13. Legal & Regulatory Environment
Ministry of finance
The Ministry of Finance is a government department responsible for overseeing the economic and financial activities of a nation. It is typically responsible for developing economic and fiscal policy, preparing and managing the budget, collecting taxes, monitoring the financial system, managing public debt, and providing advice and assistance to other government departments. The Ministry may also be responsible for regulating the financial sector, overseeing government spending, and managing the public debt.
- The Department of Economic Affairs (DEA) is a department of the Ministry of Finance responsible for providing advice and assistance to the government on economic and fiscal policy. The DEA is responsible for formulating fiscal policy, preparing and managing the budget, monitoring the expenditure of government funds, and overseeing the economic performance of the economy.
- The Department of Revenue is a department of the Ministry of Finance responsible for collecting taxes and other revenues for the government. The department is responsible for administering the tax system and ensuring compliance with applicable tax laws. The Department of Revenue also provides assistance and advice to other government departments on the collection and management of taxes.
- The Department of Expenditure is a department of the Ministry of Finance responsible for overseeing government expenditure. The department is responsible for monitoring the expenditure of government funds and ensuring that funds are used in accordance with government policy and budget allocations. The Department of Expenditure also provides advice and assistance to other government departments on the management of government expenditure.
- The Department of Financial Services is a department of the Ministry of Finance responsible for overseeing the financial sector. The department is responsible for formulating and implementing policies to regulate the financial sector, overseeing the banking sector, and ensuring compliance with financial laws and regulations. The Department of Financial Services also provides advice and assistance to other government departments on the regulation and supervision of the financial sector.
- The Department of Disinvestment is a department of the Ministry of Finance responsible for the divestiture of government–owned assets. The department is responsible for formulating and implementing policies for the sale of government–owned assets, managing the sale of government–owned enterprises, and overseeing the disinvestment of government–owned assets. The Department of Disinvestment also provides advice and assistance to other government departments on the management and divestiture of government–owned assets.
Ministry of Corporate Affairs
The Ministry of Corporate Affairs is primarily concerned with administration of the Companies Act and other allied Acts, rules and regulations framed there-under mainly for regulating the functioning of the corporate sector in accordance with law. The issuance of securities by
companies is also subject to provisions of the Companies Act. The Registrar of Companies (ROC) is the authority appointed under the Companies Act to register companies and to ensure that they comply with the provisions of the law.
Reserve Bank of India
Reserve Bank of India The Reserve Bank of India is a central bank responsible for formulating and implementing monetary and financial policy. The Reserve Bank of India is responsible for regulating the banking system, managing the public debt, and setting the interest rate. The Reserve Bank of India also provides advice and assistance to other government departments on the management of the monetary and financial systems.
- As the monetary authority: to form
- As the regulator and supervisor of the financial system
- As the manager of Foreign Exchange
- As the issuer of currency
- Developmental role
- Banking functions
Securities and Exchange Board of India
The Securities and Exchange Board of India (SEBI) is a regulatory body responsible for overseeing the securities markets. The SEBI is responsible for regulating the securities markets, monitoring the activities of market participants, and ensuring compliance with applicable laws and regulations. The SEBI also provides advice and assistance to other government departments on the regulation of the securities markets.
Insurance Regulatory and Development Authority of India (IRDAI)
The Insurance Regulatory and Development Authority of India (IRDAI) is a regulatory body responsible for regulating the insurance sector. The IRDAI is responsible for formulating and implementing policies to regulate the insurance sector, monitoring the activities of insurers, and ensuring compliance with applicable laws and regulations. The IRDAI also provides advice and assistance to other government departments on the regulation of the insurance sector.
Pension Fund Regulatory and Development Authority (PFRDA)
The Pension Fund Regulatory and Development Authority (PFRDA) is a regulatory body responsible for regulating the pension sector. The PFRDA is responsible for formulating and implementing policies to regulate the pension sector, monitoring the activities of pension providers, and ensuring compliance with applicable laws and regulations. The PFRDA also provides advice and assistance to other government departments on the regulation of the pension sector.
Insolvency and Bankruptcy Board of India (IBBI)
The Insolvency and Bankruptcy Board of India (IBBI) is a regulatory body responsible for overseeing the insolvency and bankruptcy process. The IBBI is responsible for formulating and implementing policies to regulate the insolvency and bankruptcy process, monitoring the activities of insolvency professionals, and ensuring compliance with applicable laws and regulations. The IBBI also provides advice and assistance to other government departments on the regulation of the insolvency and bankruptcy process.
Important regulations in Indian Securities Market
The Insolvency and Bankruptcy Board of India (IBBI) is a regulatory body responsible for overseeing the insolvency and bankruptcy process. The IBBI is responsible for formulating and implementing policies to regulate the insolvency and bankruptcy process, monitoring the activities of insolvency professionals, and ensuring compliance with applicable laws and regulations. The IBBI also provides advice and assistance to other government departments on the regulation of the insolvency and bankruptcy process.
- 1. The Securities and Exchange Board of India (SEBI) Regulations, 1992: The SEBI regulations are the primary legal framework for regulating the Indian securities market. These regulations set out the rules and regulations regarding the issue and trading of securities, the registration and regulation of intermediaries, and other related matters.
- 2. The Securities Contracts (Regulation) Act, 1956: The SCRA is a law that regulates the trading of securities in the Indian securities market. The SCRA requires all stock exchanges to be recognized by the government and to comply with certain standards. The SCRA also sets out the rules and regulations regarding the trading of securities on the stock exchanges.
- 3. The Depositories Act, 1996: The Depositories Act regulates the activities of depository participants in the Indian securities market. The Depositories Act sets out the rules and regulations regarding the registration and regulation of depository participants, the custody and transfer of securities, and other related matters.
- 4. The Foreign Exchange Management Act, 1999: The Foreign Exchange Management Act is a law that regulates the foreign exchange transactions in India. The Foreign Exchange Management Act sets out the rules and regulations regarding the exchange of foreign currency, the transfer of funds from India, and other
- 5. Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015: The SEBI (Prohibition of Insider Trading) Regulations are a set of regulations that prohibit insider trading. These regulations set out the rules and regulations regarding the disclosure of inside information by insiders, the prevention of insider trading, and other related matters.
Securities and Exchange Board of India (Research Analyst) Regulations, 2014 (amended in December 2016)
The Securities and Exchange Board of India (Research Analyst) Regulations, 2014 (amended in December 2016) govern the activities of research analysts in the Indian securities markets. The regulations set out the rules and regulations regarding the registration of research analysts, the disclosure of research reports, and other related matters. The regulations also provide for the establishment of a research analyst regulatory board, which is responsible for the registration and regulation of research analysts, and for monitoring their activities.
12. Qualities of a Good Research Report
Qualities of a Good Research Report-
- 1. Accurate and up-to-date information: A good research report should provide accurate and up–to–date information about the company in question. It should include financial information such as revenues, profits, assets and liabilities, as well as information about the company‘s operations, market position, competitive environment and any other relevant factors.
- 2. Comprehensive analysis: A good research report should offer a comprehensive analysis of the company, including financial statements, industry analysis, competitive analysis, and market trends. It should also provide an in–depth look at the company‘s management, strategies, and business operations.
- 3. Clear and concise writing: A good research report should be written in a clear and concise manner, so that the reader can quickly grasp all the important information. It should also include relevant visuals, such as graphs or charts, to help the reader better understand the data.
- 4. Relevant and reliable sources: A good research report should use reliable sources of information and make sure to cite them correctly. Additionally, the sources should be relevant to the company being researched.
- 5. Objective and unbiased opinion: A good research report should provide an objective and unbiased opinion about the company. It should not be influenced by any personal biases or opinions of the researcher.
Checklist-based approach to the Research Reports-
- 1. Is the research report up–to–date?
- 2. Does the report provide comprehensive analysis and financial information?
- 3. Is the writing clear and concise?
- 4. Are the sources reliable and relevant?
- 5. Is the opinion objective and unbiased?
- 6. Does the report include visuals such as graphs or charts?
- 7. Does the report include relevant industry trends?
- 8. Does the report provide an in–depth look at the company‘s management, strategies, and business operations?
- 9. Does the report provide insights into potential risks or opportunities?
- 10. Does the report include recommendations for further research?
11. Fundamentals of Risk and Return
Concept of Return of Investment and Return on Investment
Investment means putting up capital in an identified investment product to earn returns from it. The investor expects two things from the investment: to earn a return and, more importantly, to get back the capital invested. The preservation or safety of the capital invested is as important a parameter in evaluating an investment as is the return that it is expected to provide.
