How to Analyse a Stock

December 2020
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 Overview of this Work
YouTube Video: https://youtu.be/dxFtNsxm5gg?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson

Image courtesy: Slidecarnival.com

 DISCLAIMER
• This video series is intended to share a high level overview of steps / stages
involved in analyzing a stock
• The contents discussed are for a high level understanding with a few pointers for
your thoughts to research further, and not a (1) exhaustive nor (2) a ‘ready-to-
implement’ framework / philosophy
• Any examples, sectors, stocks and cases discussed in this video series are only for
educational purpose and not BUY or SELL recommendations
Read these slides in conjunction with the corresponding YouTube Videos –
Links shared in the section dividers
Link to entire play list:
https://www.youtube.com/playlist?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson Contd...
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 DISCLAIMER (Contd.)

• Viewers are requested to do their own research and run their calculations before
investing

• I have made the best efforts to ensure accuracy of contents in this presentation, however,
errors could have crept – Do bring to my notice

• I shall in no way be responsible to any one (directly or indirectly) for any kind of loss that
might arise from using or sharing the information in this video series.

Read these slides in conjunction with the corresponding YouTube Videos –

Links shared in the section dividers
Link to entire play list:
https://www.youtube.com/playlist?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson
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 BACKGROUND OF THIS SERIES

• Read multiple books on Investing

• The knowledge was in silos
• Could not see the connection between various facets
• No meaningful process or framework or a investment philosophy
• Viewed Videos of various Indian Fund Managers and Investors
• Led to Bigger picture and connections

Facets of Knowledge – Investment Process / Framework

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 WHAT IS REQUIRED FOR STOCK ANALYSIS

Qualitative Analysis Quantitative Analysis Valuation Methods

Management Quality Financial Analysis Free Cash Flow / ROCE

Analyse Moat Balance Sheet Analysis DCF Way of Valuation

Analysing Annual Reports

Themes Others ALL ARE CONNECTED

What Stock to Analyse? Future Growth • Few facets in Silos

Sector / Cyclic companies Red Flags • Framework

Analyse Holding Company Tools – Screen / Monitor • Big Picture

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 WHAT TO EXPECT AND WHAT NOT TO…

Is this the only Framework?

Financial Statement Analysis

Technical Analysis

Valuation

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 7-STEPS IN STOCK ANALYSIS
STEP 5 – FINANCIAL STATEMENT ANALYSIS
• Analyze Financial Statements of the Company

STEP 4 - DISRUPTION
STEP 6 - VALUATION
• Identify disruption to Growth rate and period
• Appropriate Valuation
Models
• Use Margin of Safety STEP 3 – LENGTH OF GROWTH PERIOD
• Identify years of sustained growth - Estimated

STEP 2 - GROWTH
• Opportunity Size
STEP 7 – REFLECT ON YOURSELF
• Growth rate – Future Growth
• Check Behavioral Aspects / Bias
STEP 1 – QUALITY
• Create Investment Thesis
• Identify Sell Triggers • Quality of Business
• Quality of Management

STEP 0 – STOCK IDEA / SCREENING

• Fish for Ideas

• Initial Screening
• Story behind the Idea

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 Step 0: Stock Idea / Screening
YouTube Video:
https://youtu.be/DrQLM5HHfyY?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson
https://youtu.be/239xQsu93YQ?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson

Image courtesy: Slidecarnival.com

 7-STEPS IN STOCK ANALYSIS
STEP 5 – FINANCIAL STATEMENT ANALYSIS
• Analyze Financial Statements of the Company

@EWFA_ STEP 4 - DISRUPTION

STEP 6 - VALUATION
• Identify disruption to Growth rate and period
• Appropriate Valuation
Models
• Use Margin of Safety STEP 3 – LENGTH OF GROWTH PERIOD
• Identify years of sustained growth - Estimated

STEP 2 - GROWTH
@EWFA_
• Opportunity Size
STEP 7 – REFLECT ON YOURSELF
• Growth rate – Future Growth
• Check Behavioral Aspects / Bias
STEP 1 – QUALITY
• Create Investment Thesis
• Identify Sell Triggers • Quality of Business
• Quality of Management

STEP 0 – STOCK IDEA / SCREENING

• Fish for Ideas

• Initial Screening
• Story behind the Idea

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 HOW TO IDENTIFY A STOCK

Top Down Pick what you

Approach see

Bottom Up Pick what you do

Approach or Know

Cloning Stock
Ideas
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 TOP DOWN APPROACH BOTTOM UP APPROACH

Macro Economic Factors  Individual Companies 

Individual Stocks Specific Parameters
Stock screens: Valuation or
Good going sectors in the
Profitability Metrics
Economy
www.screener.in/

Good companies within these In-depth Fundamental Analysis

sectors
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 WHAT YOU SEE WHAT YOU KNOW / DO

Invest in what you know

Peter Lynch / understand – Circle of
Competence

Our Profession or Business gives

valuable insights

Insights help to pick stocks with

List of 30-40 companies easy

Not a immediate “Buy”, Easy to Analyse – Greater

must Analyze further chance of Success
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 CLONING STOCK IDEAS

Stock names from Big investors & Mutual Fund houses.

NOT Coat Tail Investing – Pick ONLY the stock names for
further analysis
How to know the holdings?
Big Investors Mutual Funds
• Media / Websites • Respective MF websites
• Value Research

Confirmation bias and Hallo effect

We may ignore further analysis

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 STORY BEHIND… ACTIONS

What is the story behind the Time for Actions...

company?
• Identify stock using all of any
of these approaches
Details of Promoter, Market
Share, Other products of the • Go by the approach which
company, Competitor details, you are confident
years in business etc.
• The picked stock can be used
High level details are sufficient. for hand-on approach

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 TOP DOWN APPROACH
• Macro Economic Factors  Individual Stocks
• 3-5 Good going Sectors in the Economy / Sectors with
high future growth
• Look of Good companies within sectors, based on Market Share or
Market Capitalization – Investible Universe
• Fundamental analysis of stocks from the
Investible Universe
How to know the best performing Sectors?

