Company Analysis: Side Involves Looking at Factors That Can Be Measured Numerically

COMPANY ANALYSIS
Fundamental analysis is the method of analyzing companies based on factors that affect their intrinsic value. There are two sides to this method: the quantitative and the qualitative. The quantitative side involves looking at factors that can be measured numerically, such as the companys assets, liabilities, cash flow, revenue and pricetoearnings ratio. The limitation of quantitative analysis, however, is that it does not capture the companys aspects or risks unmeasurable by a number - things like the value of an executive or the risks a company faces with legal issues. The analysis of these things is the other side of fundamental analysis: the qualitative side or nonnumber side. Although relatively more difficult to analyze, the qualitative factors are an important part of a company. Since they are not measured by a number, they more represent an either negative or positive force affecting the company. But some of these qualitative factors will have more of an effect, and determining the extent of these effects is what is so challenging. To start, identify a set of qualitative factors and then decide which of these factors add value to the company, and which of these factors decrease value. Then determine their relative importance. The qualities one analyzes can be categorized as having a positive effect, negative effect or minimal effect. The best way to incorporate qualitative analysis into evaluation of a company is to do it once you have done the quantitative analysis. The conclusion come to on the qualitative side can put quantitative analysis into better perspective. If when looking at the company numbers one saw good reason to buy/invest in the company, but then found many negative qualities, he may want to think twice about buying/investing. Negative qualities might include potential litigations, poor R and D prospects or a board full of insiders. The conclusions of qualitative analysis either reconfirm or raise questions about the conclusions of quantitative analysis. Fundamental analysis is not as simple as looking at numbers and computing ratios; it is also important to look at influences and qualities that do not have a number value. The present and future values are affected by the following factors (Figure-1): 1) Competitive Edge: Many industries in India are composed of hundreds of individuals companies. The large companies are successful in meeting the competition and some companies rise to the position of eminence and dominance. The companies who have obtain the leadership position; have proven his ability to withstand competition and to have a sizable share in the market. The competitiveness of the company can be studied with the help of: a) Market share: The market share of the company helps to
determine a companys relative position with in the industry. If the market share is high, the company would be able to meet the competition successfully. The size of the company should also be considered while analyzing the market share, because the smaller companies may find it difficult to survive in the future. b) Growth of annual sales: Investor generally prefers to study the growth in sales because the larger size companies may be able to withstand the business cycle rather than the company of smaller size. The rapid growth keeps the investor in better position as growth in sales is followed by growth in profit. The growth in sales of the company is analyzed both in rupee terms and in physical terms. c) Stability of annual sales: If a firm has stable sales revenue, other things being remaining constant, will have more stable earnings. Wide variation in sales leads to variation in capacity utilization, financial planning and dividends. This affects the companys position and investors decision to invest. 2) Earnings: The earning of the company should also be analyzed along with the sales level. The income of the company is generated through the operating (in service industry like banks- interest on loans and investment) and non-operating income (ant company, rentals from lease, dividends from securities). The investor should analyze the sources of income properly. The investor should be well aware with the fact that the earnings of the company may vary due to following reasons: Change in sales. Change in costs. Depreciation method adopted. Inventory accounting method. Wages, salaries and fringe benefits. Income tax and other taxes. 3) Capital Structure: Capital structure is combination of owned capital and debt capital which enables to maximize the value of the firm. Under this, we determine the proportion in which the capital should be raised from the different securities. The capital structure decisions are related with the mutual proportion of the long term sources of capital. The owned capital includes share capital a) Preference shares: Preference shares are those shares which have preferential rights regarding the payment of dividend and repayment of capital over the equity shareholders. At present many companies resort to preference shares. The preference shares induct some degree of leverage in finance. The leverage
effect of the preference shares is comparatively lesser than that the debt because the preference shares dividend are not tax deductible. If the portion of preference share in the capital is large, it tends to create instability in the earnings of equity shares when the earnings of the company fluctuate. b) Debt: It is an important source of finance as it has the specific benefit of low cost of capital because interest is tax deductible. The leverage effect of debt is highly advantageous to the equity shareholders. The limits of debt depend upon the firms earning capacity and its fixed assets. 4) Management: The basic objective of the company is to attain the stated objectives of the company for the good of the equity holders, the public and employees. If the objectives of the company are achieved, investor will have a profit. Good management results in high profit to investors. Management is responsible for planning, organizing, actuating and controlling the activities of the company. The good management depends upon the qualities of the manager. 5) Operating Efficiency: The operating efficiency of the company directly affects the earnings capacity of a company. An expanding company that maintains high operating efficiency with a low break even point earns more than the company with high break even point. If a firm has stable operating ratio, the revenues also would be stable. Efficient use of fixed assets with raw materials, labour and management would lead to more income from sales. This leads to internal fund generation for the expansion of the firm. 6) Financial Performance: a) Balance Sheet: The level, trends, and stability of earnings are powerful forces in the determination of security prices. Balance sheet shows the assets, liabilities and owners equity in a company. It is the analysts primary source of information on the financial strength of a company. Accounting principles dictate the basis for assigning values to assets. Liability values are set by contracts. When assets are reduced by liabilities, the book value of share holders equity can be ascertained. The book value differs from current value in the market place, since market value is dependent upon the earnings power of assets and not their cost of values in the accounts. b) Profit and Loss account: It is also called as income statement. It expresses the results of financial operations during an accounting year i.e. with the help of this statement we can find out how much profit or loss has taken place from the operation of the business during a period of time. It also helps to ascertain how the changes in the owners interest in a given period has taken place due to business operations.

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COMPANY ANALYSIS

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