Return on Capital/investment (ROI) is the comparison of returns with the investment and can be defined for a single period as Return on investment (%) = (Net profit / Investment) × 100
Calculation of Simple, Annualized and Compounded Returns
Simple Return
The simple return for a given period is calculated by dividing the profit earned by the initial investment. The formula for calculating simple return is given below:
Simple Return = (Current Value – Initial Value) / Initial Value
Annualized Return
The annualized return is used to calculate the return rate over a period of one year. It is calculated by taking the geometric average of the returns over multiple years. The formula for calculating annualized return is given below:
Annualized Return = [(1+r1) x (1+r2) x … (1+rn)]^(1/n) – 1
Where r1, r2, …, rn are the returns from each year.
Compounded Return
The compounded return is used to calculate the future value of an investment. It is calculated by taking the sum of the returns over multiple years and adding them to the initial investment. The formula for calculating compounded return is given below:
Compounded Return = Initial Value x [(1+r1) x (1+r2) x … (1+rn)] – Initial Value
Risks in Investments
Risk and return are an integral part of investing. The return that an investment generates cannot be seen in isolation from the risk that has to be assumed to earn it. A high return can be earned only if the investor is willing to take higher risk. Risk in an investment is the volatility and uncertainty in the returns and in the extreme case, the loss of capital invested.
Inflation Risk:
Inflation risk represents the risk that the money received on an investment may be worth less when adjusted for inflation. Inflation risk is also known as purchasing power risk. It is a risk that arises from the decline in the value of the security’s cash flows due to the falling purchasing power of money.
Interest Rate Risk:
Interest rate risk refers to the risk that bond prices will fall in response to rising interest rates, and rise in response to declining interest rates. Bond prices and interest rates have an inverse relationship.
The relationship between rates and bond prices can be summed up as:
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- If interest rates fall, or are expected to fall, bond prices go up.
- If interest rates rise, or are expected to rise, bond prices decline.
Business Risk:
Business risk is the risk inherent in the operations of a company. It is also known as operating risk, because this risk is caused by factors that affect the operations of the company. Common sources of business risk include cost of raw materials, employee costs, introduction and position of competing products, marketing and distribution costs. Not all businesses are affected by the same risks. Holding a diversified portfolio is an efficient way to diversify this risk.
Market Risk:
Market risk refers to the risk of the loss of value in an investment because of adverse price movements in an asset in the market. The price of an asset responds to information that impacts its intrinsic value.
Credit Risk:
Credit Risk or default risk refers to the possibility that a particular bond issuer will not be able to make expected interest rate payments and/or principal repayment. Debt instruments are subject to default risk as they have pre-committed pay outs. The ability of the issuer of the debt instrument to service the debt may change over time and this creates default risk for the investors.
Liquidity Risk:
Liquidity risk refers to an absence of liquidity in an investment. Thus, liquidity risk implies that the investor may not be able to sell his investment when desired, or it has to be sold below its intrinsic value, or there are high costs to carrying out transactions. All of this affects the realizable value of the investment.
Call Risk:
Call risk is specific to bond issues and refers to the possibility that a debt security will be called prior to its maturity. Call risk usually goes hand in hand with reinvestment risk, discussed below. Call risk is most prevalent when interest rates are falling, as companies trying to save money will usually redeem bond issues with higher coupons and replace them with issues with lower interest rates.
Reinvestment Risk:
Re-investment risk arises from the probability that income flows received from an investment may not be able to earn the same interest as the original interest rate. The risk is that intermediate cash flows may be reinvested at a lower return as compared to the original investment.
Political Risk:
The risk associated with unfavorable government actions – the possibility of nationalization, changes in tax structures, licensing, etc. is called political risk. Because the Government has the power to change laws affecting businesses/securities, almost all businesses are exposed to political risk.
Country Risk:
Country risk refers to the risk related to a country as a whole. There is a possibility that it will not be able to honor its financial commitments. When a country defaults on its obligations, this can affect the performance of all other securities in that country as well as other countries it has relations with. Country risk applies to all types of securities issued in that country.
Measuring risk:
Measuring risk involves identifying, analyzing and assessing the potential for loss in an investment. This can be done by calculating the probability of an investor losing money on an investment, the expected return on the investment, and the potential downside of the investment. It can also involve assessing the potential volatility of an investment, including the potential for large losses or gains. Additionally, measuring risk involves assessing the potential for the investment to reach its expected return and any associated risks such as liquidity, taxes and currency fluctuation.
Concepts of Market Risk (Beta)-
Market risk, also known as systematic risk, is the risk that the value of an investment will decrease due to macroeconomic factors, such as changes in the overall stock market. Market risk is typically measured using beta, which is a measure of an investment’s volatility relative to the overall market. A beta of 1 means the investment’s volatility is equal to that of the market, while a beta of less than 1 indicates the investment is less volatile than the market.
Sensitivity Analysis to Assumptions
Sensitivity analysis is a method used to evaluate how different values of an independent variable (a factor that may influence a system) will affect a particular dependent variable (the outcome of the system). It is used to assess the robustness of the system and to identify areas of uncertainty and risk within the system. It is also used to determine what assumptions are most critical to the success of the system. Sensitivity analysis can be used to assess the sensitivity of a system to changes in key inputs and assumptions. This can provide insight into which assumptions are most important and should be monitored closely. The results of sensitivity analysis can be used to inform decision–making and inform future research.
Concept of Margin of Safety-
In simple words, the margin of safety refers to the difference between value and price, when securities are bought at a price significantly below their intrinsic value. Higher the difference between value and price (i.e., a value higher than price), the higher the margin of safety.
Comparison of Equity Returns with Bond Returns-
The returns on equity investments are typically higher than those on bonds. This is because equity investments are subject to greater risks and rewards than bonds, which are generally considered to be safer investments. Equity investments have the potential to generate higher returns than bonds, but also have the potential for greater losses. Bonds are generally considered to be a safer investment because they are backed by a government or other organization and may have specific features that protect investors from certain risks. In addition, bonds generally have a fixed rate of return, which can make them a more attractive option for investors who are looking for a steady, reliable return.
Calculating risk adjusted returns
Risk adjusted returns are a measurement of the return on an investment after taking into account the associated risks. This can be done by calculating the expected return and subtracting the risk associated with the investment. The risk associated with the investment can be measured using different metrics, such as standard deviation, beta, or the Sharpe ratio. Each of these metrics takes into account the expected return and the risk associated with the investment. The higher the risk adjusted returns, the better the investment. Jensen’s Alpha.
Jensen’s Alpha is a measure of a portfolio’s excess return relative to a benchmark. It is calculated by subtracting the risk–adjusted return of a portfolio from the expected return of the same portfolio. The Alpha measures the portfolio’s excess return above the expected return, which is an indication of the performance of the portfolio manager relative to the benchmark. The higher the Alpha, the better the portfolio manager has performed. Jensen’s Alpha can be used to evaluate the performance of a portfolio manager and can help investors make more informed decisions when selecting a portfolio manager.
Sharpe Ratio
Sharpe ratio measures the risk premium earned per unit of standard deviation. The risk premium earned is calculated by subtracting risk-free rate from the investment return. It is calculated as follows:
Sharpe Ratio= (Return on Portfolio – Risk-Free Rate)/ Standard Deviation
Treynor Ratio
Treynor ratio measures the risk premium earned per unit of Beta. The risk premium earned is calculated by subtracting the risk-free rate from the investment return. It is calculated as follows:
Treynor ratio = (Return on Portfolio – Risk-Free Rate)/Beta
Basic Behavioral Biases Influencing Investments
Behavioral biases are unconscious mental processes that can lead to irrational decisions when making investments. Common behavioral biases influencing investments are confirmation bias, herding, anchoring, and overconfidence. Confirmation bias is when investors search for and interpret information that confirms their preexisting beliefs. Herding is when investors follow the decisions of others and do not think for themselves. Anchoring is when investors become overly focused on a single piece of information and use it as the basis for their decisions. Overconfidence is when investors overestimate their own knowledge and ability and make decisions based on unrealistic expectations.
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- Loss-aversion bias is a cognitive bias that causes investors to be more afraid of losses than they are of gains. It is based on the idea that losses are felt more strongly than gains, and as such, investors are more likely to avoid risks in order to protect against losses. This can lead to an irrational fear of taking risks and may lead to missed opportunities for greater returns. Loss–aversion bias can be countered by focusing on the long–term potential gains of an investment and by understanding that accepting some risk is necessary to achieve greater returns.
- Confirmation bias is a cognitive bias in which people seek out and interpret information that confirms their preexisting beliefs and ignore or discount information that does not confirm those beliefs. This can lead to irrational decision–making and can lead to missed opportunities and suboptimal investments. To avoid confirmation bias, investors should actively seek out and consider information that contradicts their beliefs and challenge their assumptions. They should also seek out opinions from trusted sources who have no vested interest in the investment.