This approach may not be “Everyone’s cup of Coffee”

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TOP DOWN APPROACH

Sector 1

Sector 2

Sector 3

These are not immediate investments

Repeat this for the other 2 identified sectors

1. Many sectors eliminated – Less Diversification

2. Missing good opportunities in other sectors
3. Many variables – Not easy for retail investors
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 BOTTOM UP APPROACH
Individual Companies  Investible Universe  Deep dive

Challenge: 5500+ companies in Indian Markets

Stock Screeners  Using filters/parameters

Stock Screeners Parameters…

• Market Cap – Large, Mid & Small
https://in.investing.com/ • Sectors
www.screener.in/ • Valuation and Profitability Metrics
• Financial Ratios i.e. Debt-Equity

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 BOTTOM UP APPROACH

Parameters… Which Parameter /

• Market Cap – Large, Mid & Small Range of Value
• Sectors
• Valuation and Profitability Metrics Answer lies in you
• Financial Ratios i.e. Debt-Equity

1) Market Cap – Large, Mid & Small 3) Valuation / Profitability Metric

2) Sectors – Good understanding 4) Financial Ratios

Be Flexible! Don’t be Precise

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 BOTTOM UP APPROACH
https://in.investing.com/

Stock Screener Page

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 BOTTOM UP APPROACH

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 BOTTOM UP APPROACH

What parameter to choose and range of values – Individual choice

based on requirement

Put some time to understand Metrics and Ratios

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BOTTOM UP APPROACH

https://www.screener.in/

Simplicity of the approach

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 BOTTOM UP APPROACH

Other Screeners…

https://trendlyne.com/ https://stockedge.com/

https://marketsmithindia.com https://www.tickertape.in/screener

https://www.valueresearchonline.com https://www.moneyworks4me.com

https://chartink.com/screeners

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 WHAT YOU SEE

Not a immediate “Buy”, must Analyze further

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 WHAT YOU DO

Most of us are associated with a profession or a Business

The experience from our Profession or a Business gives valuable

insights about a sector

These sector insights helps to analyse and compare the companies

in the sector

Doctor, IT Professional, FMCG, Automobile

This approach may not be suitable if…
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 CLONING STOCK IDEAS

Stock names from Big investors & Mutual Fund houses.

Holding of Mutual Fund houses https://www.valueresearchonline.com/

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 CLONING STOCK IDEAS

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 ACTIONS
Time for Actions...

• Identify stock using all or any of these approaches

which ever you are comfortable

• Go by the approach which you are confident

• The picked stock can be used for hand-on approach

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 Step 1: Quality
Quality of Business

YouTube Video: https://youtu.be/Tkh-zVrcEcU?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson

Image courtesy: Slidecarnival.com

 7-STEPS IN STOCK ANALYSIS
STEP 5 – FINANCIAL STATEMENT ANALYSIS
• Analyze Financial Statements of the Company

@EWFA_ STEP 4 - DISRUPTION

STEP 6 - VALUATION
• Identify disruption to Growth rate and period
• Appropriate Valuation
Models
• Use Margin of Safety STEP 3 – LENGTH OF GROWTH PERIOD
• Identify years of sustained growth - Estimated

STEP 2 - GROWTH
@EWFA_
• Opportunity Size
STEP 7 – REFLECT ON YOURSELF
• Growth rate – Future Growth
• Check Behavioral Aspects / Bias
STEP 1 – QUALITY
• Create Investment Thesis
• Identify Sell Triggers • Quality of Business
• Quality of Management

We are here
STEP 0 – STOCK IDEA / SCREENING

• Fish for Ideas

• Initial Screening
• Story behind the Idea
@EWFA_
 Types of Business

How can Businesses be classified based on Quality?

Three categories - Great, Good and Gruesome

Warren Buffett classifies business as Great, Good

and Gruesome - Details in 2007 Berkshire Annual
Report (Page 6 to 8).

https://www.berkshirehathaway.com/2007ar/2007ar.pdf
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 Types of Business (Contd.)

“Think of three types of savings accounts.

• The Great one pays an extraordinarily high
interest rate that will rise as the years pass.

• The Good one pays an attractive rate of

interest that will be earned also on deposits
that are added.

• Finally, the Gruesome account both pays an inadequate interest rate and requires you to
keep adding money at those disappointing returns.”

- Berkshire Hathway, 2007 Annual Report, Page 8

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 Understanding the Basics

Cost of Capital
• Business, needs capital which may be borrowed (or internally funded)
• This capital has a cost associated which depends on mode of financing i.e. Equity or Debt

Competitive Advantage
• When a company earns above Cost of Capital, more players (Competitors) enter the
business who operate at lower returns.
• Company can protect its returns only if it has a competitive advantage

Product Low Cost of

Strong Brand
Differentiation Production
Unique Value Customer pull Low cost in comparison to Pricing Power
proposition Competitors

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 Understanding the Basics (Contd.)
Pricing Power
• Ability to increase the price without any (or less) impact to Sales
• Primarily comes from Competitive Advantage i.e. Strong brand, returning customers or
product differentiation

Moat
• Sustained Competitive Advantage =
Enduring Moat
• Moat protect the company’s profit
and profitability for a extended
periods of time.
• High Moats = High RoE and cash
flows.
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 Six Parameters for Evaluating Business

Nature of Competitive
Business Advantage

Cost of Pricing
Capital Power

Great Gruesome
Financial
Growth
Numbers %
Good

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 Great Business

Stable Business, Asset Light (Less Physical Assets, More Intangible assets – No huge
Capex

Earn significantly higher than Cost of Capital

Less than Good and Gruesome companies. The growth comes from very little
addition capital

High and increasing competitive advantage – Brand & Low cost of Production

High Pricing Power

%
High and Rising RoE (10Y Avg. > 25%), High FCF and High Dividend Payout
 Good Business

Moderate Change

Earn higher than Cost of Capital (But lesser than Great Business)

Grow at healthy rates, but need additional capital to support the growth

High competitive advantage – Primarily from economies of scale

Moderate Pricing Power

Steady & Attractive RoE (10Y Avg. between 10 – 25%), other parameters relative less
%
than Great companies
Gruesome Business

Rapid Changes, Capital Intensive and frequently need huge Capex

Earn lower than Cost of Capital

High growth rates, which actually is a curse

No competitive advantage

No Pricing Power

Low and declining RoE (10Y Avg < 10%), Low or Negative FCF, Low or No Dividend
%
Payouts
 Investment Strategy

• 1 – 2% of Market • Remaining share of Market

• Buy at Reasonable Price • Avoid Entering our Portfolio
• Deeply Understand these
companies

Great Gruesome

• 5 – 10% of Market
• Buy at Bargain Prices / Good
Margin of Safety

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ACTIONS

• Pick stocks identified in Step 0

• Categorize them as Great, Good and Gruesome

• Nature of Business, Competitive Advantage and Pricing Power

• Screener – RoE value and trend, Growth Rate, Dividend Payout

 Step 1: Quality
Quality of Management

YouTube Video:
https://youtu.be/7IbEncmTXho?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson
https://youtu.be/PsETCuyabak?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson
https://youtu.be/bcNl7AGpCGM?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson
 Have Open Mind
• Most important thing - Open mind when analysing Managements

• Barrier – Existing opinion for/against the Management from discussions,

media, social media etc.

