tool in FA ?

  7. Shochis Natrajan says:

    i would like to ask a question that how much years of past data is considered while doing proper analysis of a company

    • Karthik Rangappa says:

      Look for at least past 5-7 years of annual data. They say when a company completes every 7 years of business, it would have undergone 1 economic cycle. Hence when you look at 7 years of data, you will be factoring (and analyzing) 1 full economic cycle.

      • Ishan Choubey says:

        BUT KARTHIK THESE CYCLES CAN VARY, HOW WOULD I KNOW THAT AT WHAT TIME PERIOD THE ECONOMIC CYCLE OF THE COMPANY STARTED. WE ARE JUST ASSUMING THAT THIS CYCLE COULD HAVE STARTED EXACTLY 7 YEARS BACK.

  8. harshendra singh says:

    Varsity is really good and this educative series has really helped in understanding the technical aspects of the market

  9. harshendra singh says:

    I have a question.
    Will it be feasible for me to enter stock market by this much technical knowledge ?
    I want to do short term trading and I am entirely new to it.
    Thanks in advance.

    • Karthik Rangappa says:

      Yes, please be through with everything we have discussed on Varsity and I’m confident you will be on the right track.

  10. Adam says:

    The Satellite portfolio can be expected to yield at least 10% to 12% absolute return on a yearly basis.
    If the stock market is giving me just 10%, then why should I even care to do so much of hard work in analyzing stocks when I can get 9%(just a percent less) just by simply keeping it in the bank’s FD!!!

    • Karthik Rangappa says:

      Couple of things here Adam –

      1) Long term Capital Gains tax is nil. Hence if you manage 12% on your portfolio over the last 365 days then do remember this is tax free
      2) FD returns are taxable – so 9% after tax is about 7%. So contrast 7% versus 12%!
      3) 12 % is a bit conservative…well managed Equity portfolios can generate over 15%
      4) At 15% year on year your money will start working really well in your favor. To appriciate this point I would suggest you read the next chapter ‘Mindset of an Investor’, especially section 2.2.

  11. Michael Mathew says:

    Where can we find the industry data?? and i can not find 10 years of annual reports for many companies in their respective websites could only get hands on 3-5 years of data so what to do 10 years of data??

    • Karthik Rangappa says:

      Usually the industry data is made available by the industry association/lobby. For example you can get all automobile data you could check SIAM – http://www.siamindia.com/ . I guess for historical AR you could check with the company directly, you will be surprised to know that most of the companies oblige and point you to the source.

  12. Michael Mathew says:

    I do i contact companies for historic annual reports

  13. Michael Mathew says:

    Sorry earlier was a typing mistake,How do i contact companies for historic annual reports??

  14. Amit Kumar Pal says:

    In where I got 5 to 7 year data for FA for a company ?

  15. anoop says:

    i bought a share in 5000 quantity, cupid ltd 2 years back at 30 rupees.i sold the at 500 .now share are trading at 353 rupees .its valuation are not seems correct..should i reenter ?

  16. Supriti Swagatika says:

    Where can we find the banking industry data?
    Is there any official website available to know about banking industry data?

  17. RD3032 says:

    Hi Karthik,
    Could you explain more on getting the news about the companies. Please mention some good tools or websites those are helpful.
    Thanks,
    Deepak

  18. RD3032 says:

    Hi Karthik,
    I read from Intelligent Investor that bonds and stocks should occupy 50:50 amount in portfolio. When stocks become expensive then bonds get valuable and vice versa. Because of your excellent articles I am now confident in stocks. But I know nothing about the bonds. So, could you please introduce a lesson about bonds?
    Thanks,
    Deepak

    • Karthik Rangappa says:

      We will try and put up information on bonds sometime soon. However, the bond market in India is not really vibrant for retail participants.

  19. Vaibhav Joshi says:

    Hi

    Impressed! Very interesting way of learning.
    Is it possible on can target dividends in a short term trade? E.G. Today for company x’s dividend declared and buy on the same date then one can expect dividend? Please elobrate on complete process, declaration date, record date etc

  20. Sai Sreedhar says:

    Hi Karthik
    This could be trading strategy related question. I have read in a book that the author invests in shares of a company and exits after a year leaving the profit and withdrawing the principal amount invested. Which leaves the profit money to grow and principal is safe (of course the principal shall be invested elsewhere in order to get benefitted).
    What could be the disadvantages or advantages in this kind of approach?

  21. Deepak Kumar Singh says:

    Hi Karthik,
    I have a basic question. As per most of the good investors it is advised that long term mindset should be set to become a successful investor in stock market. Companies performance does not contribute to the price of the shares as share price is totally dependent on investors emotion and market news. So how can we ensure that the current share price will not come down to its initial invested value after 5-6 years?

