I have never understood the line which i listen from many Investors --- I buy only fundamentally sound stocks.
So the next thing that pops up - What is Fundamental Analysis which gives me so called fundamentally sound stocks.
So in this post I am trying to make a note on Fundamental Analysis for myself and check whether I can do it. I am not qualified financially ( IT engineer by qualification) , not good at understanding businesses or people neither can i read through a balance sheet,annual reports or accounts.
Let us look what is Fundamental Analysis.
This is just one of the definition i got from stockcharts.com
Fundamental analysis is the examination of the underlying forces that affect the well being of the economy, industry groups, and companies. As with most analysis, the goal is to derive a forecast and profit from future price movements. At the company level, fundamental analysis may involve examination of financial data, management, business concept and competition. At the industry level, there might be an examination of supply and demand forces for the products offered. For the national economy, fundamental analysis might focus on economic data to assess the present and future growth of the economy. To forecast future stock prices, fundamental analysis combines economic, industry, and company analysis to derive a stock's current fair value and forecast future value. If fair value is not equal to the current stock price, fundamental analysts believe that the stock is either over or under valued and the market price will ultimately gravitate towards fair value.
Now let us look into some basic steps in analyzing a company or things I need to know.
- > Business Plan
- > Management
- > Financial Analysis.
Further to this there could be many approaches. One of the simplest books i read recently was Philip Fisher– Common Stocks Uncommon Profits. There are 15 points to do a good quantitative analysis of the company – Check Link here .
When I go through the above three points let me look into how can I do the analysis myself. If i cannot then whom can I rely on. ( The best thing we learn in Engineering CTRL – C and CTRL – V or Copy Paste) So if i cannot do it will find some other sources who are doing it. The other people who do Fundamental Analysis according to me is Brokerages with a team of Sectoral Analysts, Investment Banks like Morgan etc, Independent Research Houses ( are there any – Veritas is in Canada) , Equity Advisory Firms . But the problem here is we COPY from people who we can rely on but can i rely on the above firms ?? I really dont know the answer.
So lets try doing it on my own.
- > Business Plan
- How can i know the business plan or rather what business does the company do. Few ways that come to my mind.
1) Companys Official Website.
2) Last 5-10 years Annual Reports.
3) Initiating Coverage Reports by Brokers ( this is the nomenclature for first report detailing the company by brokers)
Now can I actually understand how many business units does Reliance Inds, Larsen and Toubro, Ongc, Bpcl or how many countries does Tata Steel, Tata Motors, Sterlite inds operate in.
The annual report of Larsen & Toubro for instance is 269 pages, Reliance Inds is 200 + and majority of the large cap companies have such huge books. I remember in Engineering we would skip the reference books and go for Classes Notes or even in school look for Guides :).
So the next option is to rely on Brokerage Reports. Out here one analyst generally focuses on one sector or 2-3 sectors max. He might have enough time to go through those Annual Reports and various businesses. The initiating coverage report contains a good concise detail of the company.
But can you rely on these reports. Reason is simple if i am an equity research guy who meets the management understands every detail and then come out with a SELL report and a 60% down target . Will the management speak to me again. NOT AT ALL :). So even if the Analyst is bearish he needs to sugar coat it. Baring Veritas never seen any reports bashing up companies.
But that does not mean i chuck the reports. I read them but avoid looking into the Selll/Buy or Hold rating as well as the target price
On this basis majority of the top 100-200 companies need to be chucked out if I were to make a detailed analysis of their businesses. Also we as professionals in our fields may barely understand a few businesses. Like i may never know Flower Business ( aka Karuturi Networks in Ethiopia ) is there for real or not. Also if a company has 15 business can i actually analyze all of them ? Never
There can be many ways to look into it but following 3 come to my mind.
- Management Interviews and Actions.
- Qualifications and Track Record.
- Technical Capabilities and Experience.
Well there can be many such points about the management. But as an individual Investor or even a large Investor i can rarely get access to Managements and also to expect them to be true and fair in their approach. ( Can i say bad things about my Own Business – Nope Never )
One can access public information on the management , speak to the competitor companies ( scuttlebut like Fischer defines it to speak to anyone but the company management.) and do as much as possible to understand the credibility and vision of the management. Also many other things like corporate governance, sharheolder friendly etc.
There can be great companies and bad managements so this is very important. In india it becomes even more important as we do not have any investor protection cells or regulations to take action against bad managements. Like for example recently Ruias are delisting India Securities at 56 rs and they did the same with Essar Steel.
3) Financial Analysis.