• Existing Positive opinion • Existing Negative opinion

• Justify findings that are against • Low prospect idea – Due to
them existing view
• Specifically look for favourable • No interest for serious analysis
information about the
management

Have Open Mind, Gather and Analyse all information. Take a decision on Management
without emotions!
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How Important is Quality of Management

A few real life examples….

• Chit fund investment – Entrust money with a person having a good reputation in the
interest of safety of money and return of money at end of tenure

• Buying Gold – Jeweler with impeccable reputation to ensure that you buy gold with
highest purity

• Mortgage your Gold Jewelry – Trusted Mortgage company for safe return of the Jewel

Investing in Stocks is no different. Evaluating Management Integrity and other parameters is crucial for
successful Investment.
 Qualities of Good Management

Are there are some qualities & attributes of a Good Management.

Competence
• Minimum skill set required to do the
To better explain, assume a situation
task in hand
Qualities of a Good Management

of you having a driver for your car. Let

us see how these 3 qualities stack up
Integrity in this example.
• Executing the task
• Treatment of Minority Shareholders

Passion
• Enthusiasm in doing the task
• Growing business/ Enhancing
shareholders wealth

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 Qualities of Good Management (Contd.)

• Competent to drive in all conditions i.e. City traffic, high-way, day/night, rainy
weather etc. and take you safely to the required destination.
• If your driver sleeps on wheels, then you will loose your sleep!

• You give the driver a 2000 for filling fuel. He fills fuel for 1800 and pockets the
rest.
• Would you compromise and have that driver?

• Driving is his passionate & pay cheque comes next. This is a very rare virtue.
• Enjoys driving, familiar with alternative routes, never been late to duty and you
never missed any appointment

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 Qualities of Good Management (Contd.)
Now relate these qualities to Business Managements…

The person running the show must be competent enough not only to run the day-to-day business,
but also to navigate the business in all conditions i.e. Economy slow down, exploiting economy
boom, increasing competition, tightening regulations etc.

• Runs the Business and achieves growth ethically

• The management must treat the minority shareholders in par with promoters/majority share
holders.

The key person is passionate about business, very ambitious & loves to see the company grow. Learns
from failures, see challenges as opportunity and comes out big after every down turn. Shareholder’s
wealth creation is accorded priority.

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 How to Gage Managements?

Analyzing Management Quality is not an easy task like Source of Information

analysing a company’s financial performance
Annual Reports
MGT – 9 Section
Not possible to put a numerical value or have a ratio or
specific metrics to gage the quality of management.

Articles &
Even exact definition of bad or good management is Interviews
sometimes subjective and not straightforward

What can be bad management: They do all that is

possible to benefit themselves at the cost of minority Con call, Investor
shareholders. Presentations & AGM

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How to Gage Managements?

This is a heavy topic to discuss in this video series

If any of you are interested to know or read it

immediately kindly refer Chapter 7 to 9 from the book
“The Investment Checklist” by Michael Shearn

Management Analysis is a In-Depth subject in itself

with many pointers to Analyse. However I will discuss a
few pointers in this Series. But keep in mind, that there
are many more…
 Five Pointers

Acquisitions

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 1. Promoter Background
Competence
• Educational qualifications
• Experience details
• The length of tenure, the CEO and the top
management has been associated

Integrity 40Y
• Are there any pending investigations, fines
slapped by SEBI or other regulatory authorise,
Fraud, disputes etc. any enquiry pending against
the CEO or members of the management layer
• Shareholder friendliness and decisions in the
best interest of the minority shareholders

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 Pointers for Past Performance
• Strong management is the backbone of any successful company
• The past performance is a fair indicator of the management competence and outcome of
past decisions
A few pointers…
Growth in the last few years:

Debt Levels in the last few years:

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 Profitability Ratios
Trend of RoE

Constantly rising RoE

indicates economic
competitiveness.

Source: Screener.com
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 Profitability Ratios (Contd.)
Trend of RoE

Source: Screener.com
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 Dividend / Retained Earnings
Is Profits shared with the shareholders in the form of dividends.?
• This is one good indicator as there is real money outflow from the company to Investor’s
pocket
• How much dividend must be distributed as dividends or how much must be retained or
reinvested?
o If no growth or reinvestment opportunities the earnings must be distributed as dividends
o If there are good growth opportunities then the earnings must be deployed back to business

How to measure the effectiveness of earnings that are re-invested?

A few resources…
https://www.myaccountingcourse.com/financial-ratios/rore
https://www.readyratios.com/reference/profitability/return_on_retained_earnings_rore.html

@EWFA_
3. Executive Compensation
 Executive Compensation
• Gives critical insights to Management Intentions

• Management is responsible for increasing shareholders wealth over a period

of time.

• But if they pay themselves with huge amounts of money then the gains for
shareholders becomes less.

• Such high compensation at the tough times, are not encouraging signs

• The compensation details are available in the Annual reports (Section MGT-
9)
@EWFA_
 Executive Compensation (Contd.)
• But the next question is how much is huge?
• Determining what level of compensation would be too high or low, is no
doubt a difficult task, However a few pointers would help:
o Periodic Comparison & Peer Comparison
o The ceiling set by Regulations
o “Salary range for promoter directors/management is about 2-4% of Net
Profit After Tax (PAT). The salary generally contains 2% commission on PAT
and a fixed monthly component along with other perquisites” - Dr. Vijay
Malik

@EWFA_
 Compensation - Samples
• Comparison of Managerial compensation without reference would be misleading
• The Managerial Compensation (MC) must be referenced to a base value for making a
meaningful comparison.
• The base will be Net Profits (Profit After Tax) for the year
• This gives the Managerial Compensation as a %-age of Net profits
Year on Year Comparison Peer Comparison
Year 1 Year 2 Year3 Year 4 Target Comp 1 Comp 2 Comp 3
Net Profit (NP) Net Profit (NP)
MC* MC*
% of (MC/NP) % of (MC/NP)

If MC is calculated as a % of Net Profits… then what would

be compensation if the company was in loss? ☺

@EWFA_
 Compensation - Samples

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 Compensation - Samples

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 Compensation - Samples
CURRENT YEAR

PREVIOUS YEAR

1% of Net Profit
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 Compensation (Contd.)