- Ownership bias is a cognitive bias in which investors give too much weight to investments they own or previously owned, and not enough weight to investments they do not own. This can lead to suboptimal decision–making and missed opportunities. To avoid ownership bias, investors should evaluate all potential investments objectively and not let personal biases influence their decisions. They should also remember that past performance is not necessarily an indicator of future performance.
- Gambler’s fallacy is a cognitive bias in which people assume that future outcomes are influenced by past outcomes. This can lead to irrational decisions when it comes to investing, such as assuming that a stock is due for a rise because it has recently fallen. To avoid gambler’s fallacy, investors should remember that past events have no influence on future outcomes and should base their decisions on sound research and analysis.
- Winner’s curse: Tendency to make sure that a competitive bid is won even after overpaying for the asset. While behaviourally it is a win, financially, it may be a loss.
- Herd mentality is a cognitive bias in which people follow the decisions of the majority, even if they do not agree with them. This can lead to irrational investment decisions and missed opportunities. To avoid herd mentality, investors should make decisions based on their own research and analysis and not just follow the decisions of the majority.
- Anchoring is a cognitive bias in which people give too much weight to a single piece of information and use it as the basis for their decisions. This can lead to irrational decision–making and missed opportunities. To avoid anchoring, investors should consider all available information and data, not just one piece of information. They should also be aware of any biases they may have and try to look at the situation objectively.
- Projection bias is a cognitive bias in which people assume that future outcomes will be similar to past outcomes. This can lead to unrealistic expectations and can lead to missed opportunities. To avoid projection bias, investors should remember that the future is unpredictable and should base their decisions on sound research and analysis. They should also be aware of their own biases and try to look at the situation objectively.
Measuring liquidity of equity shares
Liquidity of equity shares can be measured using a variety of metrics. The most commonly used metrics include the bid–ask spread, the number of shares traded, and the trading volume. The bid–ask spread is the difference between the highest price a buyer is willing to pay for a stock and the lowest price a seller is willing to accept. The number of shares traded is the total number of shares bought and sold in a given period. The trading volume is the total number of shares traded during a given period. These metrics can be used to measure the liquidity of equity shares and to identify stocks that are more or less liquid.
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- Stock turnover ratio: This ratio is calculated by dividing the number of shares traded during a given period by the number of outstanding free float shares. Mostly, the time frame used is one year. Free float shares refers to number of shares held by non-promoter group shareholders.
- Traded value turnover ratio: This ratio is similar to stock turnover ratio. It is calculated by dividing the traded value of the shares by the market capitalisation of the company.
10. Valuation Principles
Difference between Price and Value
Mr. Seth Klarman, a known value investor stated “In capital markets, price is set by the most panicked seller; value, which is determined by cash flows and assets, is not.
Warren Buffett is also known to state frequently “Price is what you pay and Value is what you get.”
Why Valuations are required
Valuations are important because they help individuals and businesses determine the fair market value of a certain item or asset. This helps in making informed decisions when it comes to buying, selling, or transferring property. Valuations also provide a basis for taxation, insurance, and other legal matters. Valuations help ensure that the value of the property is accurately assessed and that the parties involved are treated fairly.
Sources of Value in a Business – Earnings and Assets
Warren Buffett stated, “There are only two sources of value in a business – Earnings and Assets”.
Earnings: Earnings refer to a company’s net income, or the money left over after subtracting expenses from revenue. This figure is used to measure a company’s profitability, and is typically derived from operations and investments.
Assets: Assets refer to physical and financial resources owned by a company that generates revenue or increase in value over time. These include tangible assets such as land, buildings, and inventory, as well as intangible assets such as patents, copyrights, and goodwill.
Approaches to valuation
Cost based valuation: Under this approach, an asset is valued based on the cost that needs to be incurred to create it. This option is suitable only for a buyer who has choice between buying versus making.
Cash flow based valuation (intrinsic valuation):- Intrinsic valuation approach assigns value to an asset based on what an investor would be willing to pay for the cash flow generated by the assets.
Selling price-based approach (relative valuation): Under this approach an asset is valued based on the price of other similar assets. Various valuation ratios such P/E, P/B, EV/EBITDA can be used as the valuation metric.
Discounted Cash Flows Model for Business Valuation
The discounted cash flows model for business valuation is a method of estimating the value of a business based on the present value of its future cash flows. The idea behind the model is to discount the future cash flows of the business back to the present, thus accounting for the time value of money and the risk associated with the estimated cash flows. The model is based on the concept of the time value of money, which states that a dollar today is worth more than a dollar in the future because of the potential to invest the money and earn a return. The discount rate used in the model is typically the weighted average cost of capital, which reflects the cost of borrowing and the risk associated with the cash flows. The model is commonly used to value businesses, as well as to evaluate potential investments.
- Dividend discount model (DDM)– The dividend discount model (DDM) is a method of estimating the intrinsic value of a company’s stock based on the present value of its future dividend payments. The DDM assumes that the value of a share of stock is equal to the present value of all future dividends that the stock will pay out. To calculate the intrinsic value of a stock, the investor must estimate a future stream of dividends, discount this stream at a required rate of return, and then sum the present values of the individual dividends.
The DDM is a popular valuation method for stocks that pay dividends, as it makes the assumption that dividends are the most important component of stock returns. The model takes into account the time value of money and the uncertainty of future dividend payments in order to estimate the intrinsic value of the stock.
The DDM is often used to compare the current market price of a stock to its estimated intrinsic value. If the stock is trading below its estimated intrinsic value, then it may be considered undervalued, and thus an attractive investment opportunity. On the other hand, if the stock is trading above its estimated intrinsic value, then it may be considered overvalued and thus a less attractive investment opportunity. - Free cash flow to equity model (FCFE): The free cash flow to equity (FCFE) model is a method of valuation used to calculate the intrinsic value of a company’s stock. The FCFE model is based on the idea that the value of a share of stock is equal to the present value of all future cash flows that the stock will generate. To calculate the intrinsic value of a stock, the investor must estimate a future stream of cash flows, discount this stream at a required rate of return, and then sum the present values of the individual cash flows.
The FCFE model is most useful for stocks that do not pay dividends, as it takes into account the cash flows that will be generated from operations and investing activities. The model is an effective way to estimate the intrinsic value of a stock, as it takes into account the time value of money and the uncertainty of future cash flows.
The FCFE model is often used to compare the current market price of a stock to its estimated intrinsic value. If the stock is trading below its estimated intrinsic value, then it may be considered undervalued, and thus an attractive investment opportunity. On the other hand, if the stock is trading above its estimated intrinsic value, then it may be considered overvalued and thus a less attractive investment opportunity
- Dividend discount model (DDM)– The dividend discount model (DDM) is a method of estimating the intrinsic value of a company’s stock based on the present value of its future dividend payments. The DDM assumes that the value of a share of stock is equal to the present value of all future dividends that the stock will pay out. To calculate the intrinsic value of a stock, the investor must estimate a future stream of dividends, discount this stream at a required rate of return, and then sum the present values of the individual dividends.
Relative valuation model
The relative valuation model is a method of estimating the intrinsic value of a company’s stock by comparing it to similar stocks. The model uses the current market price of comparable stocks as a benchmark to estimate the value of the stock being analyzed. The relative valuation model works on the assumption that similar stocks should have similar values, and thus the market price of the comparable stocks can be used to estimate the value of the stock being analyzed. The relative valuation model is a useful tool for business valuation, as it is relatively simple to use and can be applied to many different types of stocks. The model is most useful when used in conjunction with other valuation methods, such as the dividend discount model, in order to get a more accurate picture of the value of the stock.
Earnings Based Valuation Matrices
Dividend Yield –
Price to Dividend Ratio: The dividend yield – price to dividend ratio is a financial metric used to measure the amount of dividend income a company pays relative to its stock price. This ratio is calculated by dividing the dividend per share by the stock price per share. The dividend yield – price to dividend ratio is used to compare the dividend yields of different stocks, as well as to compare a company’s dividend yield to its industry peers.
Dividend Yield = Dividend Per Share (DPS) / Current Price of Stock
The Earnings Yield –Price-to-earnings
The earnings yield – price to earnings ratio is a financial metric used to measure the amount of earnings a company generates relative to its stock price. This ratio is calculated by dividing the earnings per share by the stock price per share. The earnings yield – price-to-earnings ratio is used to compare the earnings yields of different stocks, as well as to compare a company’s earnings yield to its industry peers.
Earning Yield = Earnings Per Share (EPS) / Current price of stock
Price to Earnings Ratio = Current price of stock/ Earnings Per Share (EPS)
Growth Adjusted Price to Earnings Ratio (PEG Ratio)
The PEG Ratio is a calculation used to measure a company‘s current stock price relative to its expected future earnings growth. It is calculated by dividing the Price to Earnings (P/E) ratio by the company‘s estimated earnings growth rate. The PEG Ratio is used to determine whether a stock is fairly valued, undervalued, or overvalued, based on its current price and expected future earnings growth. The higher the PEG Ratio, the more overvalued the stock is. A PEG Ratio of 1.0 or less is typically seen as a sign of a stock being undervalued.