Is it that simple to buy stocks with low p-e ratios or available at 1/3rd book, Historically low p-e bands or positive cash flows. There has to be a detailed Financial Analysis of many aspects of the balance sheet and product pricing.
There are way too many things which need to be seen. Right from p-e, cash flows, price to book value, dividiend yield and the list goes on and on. On that people add on to more data points.
So if a company has many products/business units/subsidiaries the process gets more and more difficult to dig into the data points of each part. Above all whether al the data available can be trusted ( I remember this very well because i recommended Satyam at 140-110 and sold it at 160-180. Purely relying on the cash on books – Check post here. Ever since that have become wary of cash on books. Never play on luck again) .Majority of the complex companies will get out of the list.
Half the small cap IT companies we can never understand as we may never know that 100 million dollar acquisition in Europe ever existed.
The process does not stop here.
But even after this analysis every Stock quotes at a Price !!
After all the analysis i need to figure out is the stock has Margin of Safety ( Do read Benjamin Graham ) and prospects of Growth or Appreciation over the next few months or years. Also when do we exit ? or accept that we picked a wrong company ? When do we book profits ? Can i just hold forever like Warren Buffet.
So when i look into the detailed aspects then i can barely analyze 5-10 companies with lesser products, few businesses and mainly in India or in few countries. Or i rely on the financial analysis with a simple assumption – Everything stated in the balance sheet is true and historical assumptions about the company. ( now this is too risky aka Satyam or a p-e derating in capital goods like Bhel and crompton )
If i am buying Reliance at 900 or at 700, Larsen and Toubro at 1400 or 1000 all I am trying to do is speculate on the future of the above two companies which i have NO IDEA of or neither do I understand if they will do well or do really bad !! . Also neither do i have any idea when to exit ? The simplest thing is I exit if there is profit or when i get scared about the markets. ( btw i did recommend Reliance and Larsen as investments at 700 and 1000 ) .
If i were to do the above things playing on luck then I might as well increase my odds by applying technical analysis to the above so called Fundamentally Sound Stocks !!!
Finally after a detailed working on this Blog Post I consider myself to be highly unqualified, unfit for doing Fundamental Analysis. But still I continue to read and speak to a lot of Value Investors who are doing it for a long time to get more insights and the process continues for the last 5 years. The reason i can do it is I am full time into Technical Analysis which focuses on keeping things Simple
Some of the picks which i like on a bit of Fundamental Analysis which i do and have recommended as defensive bets continously – Aditya Birla Nuvo ( was a buy below 820 always. A must buy according to me ) , Smartlink Network ( Oops this one has highly underperformed from my levels of 42. Is it a Value trap ? Well i trust the management so will wait for couple of quarters more) , Godrej Inds ( from 200-170 accumulation this has given every reader super returns. I stick to my long term view.) , Nesco ( a buy at 640-540 gave excellent returns and numerous ins and outs, But the story is simple and for long term at least 2 + years) , Bombay Burmah ( this is a value pick acc to me and more of technical timing got us quick 20% returns so can keep holding after booking part )
Recently looking into a few stocks like Bengal & Assam Holding, Numeric Power Systems, S Kumars Nationwide which look interesting and have taken a bet on.
Please do your own research on stocks recommended by me on Fundamental Analysis as I am totally unqualified from the above post. On the Technical Analysis front there is always a Entry Level, Exit on Stoploss and Profit Target which is very clear and one can definitely put up with it easily. Also the track record of my Technical views is up for everyone to see as have been writing for last 6-7 years on this website so you can find where i have screwed up . I continue to learn Technical Analysis and more ways to increase the odds for a better hit ratio and good risk-reward strategies.
One strategy which i look for novice investors is Index Funds or Top 200 cos fund. Simple reason is the exchanges throw out smaller or non performing companies out of the Index so you never see a huge fall in the portfolio over longer time. Like now Rcom, Rcap have been thrown out. Also as per market cap calculations Non performing companies start constituting a lesser weightage ( has its pros and cons) . Reliance Inds was 18% of index is now close to 10% :). This can also be the reason why many Mutual Funds tend to underperform as they dont sell on the way down
Please note I have nothing against Fundamental Analysis and I accept and believe the fact that it is the Fundamentals of the company or country which drive growth. We as Technical Analysts try to find a way to time it and profit from it.
Also we at Analyse India try to avoid Dabba Companies or Bad Managements as much as possible and focus on Technical Trades in companies with good track record with a honest approach
btw this is a very long post. if you found it boring please comment. As people hardly comment here.