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 Compensation (Contd.)

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4. Related Party Transactions

Related Party Transactions

 Basics of Related Party Transactions
Who all constitute as Related Party?
Companies Act 2013, gives the definition for Related Party. A few being:
• Director / Relatives to Director
• Key Management Personal / Their relatives
• A Holding Company Complete List from Companies Act 2013
• A Subsidiary Company
• An Associate Company and many more http://www.mca.gov.in/SearchableActs/Section2.htm

What is a Related Party Transaction (RPT)?

A Related Party Transaction is a transfer of resources, services or obligations between the
reporting entity (The company which you are analysing) and a related party, regardless of
whether a price is charged.

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 Importance of Related Party Transactions
• Goldmine of the information for assessment of any management
• Related party transactions section is one of the essential parts of the annual report that
every investor should analyse in detail for every company they invest.
• This section discloses a summary of all the transaction and dealings that the company
made with Related parties i.e. promoters and their personal entities, subsidiaries, holding
or associate company etc.
• By studying each transaction in this section, an investor can get a fair idea of whether the
promoters are benefiting from the company at the cost of minority shareholders.
• Less the number of RPT, the better – This directly related to number of subsidiaries

• Related party transactions are not necessary a mechanism for fraud – But investors need to
evaluate in in light of its broader corporate governance.

• Their presence need not indicate fraudulent financial reporting.

@EWFA_
 Where all can mistakes happen
Creative areas in RPT

• Subsidiaries Provide Raw materials - Purchase of Raw materials at higher than market
cost which gives gains to Subsidiary

• Concessionary Loans: Loans to Subsidiary at low interest rates than market rates

• Purchase of Fixed Assets from Subsidiary at a higher price (or) sale of Fixed assets to
Subsidiary at a lower price

• Lease/Rent of facilities from Subsidiary at higher rates (or) Lease/Rent of facilities to

Subsidiary at lower rates

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Related Party Transactions - Samples
Transactions with Subsidiaries

https://www.businesstoday.in/magazine/cover-story/how-funds-are-siphoned/story/3684.html
 Number of Subsidiaries

More the number of Subsidiaries,

more the number of
opportunities for Related Party
Transactions and more the
number of options to Siphon
company money to the Subsidiary
Sample – With no significant RPT
5. Acquisition
Check the Acquisition Details
Purpose of Acquisition
• Raw Materials
Growth Strategic Move • Enhanced Logistics strength or Distribution network
• Enter Foreign Market

• Does the company grow only with frequent acquisitions? – Concern

• During acquisition, does the management stick to core business or their competencies?

• Is the acquisition funded internally or taking high debt affecting the quality of Balance
Sheet
• How does the acquisition work out? Is it sold after poor performance? – A bigger
concern
Have these in mind…

Annual Reports hide more what they disclose.

Annual Reports disclose more than what it can hide or we can

see, but we need to bring in time and skill.

Most of the details that we discussed in these three videos were picked from Annual
Report.

https://economictimes.indiatimes.com/wealth/invest/annual-report-can-reveal-the-secrets-a-company-wants-to-hide-
heres-how-to-uncover/articleshow/59190442.cms?from=mdr
Have these in mind…

• Only few pointers and not a exhaustive or a complete set

• Don’t make a decision with only one parameter in isolation.

• Connect the dots and see the bigger picture i.e. Managerial Competence,
Compensation, Related Party Transactions etc

• Analysis of Management Quality – Investigation work, Old reports, compare

with peers, previous year reports etc.
 ACTIONS
• Who is heading the company?
• What are their educational qualifications
• Their experience and tenure in the company
• Pending Investigations on the CEO
Promoter Background

Try to find as much as

possible about CEO and
Management layer from
Annual Reports and
Internet

@EWFA_
 ACTIONS
• Check 5-10 Year Sales and Profit Growth
• Trend of Profitability Ratios
• Check the debt levels (Increased or Decreased)
• Amount of Dividend Distributed & Retained
• Effectiveness Retained Earnings – Return on Retained
Past Performance
Earnings

Document the Observations

• 5-10 Year Sales growth _____CAGR

• 5-10 Year profit growth _____CAGR
• 5 – 10 Year trend of Profitability Ratios
(Not Average!)
• Debt level (Increased / Decreased)
• Effectiveness of Retained Earnings:
RORE ______ %

@EWFA_
 ACTIONS
• Calculate the Managerial Compensation (MC) Ratio:
(Compensation / Net Profit After Tax)
• 5 – 10 years data of the same company
• Comparison of the same ratio with peers in the industry
Executive Compensation

@EWFA_
 ACTIONS
• How many subsidiaries does the company have?
• Gather details of Related Party Transactions, (1) The
number of such transactions, Amount (Monetary value)
of such transactions, Nature of Transaction (Loan,
interest back etc)
Related Party Transaction

Document the findings…

What is your general feel
about these transactions

@EWFA_
 ACTIONS
• Evaluate the nature of recent acquisitions
• How was it acquired? Internal funds or debt?
• Was it into a related or unrelated business?

Acquisition

@EWFA_
 Sum Up…
• STEP 1 – ANALYZING QUALITY OF BUSINESS AND MANAGEMENT IS THE BIGGEST, TIME
CONSUMING ANALYSIS THAT A INVESTOR MUST DO METICULOUSLY

• COMPLETING THIS ACTIVITY PROPERLY IS LIKE NEARLY HALF JOB DONE

• IF THE QUALITY OF BUSINESS / MANAGEMENT IS NOT GOOD, FURTHER ANALYSIS OF

THAT COMPANY IS NOT REQUIRED

• IF THIS STEP IS PASSED, ONLY THEN CAN ONE GO FOR ANALYSING GROWTH

• WHAT IS THE USE OF FOCUSSING ON A BUSINESS THAT IS NOT A GOOD BUSINESS OR

NOT RUN BY A GOOD MANAGEMENT?

