Fundamental Analysis – Part I
What is Fundamental Analysis?
Fundamental analysis is based on detailed study of the financial statements of a company and its future prospects, expansion plans and socio-economic factors that may affect the progress of the company. To achieve an assessment of a value, the analyst makes estimates of sales, cash flows, future earnings and dividends. The fundamental analyst target prices set discounts based on future cash flows, PER levels, earnings growth, comparisons with the market and the sector and sum of different parts of the business (among other methods) and assigns recommendations of overweight (if think that the value will perform better than the market), neutral (If he believes that he will behave as the market) and underweight (if it considers that their behavior will be worse than the market).
Fundamental analysis tools
Unlike technical analysis, analysis tools, given the goal of obtaining the “true” value of a title, are all the elements that can affect the value.
· Periodic financial statements: calculation
· Business valuation techniques.
· Economic forecast: situation analysis.
· General economic information.
· Any additional information that affects the value of a title.
Types of Fundamental Analysis.
To determine the value of companies, there are several methods that could be divided into two groups:
· Top-Down Analysis
For this type of analysis is part of a global position, to move to a concrete, which is the one that definitively ends up by selecting the choice of concrete values.
So begin by analyzing the current global economic situation, first worldwide, to move to analyze individual economies that seem related to the strategy. The next step is the choice of sector or sectors with greater appeal to finally select specific companies in which to invest.
· Bottom-up analysis
This type of analysis is based on the selection of attractive investment opportunities in individual companies, and then analyzes the industry and national economic environment and the global order.
Currently and to the global nature of markets, increasingly more investors opt for an analysis Top-up when it comes to making investment decisions, although it doesn’t mean that the Bottom-up, not lacks attractive or followers. But the truth is that hard a value will experience a bullish long-term tour when a sector or an economy is in recession.
If we assume an analysis top-down, we start from the macroeconomic analysis, to go to the sectoral and finally to the valuation of company.
We start the analysis of the international economic situation, which would analyze the economic variables that affect the behavior of the income statements of companies.
To achieve this, first we should determine the time when the economy is in which the company conducts its business.
Will develop estimates of the main economic variables on GDP growth, government debt on GDP, government deficit over GDP, inflation, interest rates, foreign exchange policy…
The next step is to analyze more comprehensively the major national economic variables, being recommended to distinguish between the cyclical and structural analysis.
Structural analysis would be he that studies the variables of the main components of supply and demand and the basic of economic growth, as components of the GDP, the evolution of private consumption and investment.
The conjectural analysis, studies the variables with impact or presence short term, as inflation, evolution of types of interest, of sales, of wage costs, of the monetary mass, domestic credit, secondary market of obligations, of the exchange policy, fiscal policy, government deficit over the GDP, the labor market or monetary policy the ECB or specifically of Central Bank of Spain if it were the country to analyze.
We must take into account and always present, due to the increasing globalization of markets, and of economies, political and economic decisions of a country is likely to have an impact on the rest.
In general analysis departments, there are people in charge of these economic projections that serve as the basis for the rest of the analysts.
The second step in our process, it would be after deciding the status of global and national economic environment, move to assess the situation in the sector.
First, we would study the influence of economic variables previously assessed in this sector, or what is the same, carry out a sensitivity analysis, relating these economic variables to the sector.
Thus, the importance of the national scale and in terms of GDP is important, and we must bear in mind that we cannot stay only at the national level, since international comparison is important, with data evaluation and cost structure, technology, market positioning, integration, applicable policies…
The competitive structure of the industry, with market shares and zones of influence is essential to evaluate a strategy. Also, it is vital to assess the positionof the sector over the business cycle in which we are to know when the right time to invest in the sector is.
So, if for example we were in recession, the defensive sectors (those covering basic needs such as food, distribution, construction …) usually presenting a better performance.
Conversely if it is sensitive to consumption, as vehicles, manufacturing or large sectors, given that the income available for consumption doesn’t pick up until the middle of the bullish cycle, it would have to wait until this situation to make the entry into the sector.
Also when analyzing a sector, will have to take account of the same regulation and its stock market position (weighting, volatility…).