    • Karthik Rangappa says:

      In the long run, it is the performance of the company that takes the stock price to its true value. As an investor one need to spend more time analyzing the business of a company rather than the price of a stock, this will naturally ensure your investments are safeguarded.

  22. sumit says:

    can u name some site where i can track the performance of company industry.

  23. Dhinakaran says:

    Hi Karthik, I am one among those who came into stock market without knowing what is Stock Market. I read few basic books (Intelligent Investor, Common Stock & uncommon profits, One up, Fooled by Randomness etc) to get a perspective. Very recently I can across varsity (Luckily!). It is very useful and I like the way you explain. All these basic books are completely against Technical Analysis. Could you please tell me if it is possible to get returns greater than FD rates by following technical Analysis CONSISTENTLY ? I did go through the fundamental analysis modules. Is it worth to dig deeper into Trading(Understanding Black & Scholes and trading strategies etc) ? Please clarify. Thank you .

    • Karthik Rangappa says:

      I’m happy to know you liked Varsity 🙂

      Yes, there are traders who make more than FD rates consistently while trading. We have even interviewed few of them to understand their mindset – http://zerodha.com/z-connect/category/zerodha-60-day-challenge/winners

      This is hard work, but can be worth if you do it the right way.

      • Dhinakaran says:

        Karthik, Thank you very much for replying. Looking at the winners, isn’t it the survivor bias (I am getting reminded of the Monkeys on the Typewriter analogy )? I am convinced that money can be made on long term(Thanks to you & Varsity team!). I am just skeptic about technical analysis and short term trading. If I learn more, does it help? is it wroth learning the TA or luck plays a major part?

        • Karthik Rangappa says:

          There is no denying about the survivor bias here. But the practical problem is that its very hard to interview people who have lost money, they tend to shy away :). Read through the interview and treat it as just one set of inputs. Trading via TA requires a great amount of discipline, which let me assure you is not easy.

          Here is what I’d suggest – spend time learning (the right way) and give it shot with smaller amounts of money. Scale only when you feel there is substance.

  24. Bhavesh says:

    Hi Karthik

    As you have written ” You will need industry data to see how the company under consideration is performing ”
    Please provide some source where i can find Industry Related Data.

    Thank You

  25. Anand says:

    Hi Sir,

    It would be of great help if you can send me the excel sheet which have explained in the the tutorial. I’m struggling to create one from looking at your tutorial

    Thanks!
    -Anand

  26. Harish says:

    Hi Karthik,
    Can we rely on the fundamental data provided in Moneycontrol for any stock ?

  27. sainudheen says:

    Sir,
    Where will get companies valid annual reports directly for analyzing datas,
    Thanks

  28. kieron says:

    Sir
    Only technical analysis is sufficient for short term investment

    • Karthik Rangappa says:

      Depends on how you define short term. If its for few minutes or hours or maybe few weeks, then TA is good. Something like 3 months or more then its good to be aware of the fundamentals as well.

  29. sabit fikadu says:

    its a fantastic source to make a fundamental analysis
    thanks at all.

  30. Himanshu says:

    FA is indeed a very time tested investment philosophy. However I am keen to know how to take the first step ? For e.g. how to get a list of say 5-10 companies for further research and analysis. Do you suggest using some screeners or using Lynch’s approach ?

  31. thinesh says:

    Dear karthik,
    can you post a separate chapter on how to read and analyse, earnings report or any report published by a brokerage research. That would be great if you do so..

  32. paraskhungar says:

    Sir i am in confusion
    what is the differnce for Net profit For period from financials and Reported NET PROFIT .

  33. indrax says:

    Previously pdf. version was also available for download and offline reading. PDF version is very convenient for self study and marking. But now I could not find a link to download content as pdf version. Please help.

  34. Abhijit says:

    I need to know where to get the quarterly reports as soon as they are published?

    For example, few days back, Sun Pharma published q1 results. I checked their website immediately after reading thw news, but P&L statement was not there yet. Still I can see all the news about it. So from where do these news people get the information so fast?

    Basically I am interested in getting to know the financial news of a scrip as soon as possible.

    • Karthik Rangappa says:

      It will be made available on the site really quickly. If not for the official source, I’d suggest you check a 3rd party tool like MC, but I personally don’t rely much on 3rd party source.

  35. rohan bhandari says:

    Regarding NIFTY dividend yield-

    1. are dividends paid every day in nifty 51 stocks …? I think its once in few months so how come they have given nifty divident yield value for each dy?