MANY COMPANIES FAIL AT THIS STAGE

@EWFA_
 Step 2 & 3: Growth & Length of Growth
YouTube Video: https://youtu.be/RtRT9OZaDrA?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson

Image courtesy: Slidecarnival.com

7-STEPS IN STOCK ANALYSIS
STEP 5 – FINANCIAL STATEMENT ANALYSIS
• Analyze Financial Statements of the Company

@EWFA_ STEP 4 - DISRUPTION

STEP 6 - VALUATION
• Identify disruption to Growth rate and period
• Appropriate Valuation
Models
STEP 3 – LENGTH OF GROWTH PERIOD We are here
• Use Margin of Safety
• Identify years of sustained growth - Estimated

STEP 2 - GROWTH We are here

@EWFA_
• Opportunity Size
STEP 7 – REFLECT ON YOURSELF
• Growth rate – Future Growth
• Check Behavioral Aspects / Bias
STEP 1 – QUALITY
• Create Investment Thesis
• Identify Sell Triggers • Quality of Business
• Quality of Management

STEP 0 – STOCK IDEA / SCREENING

• Fish for Ideas

• Initial Screening
• Story behind the Idea
View of the Zen…

"The strategy is to find a good business – and one that I can

understand why it's good – with a durable competitive advantage,
run by able and honest people, and available at a price that makes
sense. Because we are not going to sell the business, we don't need
something with earnings that go up the next month or the next
quarter; we need something that will earn more money 10 and 20
and 30 years from now.”

– Warren Buffett, in Forbes Magazine's 100th Anniversary Issue.

Investor of today will not benefit from the profits of the past but only from the profits of the
future - Warren Buffet
 Investing is Art or Science?
• Investing is Art or Science? Some say it is art and academicians may say it is Science
• Hard to fit in one of the category - It is a mix of Both
o Science gives consistent results in the same set of conditions. Qualitative analysis and financial
models bring in Science flavour in investing.
o Art brings in using one’s prudent judgement, intuition, common sense and experience
(Unpredictable – Differs from persons and even with the same person!)

• Investing is Science to certain extent and Art beyond that

• Two great investors or fund managers could come out with two entirely contrary views on the
same stock.
• This would be more common when estimating the growth rates. While one investor could say that
IT sector would have 10% growth, other would say that there is no growth expected for next 2-3
years.
• When analysing growth, we are in Art portion of investing – No Precision or Accuracy
@EWFA_
 What is Growth?
• By Growth, we are looking for earnings growth of the company - it increases the value of
the company
• Stock prices are correlated with the earning growth and markets richly reward growth

• Earnings growth can come from

o Margin expansion (Increase in Profit margins for a given level of Revenue)
o Revenue growth (Increase in Revenue for a given level of Profit margins)

• The earnings growth must come from Revenue growth, as there is limit to Profit margin
expansion strategy
• Where does the revenue growth come from?

External Internal
Factors Opportunity Size Management Capability Factors

@EWFA_
 Growth – A Numerical Overview

• 100 Crores today and same 100 crores profit in the 10th Year! – No use to Investor

• 100 Crores today and 1000 crores in the 10th Year is what a investor needs (~25% CAGR)

• But to earn 1000 crores in 10 years, two things are vital

o Opportunity size: The industry or opportunity must be big enough to offer 10 times growth in 10 years
o Management: Competent enough to exploit this opportunity ethically

• Opportunity size – External factor and more of crystal gazing is involved, depends on our
knowledge about the industry and its future prospect

• Management with the three characters needed i.e. Integrity, competency and passion is
needed to exploit the opportunity– See in earlier videos
@EWFA_
 Is Estimating Growth Difficult?
• There is no science or technique that can help investors to
figure out the earning growth – complex and multivariate. There could be 3 situations…
1. Estimate by Market – This company can
• There is no book available which can help to estimate growth. grow at 25% for the next few years

• Growth is unique to each industry and even different within

companies in the same industry. Hence, does not yield itself to 2. Self-estimates based on understanding
any standard frameworks.
of the business, bring in a differential
• Estimating the growth rate is seeing into the future. view, this company can grow at 35%

• Your OWN understanding on the industry, trends, competition,

management and many more factors come into picture when
estimating the growth - Here comes the importance of Circle of 3. Reality (25% or 35% or contra?) of what
Competence (Investing in what you know)
happens as time passes

@EWFA_
Characteristic of Good Growth

Consistency • Cyclical growth is much more difficult to predict compared to secular growth. Stocks with
of Growth secular or consistent growth commands much higher valuations due to the predictability
of i. In short, what can be measured and predicted gets valued.

Sustainability of • The current value of companies depends considerably on the perceived longevity of their
Growth earnings growth.
• The greater the sustainability of such earnings growth, the better is likely to be the valuation
of such growth.

Profitable • For growth to become self-financing and capable of generating free-cash flows.
Growth • Earnings growth achieved at a significant capital cost is not valuable.
• RoIC > CoC (Great/Good Companies), consistently indicates good growth
Where to get details of Growth?
Another area to look for future growth values is Annual reports of various companies in the whole industry. They bring out
their own research/insights or refer to other research which can give a fair idea of expected future growth
Where to get details of Growth?
 Size of Opportunity
• Future size of opportunity - Not today (How large can that opportunity become in future)

• This is lot to do with crystal gazing into future to visualize how the business becomes over period of time

• This idea can be equated to the framework of size of fish and size of pond

• The investing world focus on size of fish, but successful investing requires figuring out the size of pond

Small fish in a big pond Big fish in a big pond Big fish in a small pond Small fish in a small pond
Note: The contents of this slide - Fish/Pond Analogy picked from the book “On Long-Term Value & Wealth Creation from Equity Investing” by Mr. Bharat Shah. Refer
the book for further details and understanding of this concept ‘Size of the Opportunity’’.
Size of Opportunity (Contd.)
Small fish in a big pond

• If the fish is capable and conditions are favourable, there will be explosive growth

• This option certain risk due to the current size of the fish and returns are much higher

These two options only will

help in Value creation
Big fish in a big pond

• The fish is already fat and has the needed strength and pond size is also big to
accommodate as the fish grows further
• This option carries lesser risk due to the maturity of the fish but gives lesser returns (In
comparison with the above option) due to the existing size of fish
 A Sample Case
• The overall Size of the opportunity.
o E.g. Aviation business: How many people travel now by air and how many would travel by 2025?
o What are enablers? UDAAN - Regional Connectivity Scheme
• Where does the company in analysis stand in relation to the opportunity size?
o How much market share does your XXX Airline company caters in the current Air travel volumes? It is 10% or 50% or
90%
• The capability of the management to exploit (Ethically!) the available opportunity size.
o This is the where the quality of Management that we previous discussed becomes important
o If the current market share is 90%, can it retain the same till 2025 without losing to competition
o If the current market share is 50%, can the management increase to 80-90% by 2025?