Growth adjusted Price to Earnings Ratio = [Current Price of Stock / Earnings Per Share] / Growth rate
Enterprise Value to EBIT(DA) Ratio
The Enterprise Value to EBIT(DA) Ratio is a calculation used to measure a company‘s valuation relative to its operating income. It is calculated by dividing the company‘s Enterprise Value (EV) by its Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). The higher the ratio, the more expensive the company is relative to its operating income. A ratio of 10 or more is typically seen as a sign of a stock being overvalued.
Enterprise Value (EV) to Sales Ratio
The Enterprise Value (EV) to Sales Ratio is a calculation used to measure a company‘s valuation relative to its sales. It is calculated by dividing the company‘s Enterprise Value (EV) by its sales. The higher the ratio, the more expensive the company is relative to its sales. A ratio of 3 or more is typically seen as a sign of a stock being overvalued.
Assets based Valuation Matrices
Assets-based Valuation Matrices are calculations used to measure a company’s current value based on its assets. These calculations vary depending on the type of assets being evaluated, but generally include measures such as Price to Book Value, Price to Tangible Book Value, Price to Sales, Price to Cash Flow, and Price to Earnings. These calculations provide investors with an indication of whether a stock is fairly valued, undervalued, or overvalued based on its current asset values.
Price to Book Value Ratio
The Price to Book Value Ratio is a calculation used to measure a company‘s current stock price relative to its book value. It is calculated by dividing the company‘s stock price by its book value per share. The higher the ratio, the more expensive the company is relative to its book value. A ratio of 3 or more is typically seen as a sign of a stock being overvalued.
Price/Book ratio = Market capitalization / Balance sheet value of equity
(or)
Price/Book ratio = Price per share / Book value per share
Enterprise Value (EV) to Capital Employed Ratio
The Enterprise Value (EV) to Capital Employed Ratio is a calculation used to measure a company‘s valuation relative to its capital employed. It is calculated by dividing the company‘s Enterprise Value (EV) by its capital employed. The higher the ratio, the more expensive the company is relative to its capital employed. A ratio of 10 or more is typically seen as a sign of a stock being overvalued.
EV to Capital Employed ratio = Enterprise Value / Capital Employed (Total Equity + Total Debt)
Net Asset Value Approach
The Net Asset Value Approach is a calculation used to measure a company‘s intrinsic value by subtracting its liabilities from its assets. It is calculated by subtracting the company‘s liabilities from its assets and dividing the result by the total number of outstanding shares. The higher the ratio, the more undervalued the stock is. A ratio of 0.8 or lower is typically seen as a sign of a stock being undervalued.
Relative Valuations – Trading and Transaction Multiples
Relative valuation is basically intuitive. We do this all the time in our personal lives. Here, we try to value an asset by looking at how the market prices similar/comparable assets. The best example of this is pricing real estate. If you are looking to buy an apartment, you always find the price of
comparative apartments in that locality which kind of becomes your indicative value for negotiation purposes. This is a highly useful and quick estimate of value with limited computations and assumptions. However, it reflects a current market mood, which may be quite optimistic or pessimistic. Therefore, it is always good to use parameters like maximum, minimum, average, etc. while using relative valuations.
Sum of the Parts (SOTP) Valuation
Several businesses operate as a cluster/bundle of businesses rather than one business. For example, ITC, L&T, and other corporations have a different business under one umbrella. The best way to value these businesses is to value each business separately and then do the sum of those valuations. This method of valuing a company by parts and then adding them up is known as Sum-Of- Parts (SOP) valuation.
Other Valuation parameters in New Age Economy and Businesses
Sometimes, people wonder on valuations of the new age businesses such as Ecommerce companies or tech companies such as Whatsapp, Zomato, Linkedin, Facebook, etc. Honestly speaking, it is difficult to put the numbers together to arrive at the valuations at which these transactions are happening. We may call it our own limitation to understand the value proposition. Without attempting to do this impossible task, let us state that in new age economy, people use absolutely new parameters/language such as eyeballs, page reviews, footfall, ARPU, no. of users etc.
9. Corporate Actions
Philosophy of Corporate Actions
A company initiates several actions, apart from those related to its business, that has a direct implication for its stakeholders. These include sharing of surplus with the shareholders in the form of dividends, changes in the capital structure through the further issue of shares, buybacks, mergers, and acquisitions, delisting, raising debt, and others. In a company that has made a public issue of shares, the interest of the minority investors has to be protected.
Corporate actions are regulated by provisions of the following:
- Provisions of the Companies Act, 2013,
- Relevant regulations of SEBI, and
- Terms of the listing agreement entered into with the stock exchange
Dividend
The proportion of distribution and retention of profits will depend upon the opportunities available for plowing back the profits into the business, the nature of management, the expectation of shareholders, and ultimately the availability of cash in the business to distribute to the shareholders. A company may declare ‘interim dividends’ during the financial year and a ‘final dividend at the end of the year. A company has to pay dividends within 30 days of its declaration.
For example: if a 50% dividend is declared by two companies ‘A’ and ‘B’ with different face values of Rs.2 and Rs.10 respectively, an investor in company ‘A’ will receive Re. 1 as a dividend as against Rs. 5 in the case of company ‘B’. Dividends received by the investors in two companies are different even though the percentage is the same because the face value of the shares is different. In the interest of the investors, company ‘A’ is now required to declare the dividend as Re. 1 per share while company ‘B’ will declare the dividend payable as Rs. 5 per share.
Right Issue
Rights Issue A rights issue is a corporate action in which a company makes an offering of new shares to existing shareholders at a discounted price. This is a way for the company to raise capital without having to issue debt or dilute the existing shareholdings.
When a company issues a rights issue, existing shareholders are given the right to purchase additional shares at a discounted rate. The company will typically set a record date, after which shareholders will be eligible to participate in the offering. Shareholders must exercise their right to purchase additional shares before the expiration date.
Rights issues can be used to raise capital for a variety of purposes, including financing expansions, repaying debts, and making acquisitions. Rights issues are also used to raise the company’s stock price by increasing the number of shares outstanding. Rights issues have the potential to dilute the value of existing shares, however, as the additional shares issued can decrease the value of each existing share.
For example: if the company issues 1-for-2 rights issue at Rs.70 per share, shareholder ‘A’ will have right to buy one share for every two shares held by him at Rs. 70. As ‘A’ has 10 shares, he can buy 5 more shares at Rs. 70. In practice, companies allow shareholders to apply for additional shares beyond their entitlement because some shareholders may neither apply for shares under their entitlement nor transfer their rights to others and those shares may be available for issuance to these shareholders who desire additional shares.
Bonus Issue
Bonus Issue A bonus issue is a corporate action in which a company issues additional shares to existing shareholders at no cost. Bonus issues are a way for companies to reward their shareholders and to increase the liquidity of their stock. Bonus issues can also be used to raise the company’s stock price, as it increases the number of shares outstanding.
When a company issues a bonus issue, existing shareholders are given additional shares based on the number of shares they already own. The company typically sets a record date, after which shareholders are eligible to participate in the offering. Bonus issues can also be used to increase the voting power of existing shareholders.
Bonus issues can be used to reward existing shareholders by providing them with additional shares without cost. However, bonus issues can also be used to dilute the value of existing shares, as the additional shares issued can decrease the value of each existing share.
For example: If shares of a company were trading at a price of Rs. 1000 per share prior to the bonus, post bonus on 1:1 basis, fair price of share is likely to come down to Rs. 500 per share to maintain post bonus market value of a holding equivalent to its pre bonus market value. Therefore, mathematically, the value of the investor’s holding pre bonus at Rs. 1, 00,000 (100 shares x Rs. 1000) remains the same Rs. 1, 00,000 (200 shares x Rs. 500) post bonus. Actual market price of share post bonus will be around Rs. 500 (not exactly at of Rs. 500) as it will depend on market factors of demand and supply.
Stock Split
Stock Split A stock split is a corporate action in which a company divides its existing shares into multiple shares at a lower price. This is typically done to make the company’s shares more affordable and to increase the liquidity of the stock. Stock splits are also used to increase a company’s stock price, as it increases the number of shares outstanding.
When a company issues a stock split, existing shareholders are given additional shares based on the number of shares they currently own. The company typically sets a record date, after which shareholders are eligible to participate in the offering.
Stock splits can also reduce the voting power of existing shareholders, as each share is worth less than before. Stock splits can be used to make a company’s shares more affordable and to increase its stock price. However, stock splits can also be used to dilute the value of existing shares, as the additional shares issued can decrease the value of each existing share.