Analyzing the company
After having analyzed the macroeconomic environment global and national, the situation and industry characteristics, we spent to crumble the specific variables affecting the company in question.
It is important to first study the strategic and competitive position of the company. For this we assess mainly the following:
- Barriers to entry: It’s about seeing the barriers at both entry costs associated with sector and distribution networks, physical, economies of scale … affecting the company.
- Suppliers of power: analyzing the concentration thereof
- Customer of power: As in the previous case the smaller higher risk involved.
- Competition: The growth of the sector, or rivalry among firms, product differentiation, quality of them…
- Substitutes: Propensity to change, price of substitutes, quality….
From here and to proceed with a financial analysis of the company, some of the information that until now would have made or collected would count as a raw material:
· Memory of the exercise and report of audit
· Quarterly information
· Investor relations
· Industry associations (Unesa, the Seopan, AEB)
· Sectoral and specialized publications
· Press, media in general (need to check)
· Consensus of analysis, market drive
· Information diffusers (Bloomberg, Reuters, Infobolsa…)
· The market, the brokers, the positions, the rumors…
In this part of our analysis, the financier of the company, we will focus primarily on accounting numbers and figures, in order to interpret the situation of the company and developing our projections, our provisional accounting statements with estimates of sales, profits, investment, indebtedness…
Balance sheet items
The balance sheet of a company is the accounting description of the situation of its assets and liabilities.
Depending on the type of company that will analyze one or the other items in this balance but we clarify the basic concepts of the same:
· Intangible assets: Intangible assets assigned to the business of society
· Tangible assets: Tangible assigned to the business of society. Important to see the degree of redemption thereof.
· Financial assets: Financial Assets assigned to the business of society. Have greater importance in companies with major holdings, as the situation of these can affect the value of balance.
· Shares of the parent company
· Debtors for operations of long-term traffic
• Deferred expenses
• Current assets
· Stock: There are several scoring systems, but the FIFO and LIFO are certainly more employees. The FIFO (first in first out) accounted for considering that the price at which the company acquired first is the first to be sold. So if for example you buy 100 books at $ 10 and 200 to 11, if you sell 150 books it would account the exit of these first 100 books to 10 Euros and 50 to 11 euros, whereas in stock they would remain 150 to 11 Euros. The LIFO would assess (last in first out), ie last-in, first out. Both evaluation systems differently affect the income statement.
· Accounts Receivable: Accounts receivable should be analyzed also in terms of rotation and in their correct accounting for doubtful prospects not provisioned.
· Term investments
· Treasury: Counts the own cash and those short-term investments, given its high liquidity.
· Accruals: They are important because they can affect the future income statement.
Total assets: sum of the parts so far described
· Capital and reserves: would include preferred shares, net income taxes, minority interests, Accrued dividends of previous exercises, reservations of consolidated societies, dividend to account, results of the exercise and the capital contributed by the shareholders
· Subscribed Capital: Money contributed by the shareholders
· Revaluation reserve: net income taxes.
· Loss and profit attributable to parent company
· Dividend paid during the year: Dividends accrued from previous years
Income to distributing in several exercises
Provisions for risks and charges
Creditors to long term: includes debt cost and direct impact on financial costs from the income statement, together with other provisions and accounts in the long run.
Debentures and other marketable securities
Amounts owed to credit institutions
Creditors short-term: debt with or without cost in the short term
Issuance of bonds and other negotiable securities
Debts with credit institutions
Others non-trade Payables
Once we know what the items that usually make up a balance are, we could analyze them based on the following concepts:
• Working capital: The difference between current assets and current liabilities. It is indicative of the position of the accounts of the company in the short term. It is usually measured on sales of the company, working capital to sales.
• Leverage: It is the weight on the balance of the debt with cost. It can be measured on total assets or own resources. Take into account that not all growth is positive, since if coupled with sharp increases in leverage, it may result in loss of value for the shareholder.
• Fixed assets in relation to the investment plan: indicative of the renovations of the asset of the company and future liquidity needs.
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- Erick Gálvez