This analysis can be made only, if there is a fair understanding of the industry in which the company operates. To get a right
answer, your own understanding of your company and the industry in which it operates is important. The question now on you
is…

Do you have sufficient understanding of the Industry that you are analyzing to do this Growth analysis?

@EWFA_
 Longevity of Growth
• Identifying the growth rate for new future (1-2 years) is of little use, Longevity of Growth is more important
(Identifying how long a particular growth will sustain, i.e. Growth rate of 15% for 5 years)

• Ideal scenario would be to perpetual growth, but such companies are rare/few

• Longevity in this context is also the duration a company can maintain its competitive advantage and earnings
growth.

• Longevity and high growth rates are inversely co-related, Higher the growth, lesser the longevity of the
growth

• Hypergrowth sectors/stocks must be carefully approached (Hypergrowth? A stock that had grown over 40-
50% in the last 4-5 years

• While estimating growth is difficult, even much more difficult is determining the longevity of growth as there
are many factors (Known and Unknown) that can disrupt this project growth

@EWFA_
 A Compounding Machine

good growth + longevity of this growth

=
compounding machine

Compounding Machine create outstanding value over

a period of time
@EWFA_
 Growth – Key Takeaways
• WE TEMPT TO BUY-IN COMPANIES OR INDUSTRY THAT IS A CURRENT MARKET FAD.
• HOUSING FINANCE COMPANIES (HFC) AND NON-BANKING FINANCIAL CORPORATIONS
(NBFC) WAS MUCH DISCUSSED SECTOR A YEAR BACK. HOW MANY REALLY UNDERSTOOD
THE INDUSTRY DYNAMICS/RISK BEFORE INVESTING IN THESE COMPANIES?

• THIS STAGE OF ANALYSIS HELPS NOT ONLY TO SEE HOW LONG RUN-WAY OF GROWTH DOES
THIS COMPANY HAS… BUT ALSO TO REFLECT ON OURSELF TO SEE, IF WE UNDERSTAND THE
INDUSTRY AND COMPANY WELL.

• IF WE CANNOT SATISFACTORILY PERFORM THIS ANALYSIS, REST THE IDEA FOR SOMETIME,
TILL YOU GET TO UNDERSTAND THE INDUSTRY. TALK TO PEOPLE IN THE INDUSTRY AND
LEARN MORE.

MANY INVESTORS FAIL AT THIS STAGE, DUE TO LACK OF UNDERSTANDING OF THE INDUSTRY
@EWFA_
Additional Readings
 Step 4: Disruption to Growth
YouTube Video: https://youtu.be/O3PQmXBvAS4?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson

Image courtesy: Slidecarnival.com

7-STEPS IN STOCK ANALYSIS
STEP 5 – FINANCIAL STATEMENT ANALYSIS
• Analyze Financial Statements of the Company

STEP 4 - DISRUPTION We are here

@EWFA_
STEP 6 - VALUATION
• Identify disruption to Growth rate and period
• Appropriate Valuation
Models
• Use Margin of Safety STEP 3 – LENGTH OF GROWTH PERIOD
• Identify years of sustained growth - Estimated

STEP 2 - GROWTH
@EWFA_
• Opportunity Size
STEP 7 – REFLECT ON YOURSELF
• Growth rate – Future Growth
• Check Behavioral Aspects / Bias
STEP 1 – QUALITY
• Create Investment Thesis
• Identify Sell Triggers • Quality of Business
• Quality of Management

STEP 0 – STOCK IDEA / SCREENING

• Fish for Ideas

• Initial Screening
• Story behind the Idea
Sum Up So far
• STEP 0 – Different ways to get Stock Ideas

• STEP 1 – Analyzing quality of business and management is the biggest, time consuming
analysis that a investor must do meticulously. Need not proceed with further analysis,
this step is not through.

MANY COMPANIES FAIL AT THIS STEP

• STEP 2 – Estimating Growth • More of Crystal Gazing

• Investment – Both Art and Science
• Dealing with Growth is more art part
• STEP 3 – Longevity of Estimated Growth • Seeing into future / Circle of Competence

MANY OF US FAIL AT THIS STEP 2 & 3

 What do I mean by Disruption to Growth

Not using in the term mean for “Disruptors”

No Technology Disruption – While it is also one of them we discuss

This is about what can affect the growth rate or longevity of growth
that was estimated in Steps 2 and 3
@EWFA_
 Company Level Industry Level National / Global Level
Competition, Management Regulations, Technology Changes Economic Conditions, Political
competency Changes etc.

Three Levels…
@EWFA_
 Competition
Michael Porters Five Forces Framework

@EWFA_
 Competition (Contd.)

• This looks at the number and strength of your competitors / Core of the analysis

• How many competitors does the company have? and Who are they?

• If there are lot of competitors then the suppliers and buyers can go to any of them where they get a better
deal

• How is the quality of their products and services of competitors compared with your company?

• Is the competition intense?

o If Yes, Then there aggressive price cuts become rule of the day to attract customers bringing down the
profit levels of the industry

o If No, Then your company does something unique what gives competitive advantage and healthy
profits

@EWFA_
 Competition (Contd.)

• Understanding and practising this framework is

demanding

• Needs extensive practise and fair understanding and

knowledge on the 5 forces in that industry

• It is time consuming for one industry and doing it for

different industries takes significant time

• Google: “Michael Porters 5 forces analysis on XXX

Industry

• Thesis, with insights about the industry

@EWFA_
 Technology
• Look in the future. Which technology change would disrupt your company?
• Internet/Online Platforms/Apps is the Mother of all Technology disruptions.
• Ask some basic questions
o Is there a online way to paint a house? No
o Is there a online way to consume liquor? No
o Is there any substitution or threat coming in future to shoes/sandal that we have to wear? No
o Is there a way that a Automobile engine manufacturing company have a substitute? Yes,
Possible with the growth of Electric Vehicle (EV) different kind of engines come up

Yes does not mean, that the company must be skipped. But a indicator to probe more on how long can the
estimated growth sustain before being disrupted.