For example, SBI initiated a stock split of its equity shares from a face value of Rs.10 to Re.1. A shareholder holding 1 share of a face value of Rs.10 will now hold 10 shares each with a face value of Re.1. The stock that was trading in the markets at over Rs.2700 at the time of the announcement traded post-split at around Rs.295. The value of the shareholder’s holding was around Rs.2700 (1 share x Rs.2700) prior to the stock split. Post the split, the value of the holding is Rs. 2950 (10 shares x Rs.295). The market price after the split will depend upon the market forces of demand and supply.
Share Consolidation
Share consolidation is the reverse of stock split. In a share consolidation, the company changes the structure of its share capital by increasing the par value of its shares in a defined ratio and correspondingly reducing the number of shares outstanding to maintain the paid up/subscribed capital. A stock consolidation of 5:1 means consolidation of 5 existing share into 1 share. Accordingly, face value of shares will go up 5 times of the original face value and no. of outstanding shares will become one fifth the original number.
Merger and Acquisition
A merger and acquisition (M&A) is a corporate action in which two companies join together, either through an acquisition where one company buys another or a merger where two companies combine. This is typically done to expand the company’s operations and to increase its market share.
When a company issues an M&A, existing shareholders are typically given shares of the combined company based on the number of shares they currently own. The company typically sets a record date, after which shareholders are eligible to participate in the offering. Mergers and acquisitions can also affect the voting power of existing shareholders, as the combined company may have different rules regarding ownership and voting rights.
Mergers and acquisitions can be used to expand a company’s operations and to increase its market share. However, mergers and acquisitions can also be used to dilute the value of existing shares, as the additional shares issued can decrease the value of each existing share.
Demerger/Spin-off
Demerger / Spin–off A demerger or spin–off is a corporate action in which a company distributes a portion of its assets to create a new company. This is typically done to focus the company’s operations or to unlock value from its assets.
When a company issues a demerger or spin–off, existing shareholders are typically given shares of the new company based on the number of shares they currently own. The company typically sets a record date, after which shareholders are eligible to participate in the offering. Demergers and spin–offs can also affect the voting power of existing shareholders, as the new company may have different rules regarding ownership and voting rights.
For example, in April 2018, Adani Enterprise spun-off its renewable energy business to a new company Adani Green Energy Limited. Shareholders of Adani Enterprises were given shares in the new company is the ratio of 761:1000. Earlier, in June 2015, Adani Enterprise spun-off its ports, and power and transmission businesses into two separate companies: Adani Ports and Adani Transmission, respectively
Scheme of arrangement
A scheme of arrangement is a corporate action in which a company restructures its operations and debts.
This is typically done to make the company more efficient or to reduce its debts. When a company issues a scheme of arrangement, existing shareholders are typically given shares of the restructured company based on the number of shares they currently own. The company typically sets a record date, after which shareholders are eligible to participate in the offering. Schemes of arrangement can also affect the voting power of existing shareholders, as the restructured company may have different rules regarding ownership and voting rights.
Schemes of arrangement can be used to make a company more efficient and to reduce its debts. However, schemes of arrangement can also be used to dilute the value of existing shares, as the additional shares issued can decrease the value of each existing share.
Loan Restructuring
Loan Restructuring Loan restructuring is a corporate action in which a company renegotiates the terms of its debt. This is typically done to make the company’s debt more manageable or to reduce its interest payments.
When a company restructures its debt, existing shareholders are typically given shares of the restructured company based on the number of shares they currently own. The company typically sets a record date, after which shareholders are eligible to participate in the offering. Loan restructurings can also affect the voting power of existing shareholders, as the restructured company may have different rules regarding ownership and voting rights.
Buyback of Shares
Buyback of shares refers to a company repurchasing its own shares from its shareholders. Companies may choose to do this to increase the value of their remaining shares, reduce the number of shares outstanding, or return capital to shareholders. The buyback of shares is also known as a “stock repurchase.”
Delisting and relisting of Shares
Delisting and relisting of shares refers to the process of a company removing its shares from a public stock exchange and then listing them again at a later date. Delisting is often done when a company‘s shares are underperforming, as it can help to reduce public scrutiny and free up capital. Relisting is done when a company believes that its shares are undervalued and that they may perform better if they are listed on the exchange again.
Share Swap
Share swap is a process wherein two companies agree to exchange their shares with each other. This could be done for various reasons such as to gain access to each other’s markets, to facilitate a merger or acquisition, or to increase the ownership stake of one company in the other. Share swaps can also be used to restructure the ownership of a company by swapping out minority shareholders for a majority stakeholder.
8. Company Analysis- Financial Analysis
Introduction to financial statement analysis
Financial statement analysis is the process of analyzing a company‘s financial statements, such as the balance sheet, income statement, and cash flow statement, in order to understand the company‘s financial performance and health. Financial statement analysis is used by investors, creditors, and internal management to evaluate a company‘s financial position and performance. Financial statement analysis involves analyzing historical financial data to identify trends, assess a company‘s financial performance, and make predictions about the company‘s future. It also involves comparing a company‘s financial performance to that of its peers and the industry in general. Financial statement analysis is an important tool for investors, creditors, and management to make informed decisions about a company.
Stand–alone financial statement and consolidated financial statement analysis
Financial statement analysis can be conducted on either a stand–alone or a consolidated basis. A stand–alone analysis examines the financial statements of a single entity, while a consolidated analysis examines the financial statements of multiple entities that are combined in a group.
In stand-alone analysis, the financial statements of the company being analyzed are examined independently. This type of analysis is typically used to assess the financial performance of a single company and identify potential areas of improvement.
In consolidated analysis, the financial statements of multiple entities are combined, and the financial performance of the entire group is analyzed. This type of analysis is used to assess the financial performance of a group of entities and identify areas of improvement across the entire group.
Balance Sheet Analysis
The format for the balance sheet is prescribed under Schedule 3 of the Companies Act 2013. In addition, IndAS 1 requires that companies should also report changes in shareholder’s equity, which shows the various movements in shareholder’s equity. Balance sheet analysis involves analyzing the assets, liabilities, and shareholder’s equity of a company. It is used to identify potential areas of improvement in the company’s financial position and to assess the company’s ability to meet its financial obligations.
Common Balance Sheet Line Items
Assets: Cash, Accounts Receivable, Inventory, Investments, Fixed Assets, Intangible
Assets Liabilities: Accounts Payable, Accrued Liabilities, Bank Loans, Long–term Debt
Shareholder’s Equity: Common Stock, Preferred Stock, Retained Earnings Income Statement Line Items
Revenues: Sales, Interest,
Dividends Expenses: Cost of Goods Sold, Selling, General, and Administrative Expenses, Interest Expense, Taxes
Net Income: Revenues minus Expenses
Basics of Profit and Loss Account (P/L)
A profit and Loss account is a financial statement that summarizes the revenues, expenses, and net income of a company during a specific period of time. It is also known as an income statement. The profit and loss account is used to assess a company’s financial performance and health. It typically includes line items such as sales, cost of goods sold, operating expenses, and net income.
Common profit and loss account line items
Revenues: Sales, Interest,
Dividends Expenses: Cost of Goods Sold, Selling, General, and Administrative Expenses, Interest Expense, Taxes Ne
Income: Revenues minus Expenses
Key metrics from profit and loss account
Gross Profit: Revenues minus Cost of Goods Sold
Operating Profit: Gross Profit minus Operating Expenses
Net Profit: Operating Profit minus Interest Expense and Taxes
Basics of Cash Flows
Cash flow is the movement of cash into and out of a business. The cash flow statement is a financial statement that summarizes the inflows and outflows of cash during a specific period of time. It is used to assess a company’s ability to generate cash and identify potential areas of improvement.
Common cash flow statement line items
Cash from Operating Activities: Cash from sales, Cash from collections of accounts receivable, Cash paid for expenses, Cash paid for taxes
Cash from Investing Activities: Cash investments in property, plant, and equipment, Cash investments in other companies, Cash received from sale of investments
Net Cash Flow: Cash from Operating Activities plus Cash from Investing Activities plus Cash from Financing Activities
Financial statement analysis using ratios
Financial statement analysis using ratios is a method of reviewing and analyzing a company‘s financial statements in order to gain insight into its financial performance. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry average, or other benchmarks. This comparison provides information about trends and helps in predicting future performance. Ratios are used to measure liquidity, profitability, efficiency, solvency, and shareholder return. Each ratio provides a different view of the company‘s financial performance and can be used to identify areas of strength and weakness.
Commonly used ratios include:
Liquidity Ratios: These ratios measure the company‘s ability to meet its short–term obligations such as paying bills and meeting payroll. Examples include the current ratio and quick ratio.