     2. what is the relevance of nifty dividend yield? like by increasing P/E we can assume that market is overpriced…in the same way what conclusions can be taken from dividend yield

    • Karthik Rangappa says:

      1) Companies pay dividends (if at all paid) once or twice a year
      2) The dividend yield is adjusted every day. Remember the yield changes as Nifty spot changes value
      3) You can plot the historical dividend range and peg that against the Nifty’s spot price….and then arrive at some conclusion on oversold and overbought Nifty regions.

  36. Siva says:

    Good Evening Karthik,

    I have couple of queries.

    1. I assume the DCF cannot be used to value the intrinsic value of bank stocks, in that case what are the other methods i can use to so?
    2. Where can I get the EPS or ROE of a scrip for say 5 – 10 years?
    3. I want to hear from you about Godrej Consumer Scrip, product wise I see the company has less exposure to consumers when compared to HUL in that case do you think Godrej consumer is overly priced at the moment?

  37. sivashunmugam says:

    Good Day Karthik,
    I was analyzing one of the script which is under good management and consistently growing at a good pace.
    But when I calculated using DCF model it gave the Intrinsic value between (2,325.7) – (2,842.5)
    What does it indicate?
    P.S: I have cross checked
    In this case how to identify it real intrinsic value.
    Please advise

    Siva

  38. shashi says:

    hi,
    how can i do fundamental analysis on mcx and also does the same technical analysis work for mcx.

    Best Regards
    Shashishekar T S

    • Karthik Rangappa says:

      FA on commodities will be quite tricky as it varies for each commodity. Yes, same TA can be applicable on commodities.

      • shashi says:

        where can i learn FA on commodities in zerodha…or do you suggest any book

        • Karthik Rangappa says:

          I’m not sure about FA on commodities. I guess the information is scattered and not really contained in a single place.

          • shashi says:

            can you suggest any book to read for FA and TA for commodities…

          • Karthik Rangappa says:

            Nothing that I know of.

          • shashi says:

            hi,
            i have account in zerodha. i want to trade in mcx . i want to learn about commodities. i went through all your education. now i have doubts. where and how can i learn about trading commodities. can you suggest some books (both for technical analysis and FA). can you suggest . where can i get news related to commodities. is possible that you put up strategies for commodities trading like you did for options or can you suggest books for commodity trading strategies.

            Best Regards
            Shashishekar T S

          • Karthik Rangappa says:

            I’m assuming you have read through this – https://zerodha.com/varsity/module/commodities-currency-and-interest-rate-futures/

            The same set of TA rules applies to commodities as well, nothing special. FA on commodities is not easy, as it changes for each commodity.

  39. AkshayB says:

    Hello Kartik
    Can you explain me TA in some more depth. Or the provess of conducting TA.

  40. Prashant says:

    By regular investing through SIPs, I have created wealth more than 50 lacs at the age of 39 Years. Around 4 months back, I liquidated 25 lacs and invested in PMS of Birla Sun Life for better returns. Considering different types of fees of MFs and PMs charge thus eroding your wealth, I am planning to enter in equity market independently in around 1 year time. Till then I will study stock market to be a confident stock investor. Yours is a good source of knowledge which will definitely help me to become independent investor. Thank you so much!

    Query: Once I become knowledgeable in stock trading, would it be a good option to shift all corpus invested in MFs and PMS in direct equity or should I still have the exposure in MFs? Please suggest.

    • Karthik Rangappa says:

      After all these years in markets, I still do invest in MFs. This is besides having my own little EQ portfolio. So if you ask me, having exposures to MFs is good….I consider that as a hedge against my own investing… but I do secretly wish, both MFs and my own investing eventually pays off 🙂

      • Prashant says:

        Thanks Karthik Sir for the prompt response.
        My next question: How much % of total corpus should be exposed to MFs and how much % to equity (assuming a good knowledge of investing in stocks) ?

        • Karthik Rangappa says:

          If you are fairly comfortable investing in Stocks, then invest at least 30-40% in direct equity and the rest in MFs. Over time, you can think of increasing this to at least 60% in direct stocks.

  41. Jinal says:

    Hi,

    Recently my dad transferred his portfolio of equity shares in my demat account some of which aren’t trading on stock exchange or may have been de-listed like Elder pharmaceuticals, Melstar Info, Zenith infotech, Arms Paper ltd
    How do I sell them ?
    Few people suggested to contact the co. directly, but how do I go about it?

    • Karthik Rangappa says:

      You will have to touch base with the company’s registrars for this Jinal. If they are delisted and closed down, then I’m afraid there is nothing much that can be done.

  42. Nirmal Agarwal says:

    Hi,

    Previously there were link of ibook of each module but now there is only pdf available , can you please provide the link of ibooks of all the modules.

  43. kunal says:

    Hiii sir,
    can you tell me how can i download all the module in pdf format.
    I like to inform you that i dont have any accout with zerodha.

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