Business that does not change rapidly. Example of Funeral Company by Mohnish Pabrai

This analysis is easier and not required, if your company/industry is immune to Technology changes
@EWFA_
Regulation

• Mining Ban – Local provinces not renewing licenses /

Environmental Concerns / Public Concerns

• Curbs on Imports / Exports

• License permits – Banks / Cigarette Industry (Players can

suddenly enter the markets and trim the market share

• Restriction on Gold Lease early in 2013 impacted Good

Retailers

• More public sentiments or welfare / Interferences of

court / Government
Political

• National / International Level affecting a country or multiple industries in a country

• Trade wars between nations / Anti Dumping duties

• Countries bringing acts and making their outsourcing more stricter to help the job
opportunity of locals

• New political party with new policies / Ideologies – May even reverse the earlier
approved projects Plans
So what should I do?
• None of this is under investors control

• When there is no control, what is the use of analysing this?

• This are typically kind of risk register, of what can disrupt our estimations on Growth rate
and its longevity

• Record these in investment thesis

• Constantly review this with new information

• Remember always something extraordinary can happen, that cannot foresee that might
affect the growth in either ways
Additional Readings
 Step 5: Financial Statement Analysis
YouTube Video:

https://youtu.be/ksh_4jITQDs?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson
https://youtu.be/aSyg4R148n4?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson

Image courtesy: Slidecarnival.com

7-STEPS IN STOCK ANALYSIS
STEP 5 – FINANCIAL STATEMENT ANALYSIS We are here
• Analyze Financial Statements of the Company

@EWFA_ STEP 4 - DISRUPTION

STEP 6 - VALUATION
• Identify disruption to Growth rate and period
• Appropriate Valuation
Models
• Use Margin of Safety STEP 3 – LENGTH OF GROWTH PERIOD
• Identify years of sustained growth - Estimated

STEP 2 - GROWTH
@EWFA_
• Opportunity Size
STEP 7 – REFLECT ON YOURSELF
• Growth rate – Future Growth
• Check Behavioral Aspects / Bias
STEP 1 – QUALITY
• Create Investment Thesis
• Identify Sell Triggers • Quality of Business
• Quality of Management

STEP 0 – STOCK IDEA / SCREENING

• Fish for Ideas

• Initial Screening
• Story behind the Idea
Summing the various Steps…
• STEP 0 – Different ways to get Stock ideas

• STEP 1 – Analyzing quality of business and management is the biggest, time consuming
analysis that a investor must do meticulously. Need not proceed with further analysis,
this step is not through.
MANY COMPANIES FAIL AT THIS STEP

• STEP 2 – Estimating Growth

• Art part of Investments’ Art/Science debate
• STEP 3 – Longevity of Estimated Growth • More of Crystal Gazing & Seeing into future
• Circle of Competence
• STEP 4 – Disruption to Growth

MANY INVESTORS FAIL AT THIS STEP 2, 3 & 4

 Financial Statements

Balance Sheet Income Statement Cash Flow Statement

• Assets – Owned by the Company • Revenue • Cash flow from Operations
• Liabilities – Owed by the Company • Expenses • Cash flow from Investments
• Net Profit / Loss • Cash flow from Financing

@EWFA_
 Financial Ratios
Financial ratio is a relative magnitude of two selected numerical values taken from the three financial statements

• Liquidity Ratios Profitability Ratios Cash Flow Indicator Ratios

o Current Ratio Complete Margin analysis • Cash flow coverage Ratio
o Quick Ratio • Cash Return on Capital Invested
• Working Capital Cross Ratio: Return on Equity (CROCI)
• Debt/Solvency Ratios • Operating Cash Flow Ratio
o Debt to Equity Ratio Investment Valuation Ratio: • Cash Realization Ratio
o Interest Coverage Ratio P/B, P/E, P/S, Dividend Yield etc.
@EWFA_
 What Should a Investor know?
• Science part of Investment, involves more number crunching with simple mathematical tools

• Numbers not Static numbers – Convey a story of a company’s recent and past performance

• These numbers say many things, Investors must be skilled and experienced to understand/interpret the
message from the numbers

• Without the needed skill, this step in the framework cannot be performed

• Acquiring this skill – Invest a few hours to understand Financial Statement Analysis

• Same set of data or information available to everyone

• How much you can flesh out from the numbers, the way you see the numbers matters – Skill and experience
comes to play

A Semester worth Contents! Will share many Good Contents. Invest time, acquire knowledge and practise

@EWFA_
 Techniques for
Effective Financial
Statement Analysis
Where to Refer Data?
 Have your own data
• Online platforms – Treatment of various numbers / assumptions

• Create your own Excel for various ratios applicable / needed for a company or industry that you are
analysing

• Flesh out the source numbers from the Financial Statements in Annual Reports (Not any portal) over the
last 5-10 years

• Read through the notes against various numbers i.e. Investments

• This approach gives a feel of how the Numerator and Denominator in various ratios have behaved over a
period of time

• Worth going the extra mile, 5 days for a 5 year investment

@EWFA_
 Horizontal Analysis
• This method of analysis is also known as Trend Analysis

• Involves comparison of a financial line item or a ratio over a number of accounting periods – (Minimum three
period is needed)

• Different methods i.e. absolute comparison or percentage comparison

• Revenues, Profit, Expenses, Cash, Liabilities etc.

• This method is useful when comparing performance of two companies of different scale and size

@EWFA_
 Vertical Analysis
• This method of analysis is also known as Common Sized Financial Statements
• Calculated by using various components/subcomponents in a statement to a common denominator.
o Balance sheet the common denominator could be Total Assets/Liabilities
o Profit & Loss statement it is the revenue

Inferences
• What % of Inventory or Current assets or Accounts Receivable is against the Total Assets

• Observe changes over time

• How does the value of a

component or sub
component stack against
peer/competitor companies

@EWFA_
 Other Aspects

Multiple Year • Don’t limit the analysis for one financial year – Get trend
• Minimum of 5 years and 10 years (to get effect on cycles)

Create Charts • Charts help better interpretation than stand alone numbers
• Create charts with multiple year data and see the trend
• Get insights by deep-diving at anomalies

@EWFA_
 Other Aspects (Contd.)