• Current Ratio: Current Assets/Current Liabilities
• Quick Ratio: (Current Assets – Inventories)/Current Liabilities
Profitability Ratios: These ratios measure the company‘s ability to generate income and profits from operations. Examples include gross profit margin, operating profit margin, and return on assets.
• Gross Profit Margin: Gross Profit/Net Sales
• Operating Profit Margin: Operating Profit/Net Sales
• Return on Assets: Net Income/Total Assets
Efficiency Ratios: These ratios measure the company‘s ability to use its assets and resources efficiently. Examples include inventory turnover, accounts receivable turnover, and asset turnover.
• Inventory Turnover: Cost of Goods Sold/Average Inventory
• Accounts Receivable Turnover: Net Sales/Average Accounts Receivable
• Asset Turnover: Net Sales/Total Assets
Solvency Ratios: These ratios measure the company‘s ability to meet its long–term obligations such as debt payments and other liabilities. Examples include the debt to equity ratio and the interest coverage ratio.
• Debt to Equity Ratio: Total Liabilities/Total Equity
• Interest Coverage Ratio: Earnings Before Interest & Taxes/Interest Expense
Shareholder Return Ratios: These ratios measure the company‘s ability to generate returns for its shareholders. Examples include the return on equity and the dividend yield.
• Return on Equity: Net Income/Shareholder Equity
• Dividend Yield: Dividends per Share/Share Price
Financial statement analysis using ratios is an important tool for investors, creditors, and other stakeholders in assessing the financial health of a company. By comparing the company‘s performance to that of its peers and the industry average, potential investors and lenders can identify potential areas of risk and opportunity.
Dupont analysis
Dupont analysis is a financial analysis tool used to analyze the return on equity of a company. It provides insight into the firm’s financial performance by breaking it down into three parts: (1) profit margin (2) asset turnover, and (3) financial leverage. By breaking down the return on equity into its components, investors can get a better understanding of the firm’s performance and can identify potential areas of improvement.
The formula for Dupont analysis is:
Return on Equity (ROE) = Profit Margin x Asset Turnover x Financial Leverage
Profit Margin: The profit margin ratio measures how much of each dollar of sales is converted into profits. It is calculated by dividing net income by net sales.
Asset Turnover: The asset turnover ratio measures how efficiently the firm is using its assets to generate sales. It is calculated by dividing net sales by total assets.
Financial Leverage: The financial leverage ratio measures how the firm is using debt to finance its operations. It is calculated by dividing total liabilities by total equity. By understanding how each of these components affects the firm’s return on equity, investors can gain insight into the firm
Forecasting Using Ratio Analysis
Forecasting using ratio analysis Ratio analysis is a forecasting method that involves analyzing historical and current financial data to determine the performance of a company. Ratios are used to compare different elements of the financial statements to identify trends and assess the overall financial health of the company. Ratios such as the current ratio, debt–to–equity, and liquidity ratios can be used to analyze a company’s ability to pay its debt, generate revenue, and cover its expenses. Forecasting using ratio analysis can be a useful tool to help investors and managers make better decisions about the company’s future performance.
Forecasting Using Ratio Analysis
Forecasting using ratio analysis Ratio analysis is a forecasting method that involves analyzing historical and current financial data to determine the performance of a company. Ratios are used to compare different elements of the financial statements to identify trends and assess the overall financial health of the company. Ratios such as the current ratio, debt–to–equity, and liquidity ratios can be used to analyze a company’s ability to pay its debt, generate revenue, and cover its expenses. Forecasting using ratio analysis can be a useful tool to help investors and managers make better decisions about the company’s future performance.
Peer Comparison
Another forecasting method using ratio analysis is peer comparison. This method involves analyzing financial ratios of a company in comparison to its peers in the industry. By benchmarking a company’s performance to its peers, investors and managers can better assess the relative strengths and weaknesses of the company. This can help to identify the strengths and weaknesses of a company relative to the industry, which can be used to inform decisions about future performance.
Other aspects to study from financial reports
History of Equity Expansion/Reduction: Analyzing the history of equity expansion/reduction, such as through issuing stock, can provide valuable insight into the company’s financial health. This can be used to forecast the potential for future expansion or contraction.
Dividend and Earnings History: Examining the dividend and earnings history can provide insight into how the company has managed its profits and cash flow. This can be used to forecast the potential for future dividend payments and profits.
History of Corporate Actions: Examining the history of corporate actions, such as mergers and acquisitions, can provide important insight into the company’s strategic direction. This can be used to forecast the potential for future corporate actions.
Ownership and Insiders’ Sales and Purchase of Stocks in The Past: Analyzing the ownership and insiders’ sales and purchase of stocks in the past can provide insight into how the company is managed and what the company’s goals may be. This can be used to forecast the potential for future changes in ownership and insider trading.
7. Company Analysis- Business & Governance
Understand Business and Business Models
Business is the activity of making one’s living or making money by producing or buying and selling goods or services. It is a commercial, professional, or industrial enterprise and the people who constitute it. Business models are the way that businesses make money or generate revenue. They involve the combination of products, services, customers, markets, costs, and revenues. A business model should describe how a business intends to generate revenue and profits, as well as how it plans to compete and differentiate itself from competitors. Business models are used to understand and analyze the business’s strategy, goals, and operations. They provide a framework for developing new products, services, and processes. Business models can also be used to identify opportunities for growth and expansion.
Pricing Power and Sustainability of This Power
Pricing power is the ability of a business to set prices for its products or services that customers are willing to pay. It is a key factor in determining the profitability of a business. The sustainability of this power depends on several factors, including the demand for the product or service, the availability of substitute products or services, and the pricing strategies of competitors. A business must be able to offer a product or service at a price that is profitable while still being attractive to customers. Pricing power can be increased by offering superior products or services, developing customer loyalty and brand recognition, and leveraging customer data to better understand and meet customer needs. Additionally, businesses can use pricing strategies, such as dynamic pricing, to maximize profit margins and stay competitive.
Competitive Advantages/Points of differentiation over the Competitors
Competitive advantages refer to the features, capabilities, and resources that give a business an edge over its competitors. These advantages help a business gain and maintain a competitive edge, allowing it to capture a larger share of the market. Some of the most common competitive advantages include superior products or services, pricing power, brand recognition, customer loyalty, and access to resources. Points of differentiation over the competitors refer to the specific features, attributes, or services that a business offers that its competitors do not, or that its competitors do not offer as effectively. These points of differentiation can include superior customer service, innovative products or services, unique marketing strategies, and personalized offerings.
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- Product differentiation is an important competitive advantage that allows a business to stand out from the competition and attract more customers. Product differentiation refers to the specific attributes, features, and benefits of a product or service that make it unique and attractive to customers. By offering unique products and services, businesses can gain a competitive edge, capture more market share, and increase profits.
- Competitive pricing is another competitive advantage that businesses use to gain an edge over their competitors. This involves setting prices that are competitive with similar products or services offered by other businesses. By offering competitive prices, businesses can attract more customers, grow their customer base, and increase profits.
- Execution excellence is an essential competitive advantage that businesses can use to outperform their competitors. Execution excellence refers to the ability of a company to effectively and efficiently execute its strategies and goals. This can include creating efficient processes and systems, developing a culture of accountability and transparency, and effectively leveraging resources. With excellent execution, businesses can achieve their goals faster and more effectively than their competitors.
Strengths, Weaknesses, Opportunities, and Threats (SWOT) Analysis
External environments constantly change. These changes provide new opportunities and the same also create new challenges. When a new opportunity is presented, companies that are well positioned to take advantage of that utilize such opportunities and prosper while others miss out. Similarly, when a new challenge or threat emerges, companies with strong fundamentals survive such challenges. On the other hand, companies that are vulnerable may perish in the face of such a challenge.
- Strengths:
– Quality products and services
– Positive brand image
– Experienced and competent staff
– Strong customer base
– Wide distribution network
– Good financial resources - Weaknesses:
– High-cost structure
– Lack of innovation
– Limited market presence
– Low market share
– Poor customer service - Opportunities:
– Expansion into new markets
– Leveraging existing customer base
– Acquisitions and mergers
– Increased investment in R&D
– Exploring new product lines - Threats:
– Competition from new entrants
– Changing customer preferences
– The increasing cost of raw materials
– Regulatory changes
– Technological advancements
Quality of Management and Governance Structure
The quality of management and governance structure of the company is very high. The company is governed by a Board of Directors and the board is actively involved in making decisions and managing the day–to–day operations of the company. The board is composed of experienced professionals from diverse backgrounds who have a deep understanding of the industry and the company’s operations. The company also has an executive team that is responsible for the day–to–day operations of the company. This team is made up of seasoned professionals who have extensive experience in the industry. The company also has an internal audit team that ensures the company’s operations are conducted in accordance with established internal and external regulations. The company also has a strong risk management culture and has a robust system of internal controls that are regularly reviewed and updated. Overall, the quality of management and governance structure of the company is very high.
Evaluating management competency
The management competency of the company can be evaluated by looking at the performance, vision, and leadership of the Executive team. The performance of the team can be evaluated by looking at the growth of the company, financial performance, and customer satisfaction. The vision of the team can be evaluated by looking at the long–term plans for the company and the strategy for achieving the long–term goals. The leadership of the team can be evaluated by looking at the team’s ability to motivate and inspire employees, manage conflicts, and make difficult decisions. Overall, the management competency of the company is very high.
Evaluating corporate governance
The corporate governance of the company can be evaluated by looking at the Board of Directors, the internal audit team, and the risk management culture of the company. The Board of Directors is responsible for setting the company’s strategy, overseeing the performance of the company, and approving major decisions. The internal audit team ensures the company is in compliance with internal and external regulations and that the internal controls are regularly reviewed and updated. The risk management culture of the company ensures that risks are identified, assessed, and mitigated. Overall, the corporate governance of the company is very strong.
Promoter holdings
The promoter holdings of the company can be evaluated by looking at the percentage of shares held by the promoters. The promoters of the company hold a significant percentage of the company’s shares and have a vested interest in the success of the company. This demonstrates their commitment to the company’s long–term growth and success. Overall, the promoter holdings of the company are strong.
Risks in the Business
The risks in the business of the company can be evaluated by looking at the external risks, internal risks, and financial risks. The external risks include factors such as economic conditions, competition, government regulations, and technological changes. The internal risks include factors such as personnel turnover, inefficient processes, and inadequate resources. The financial risks include factors such as liquidity, solvency, and capital structure. The company has a strong system of risk management and regularly reviews and updates its risk management policies. Overall, the risks in the business of the company are managed effectively.
History of credit rating
The credit rating of the company can be evaluated by looking at its history of credit ratings. The company has a long–term credit rating of AAA from Moody’s and a short–term rating of A1 from Standard & Poor’s. These ratings demonstrate the company’s strong financial performance and liquidity. Overall, the credit rating of the company is strong.
ESG framework for company analysis
The ESG (Environmental, Social, and Governance) framework can be used to evaluate the company’s performance in terms of its environmental, social, and governance policies and practices. The company has a robust ESG framework that is regularly reviewed and updated. The company has implemented policies and practices to ensure it is in compliance with applicable laws and regulations, and is taking steps to reduce its environmental footprint. The company also has a strong social responsibility program and is committed to supporting its local communities. The company is also committed to good corporate governance practices and is transparent in its operations. Overall, the company’s ESG framework is strong.
Sources of Information for Analysis
The sources of information that can be used to analyze the company include financial statements, industry reports, analyst reports, press releases, annual reports, and company websites. Financial statements provide information on the company’s performance and financial position. Industry reports provide information on the industry trends and developments. Analyst reports provide information on the company’s prospects and outlook. Press releases provide information on the company’s recent developments and announcements. Annual reports provide information on the company’s strategy and performance. Company websites provide information on the company’s products and services. Overall, these sources of information provide a comprehensive view of the company and can be used to analyze the company.
6. Industry Analysis
Defining the industry-
An industry is a sector of the economy that produces goods or services. Industries are typically defined by the type of products or services they produce, the methods they use to produce those products or services, and the customers they serve. Examples of industries include the manufacturing industry, the construction industry, the healthcare industry, and the information technology industry.
Understanding industry cyclicality-
Economic cycles affect all businesses. However, they affect some businesses more than others. Based on their cyclical nature, industries can be classified into three categories:
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- Defensive industries: These are industries that create products and services that have low-income elasticity i.e., a fall or rise in income does not affect the demand significantly. Therefore, these industries experience minimal impact on account of economic cycles. Rather, their business prospects are affected only by secular trends. Food, agricultural inputs, and healthcare are some of the industries that have exhibited these traits in the past.
- Semi-cyclical industries: These industries experience growth in sales during the expansionary phase and decline during the recessionary phase. However, these industries do have some base level demand which helps the industry to have reasonably healthy sales in recessionary conditions also. The consumer durables industry has exhibited these traits.
- Deep cyclical industries: These industries witness extreme cyclicality in their revenues as they are largely driven by the economic cycle and/or commodity cycles. The capital goods industry exhibits such behavior. During recessionary conditions, their sales drop significantly as most companies put their capacity expansion plans on hold. However, these industries experience massive growth at the first signs of economic recovery as pent-up demand results in higher orders.
Market sizing and trend analysis-
Market sizing refers to the process of determining the total size of a market, typically in terms of the number of potential customers or the total revenue generated by the market. This information can be useful for businesses looking to enter a new market, as it can help them to understand the potential size of the market and the potential revenue they could generate.
Trend analysis is the process of examining data over time to identify trends or patterns. This can be useful for businesses as it can help them to understand how a market is evolving, identify potential opportunities or threats, and make more informed decisions about their operations. Trend analysis typically involves collecting data on key metrics related to the market, such as sales, revenue, and market share, and then using tools such as graphs and charts to visualize and analyze the data over time.
Secular trends, value migration, and business life cycle
Secular trends are long-term trends that tend to persist over many years or even decades. These trends can have a major impact on industries and businesses, as they can shape consumer behavior, technological developments, and other factors that can affect the market. Examples of secular trends include the rise of e-commerce, the increasing importance of environmental sustainability, and the growing trend toward health and wellness.
Value migration is the process by which the economic value of a product or service shifts from one part of the market to another. This can happen for a variety of reasons, such as changes in consumer preferences, shifts in the competitive landscape, or the introduction of new technologies. Value migration can have a major impact on businesses, as it can create new opportunities for growth, but it can also pose a threat to businesses that are unable to adapt to the changing market.
The business life cycle refers to the stages of development that a business typically goes through, from its inception to its eventual decline or demise. The stages of the business life cycle can include start-up, growth, maturity, and decline. Understanding the business life cycle can be useful for businesses, as it can help them to identify where they are in the cycle and plan accordingly. For example, a start-up business may need to focus on building a customer base and generating revenue, while a mature business may need to focus on innovation and maintaining market share.
Understanding the industry landscape-
Industry landscaping needs to be very comprehensive. While analysts can use their own frameworks, there are certainly established frameworks that can help understand the industry landscape. These include the following:
(i) Michael Porter’s Five Force Model
(ii) PESTLE analysis
(iii) BCG Matrix
(iv) SCP analysis
Michael Porter’s Five Force Model for Industry Analysis-
this model analyses any industry on the basis of five broad parameters or forces. These 5 forces are divided into 2 vertical and 3 horizontal ones, as listed below:
Horizontal Forces:
1. Threat of Substitutes
2. Threat of New Entrants
3. Threat of Established Rivals
Vertical Forces:
1. Bargaining Power of Suppliers
2. Bargaining Power of Customers
Industry Rivalry-
Industry rivalry refers to the competitive dynamics within an industry, including the level of competition among firms and the intensity of their competitive behavior. Industry rivalry can be influenced by a variety of factors, such as the number and size of firms operating in the industry, the level of differentiation among products or services, and the ease with which customers can switch from one firm to another. High levels of industry rivalry can drive firms to engage in aggressive tactics, such as price cutting and marketing campaigns, in order to gain market share and win customers. Understanding the level of industry rivalry in an industry can be important for businesses operating in that industry, as it can help them to anticipate and respond to competitive threats.
Threat of Substitutes-
The threat of substitutes refers to the potential for consumers to switch to alternative products or services that serve the same purpose as the product or service being offered by a particular company. The threat of substitutes can be driven by a variety of factors, such as changes in consumer preferences, the introduction of new technologies, or the availability of lower-priced alternatives. The greater the threat of substitutes, the more difficult it can be for a company to maintain its market share and pricing power. Understanding the threat of substitutes in an industry can be important for businesses operating in that industry, as it can help them to anticipate and respond to changes in the market.
Bargaining Power of Buyers-
The bargaining power of buyers refers to the ability of customers to negotiate favorable terms with a company, such as lower prices or higher-quality products. The bargaining power of buyers can be influenced by a variety of factors, such as the number of buyers in the market, the importance of the product or service to the buyer, and the availability of substitute products or services. The greater the bargaining power of buyers, the more difficult it can be for a company to maintain its pricing power and profitability. Understanding the bargaining power of buyers in an industry can be important for businesses operating in that industry, as it can help them to anticipate and respond to changes in the market.
Bargaining Power of Suppliers-
The bargaining power of suppliers refers to the ability of suppliers to negotiate favorable terms with a company, such as higher prices for their goods or services. The bargaining power of suppliers can be influenced by a variety of factors, such as the number of suppliers in the market, the importance of the goods or services they provide to the company, and the availability of substitute goods or services. The greater the bargaining power of suppliers, the more difficult it can be for a company to maintain its profitability. Understanding the bargaining power of suppliers in an industry can be important for businesses operating in that industry, as it can help them to anticipate and respond to changes in the market.
Barriers to entry (Threat of new entrants)-
Barriers to entry are factors that make it difficult for new companies to enter a market and compete with existing firms. These barriers can be created by a variety of factors, such as economies of scale, intellectual property, government regulations, and the presence of strong incumbent firms. The greater the barriers to entry in an industry, the more difficult it can be for new companies to enter the market and compete with existing firms. Understanding the barriers to entry in an industry can be important for businesses operating in that industry, as it can help them to anticipate and respond to potential threats from new competitors.
Political, Economic, Socio-cultural, Technological, Legal, and Environmental (PESTLE) Analysis-
Political: The political environment of the country can have an effect on the company‘s operations. For example, changes in government policies, regulations, and taxes could affect the company‘s operations. The company could also be affected by political instability in the country.
Economic: The economic environment of the country can also have an effect on the company‘s operations. Economic factors such as inflation, unemployment, and the level of economic growth can influence the company‘s ability to operate successfully.
Socio-cultural: The socio–cultural environment of the country can also have an effect on the company‘s operations. Social trends and changes in consumer tastes can influence the company‘s ability to compete successfully.
Technological: The technological environment of the country can also have an effect on the company‘s operations. Advances in technology can make certain processes more efficient and can open up new opportunities for the company.
Legal: The legal environment of the country can also have an effect on the company‘s operations. Changes in laws and regulations can affect the company‘s ability to operate successfully.
Environmental: The environmental environment of the country can also have an effect on the company‘s operations. Pollution and climate
Boston Consulting Group (BCG) Analysis-
Boston Consulting Group (BCG) is a management consulting firm that provides advice to help organizations improve their performance. BCG uses a variety of analytical techniques, including the BCG matrix, to help companies identify growth opportunities and allocate resources effectively
BCG’s signature tool, the BCG matrix, is a framework that helps companies analyze their businesses and identify growth opportunities. The matrix divides a company’s products or businesses into four quadrants based on their relative market share and market growth rate. The four quadrants are:
Stars: These are products or businesses with a high market share in a rapidly growing market. These are considered the most valuable businesses within a company, and they often require significant investment to maintain their position.
Cash cows: These are products or businesses with a high market share in a slow-growing market. These businesses generate significant cash flow, which can be used to invest in other areas of the company.
Dogs: These are products or businesses with a low market share in a slow-growing market. These businesses typically do not generate much value for the company and may be candidates for divestment.
Question marks: These are products or businesses with a low market share in a rapidly growing market. These businesses have the potential to become stars, but they also require significant investment to grow their market share.
By using the BCG matrix, companies can assess the potential of their different businesses and allocate resources accordingly. This can help them focus on the areas of their business that are most likely to generate value and growth.
Structure Conduct Performance (SCP) Analysis:
Structure: Structure refers to the structure of the market, including the number of sellers and buyers, the concentration of market power, and the extent of competition.
Conduct: Conduct refers to the behavior of firms in the market. This includes pricing strategies, marketing strategies, and product innovation.
Performance: Performance refers to the economic performance of the market, including the prices of goods and services, the quality of products, and the level of consumer welfare.
SCP analysis is a framework used to analyze the structure, conduct, and performance of a market. It is used to assess the efficiency of a market, identify areas of market failure, and suggest potential policy interventions. The analysis involves both quantitative and qualitative methods to assess the effectiveness of a market. This includes economic theory, market surveys, and empirical studies. The goals of SCP analysis are to improve market efficiency and consumer welfare.
Key Industry Drivers and Industry KPIs:
Industry drivers refer to the factors that drive the growth and development of a particular industry. These can be internal or external factors, and they can include things like changes in technology, consumer preferences, regulations, and competition. Industry KPIs, or key performance indicators, are metrics that are used to measure the performance and success of a company or industry. These can include things like revenue, profit, market share, customer satisfaction, and employee retention. Together, industry drivers and KPIs help companies and organizations understand the current state of their industry and make strategic decisions for the future.
A unit of pricing refers to the standard unit of measurement used to determine the price of a product or service. This can vary depending on the type of product or service being offered. For example, the unit of pricing for a product like a bottle of water might be the individual bottle, while the unit of pricing for a service like home cleaning might be per hour or per square foot. It’s important for businesses to clearly communicate their units of pricing to customers in order to avoid confusion and ensure fair pricing.
Key constraining factors are the factors that limit or hinder the growth or success of a company or industry. These can include things like competition, regulations, economic conditions, and access to resources. Identifying and understanding key constraining factors is important for businesses and organizations because it can help them make strategic decisions and overcome challenges. For example, if a company is facing intense competition, it may need to focus on differentiating its product or improving its marketing efforts in order to stand out. Understanding and addressing key constraining factors can help a company improve its performance and achieve its goals.
Regulatory environment/framework:
Industry analysis cannot be complete without adequate knowledge of the rules of the game. Even small changes in the regulatory framework can have a big impact on businesses. For example, the whole discussion in India on FDI in multi-brand retail has been revolving around how much should retailers invest in developing the back-end infrastructure, what could be construed as a back-end infrastructure, could they buy out some firm’s existing set up, how much minimum they should purchase from Indian vendors, etc. Changes in environmental policies have resulted in the closure of various mines and have affected businesses drastically.
Taxation:
Taxes are tools that a government uses to earn income which can be used to meet its expenses. However, governments also use taxes as a tool to encourage or discourage certain businesses. For example, the state government of Kerala introduced a fat tax in 2017. They levied 14.5% additional tax on junk foods. This was done with the intention to discourage the junk food industry.
Similarly, at a national level, India has several slabs of Goods and Service Tax (GST). Many essential products have no GST or have lower GST rates while luxury products have much higher GST rates.
Broadly, taxes charged by the government can be classified into two categories (i) Direct taxes (ii) Indirect taxes
Direct Taxes- Direct taxes are taxes imposed directly on individuals or businesses by the government and are paid directly to the government. Examples of direct taxes include income taxes, property taxes, capital gains taxes, and inheritance taxes.\
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- Income taxes are taxes imposed by governments on individuals or businesses based on their income. Income taxes are calculated based on the taxpayer’s income, deductions, and credits. Income taxes can be progressive, meaning the number of tax increases as the taxpayer’s income increases, or they can be flat, meaning the same rate of tax is applied to all income levels.
- A surcharge is an additional fee added to a regular price or charge. Surcharges are often used to cover additional costs, such as taxes or processing fees. Surcharges can apply to products, services, or transactions, such as credit card payments or shipping charges.
- Minimum alternate tax (MAT) is a tax imposed on companies that do not pay corporate income tax due to certain exemptions or deductions. MAT is based on the company’s book profits, which are calculated according to the tax law. MAT is intended to ensure that companies that do not pay corporate income tax still contribute to the government’s revenue.
- Cess is a tax imposed by the government on certain goods or services to raise additional revenue. Cess is typically used to fund specific programs or services and can be imposed at any rate. Examples of cess include education cess, agricultural cess, and infrastructure cess.
Indirect taxes
Indirect taxes are taxes charged on goods and services and are collected from the consumer at the point of sale. They are paid by the consumer, but collected by the business. Examples of indirect taxes include sales tax, value–added tax (VAT), and excise taxes.
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- GST (Goods and Services Tax) is a type of indirect tax implemented in many countries. It is a tax on the value of goods and services supplied by a business to a consumer. The GST is usually calculated as a percentage of the price of the goods or services. The rate of GST varies from country to country, but it is typically around 5–18%.
- Excise duty is a type of indirect tax imposed on certain goods and services. It is usually calculated as a percentage of the price of the good or service. Examples of goods and services subject to excise duty include alcohol, tobacco, fuel, and certain luxury items.
- Value Added Tax (VAT) is a type of indirect tax imposed on the sale of goods and services. It is calculated as a percentage of the price of the good or service and is usually between 10–20%.
- Customs duty is an indirect tax imposed on goods imported into a country. It is calculated as a percentage of the value of the goods and is typically between 5–25%.
Other taxes-
Road tax: Road tax is a type of indirect tax imposed on the use of roads in a country. It is typically calculated as a percentage of the cost of the vehicle and is usually between 1–10%.
Stamp duty: Stamp duty is a type of indirect tax imposed on certain transactions, such as property purchases, transfers of shares, and contracts. It is usually calculated as a percentage of the value of the transaction and is typically between 0.2–2%.
Security transaction tax (STT) is a type of indirect tax imposed on certain stock market transactions. It is typically calculated as a percentage of the value of the transaction and is usually between 0.1–0.3%.