Consolidated • Focus on Consolidated Financial Statements

• In case of company with multiple subsidiaries, this is crucial
• Standalone may be profitable, but consolidated may show a different picture

Evaluate related • Check how two related parameters behave over time
Parameters
• What insights does it reflect?
• Revenue/Net Profits, Revenue/Inventory, Revenue/Receivables

1,600 1,400
1,400 1,200
1,200 1,000
1,000
800
800
600
600
400 400

200 200
- -
1 2 3 4 5 1 2 3 4 5

Revenue Profit After Tax Revenue Profit After Tax

@EWFA_
Recap of what we saw in last part…

• Financial Statements
• Financial Ratios
• Importance of a Investors skill in Analysing
Financial Statements

• Source data for Financial Statements / Creating your own excel / Read the notes as you refer the
source data

• Horizontal Analysis – Different time periods

• Vertical Analysis – Common Sizing of Financial Statements

• Others – Reading consolidated statements, Creating charts, deep diving at anomalies and
evaluating related parameters together
 Can you please add what ratios we should study? While
preparing the XL sheets, please mention what parameters
to be studied. This will help us build the spreadsheet.

• A technician or mechanic has every tool in his tool box, needed for his work – But may not use every tool for his work!

• The huge bunch of ratios are neatly categorized under various heads i.e. Profitability Ratios, Solvency Ratios, Efficiency
Ratios etc

• These ratios are neatly covered in all available existing literature on financial statements – Which will be shared

• Alternatively, go by the entries in each financial statement:

o Current Assets, Current Liabilities, Inventory can give Current and Quick Ratio

o Debt entries give various Solvency ratios

o Entries in P&L statement helps in Profitability analysis

@EWFA_
 Ratio Categorization

@EWFA_
 Flags in Annual Reports
1) Read Auditors Report

2) Read how Revenue is recognized, compare the policy with competitor companies

3) Monitor for change in Accounting policies, frequent change in Management or resignation of Auditors
 Focus on Cash Flow Statements
• Most neglected, when compared to the importance that Balance sheet and P&L Statement

• Most of the wrong doings in BS and P&L Statement may be evident from CFS

• Infact the CFO is the real Cash profit, while Net Profit is Accounting Profit

• A simple test would be to compare both, for a few recent (5-10 years) years – Importance of analysing multiple year
financial statements

@EWFA_
 Notes to Financial Statements
• Place for unpleasant and unexpected surprises
• Each component of Balance Sheet and P & L statement has a Note with detailed schedule in subsequent section
“Notes to Financial Statements”

@EWFA_
 Notes to Financial Statements (Contd.)

@EWFA_
 Notes to Financial Statements (Contd.)

@EWFA_
 Compare with Competitors and Peers

Company 1 Company 2 Company 3 Company 4

Net Profit Margin 12% 10% 11% 20%
RoE 18% 17% 19% 30%
Past Growth 10% 12% 8% 20%
Receivable days ? ? ? ?
Payable days ? ? ? ?
XX

• What causes the difference? What way does the company you analyse has substantially difference in parameters agains
the Sector leader or against is peers
• Check Revenue Recognition and Depreciation Policy
@EWFA_
 Statistical Models
• Altman Z-Score • James Montier C-Score
• Piotroski F-Score • Decho-Dichev Accrual Quality
• Modified C-Score • Sloan's Accruals
• Benish M Model • Lev Thiagarajan Model

Create your own excel with trend

@EWFA_
 Financial Statement Analysis
Title Author
Financial Intelligence Kerman Berman
Financial Statement Analysis Workbook Martin S. Fridson
Financial Ratios for Executives Michael Rist
How to Read a Balance Sheet John A Tracy
Quality of Earnings Hewitt Heiserman

Investopedia - https://www.investopedia.com/

This is a one stop solution for learnings about financial ratios. One can search a ratio or financial
parameter of interest here. The explanation is well illustrated with videos and examples in many cases.
Read one ratio a day, and in less than two months, one will be able to read the financial statements
comfortably.

@EWFA_
Financial Statement Analysis (Contd.)

Financial Statement Analysis And Analyzing Financial Statements by

Reporting – By Prof. Anil K. Sharma “The Finance Story Teller”
 Financial Statement Analysis (Contd.)

Click on the link “Resources” to

get the free courses on
Financial Statements,
Accounting and Valuation

@EWFA_
 Accounting Forensics
Accounting Forensics is a specialty practice area of accounting that focuses on
uncovering financial fraud.

Title Author
The Financial Numbers Game Charles W. Mulford
Creative Cash Flow Accounting Charles W. Mulford
Financial Shenanigans Howard Schilit
Using Analytics to Detect Possible Fraud Pamela S. Mantone
Quality of Earnings Thornton L. O'glove

Understanding Financial Statements (Books in the previous section) is a pre-requisite to understand the topics in this
book

@EWFA_
 Step 6: Valuation
YouTube Video: https://youtu.be/NVdl0nnzhl0?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson

Image courtesy: Slidecarnival.com

7-STEPS IN STOCK ANALYSIS
STEP 5 – FINANCIAL STATEMENT ANALYSIS
• Analyze Financial Statements of the Company

@EWFA_ STEP 4 - DISRUPTION

STEP 6 - VALUATION
• Identify disruption to Growth rate and period
• Appropriate Valuation
Models
• Use Margin of Safety STEP 3 – LENGTH OF GROWTH PERIOD
• Identify years of sustained growth - Estimated

STEP 2 - GROWTH
@EWFA_
• Opportunity Size
STEP 7 – REFLECT ON YOURSELF
• Growth rate – Future Growth
• Check Behavioral Aspects / Bias
STEP 1 – QUALITY
• Create Investment Thesis
• Identify Sell Triggers • Quality of Business
• Quality of Management

STEP 0 – STOCK IDEA / SCREENING

• Fish for Ideas

• Initial Screening
• Story behind the Idea
 Practical Approach
Check with neighbour about owner / Encumbrance from Municipality
Quality of Management

If letting out – What rent can be expected

Would there be a demand, if let out? Is the location is such that there is
good demand?

What is the value of the land in the locality – You enquire the Sq. Ft prices

What is the condition of the building? Needs repair / How many years can
that sustain?
Buying a House…
Was any similar property sold/brought in the locality near by? – Reference
to gauge over/under value of the property you are looking to buy
Relative Valuation
@EWFA_
 Practical Approach (Contd.)

Very similar as before, but a few more pointers

Are there many more restaurants near by? –

Competitor Analysis

Does your restaurant command a good will from customers and

provide some kind of a clear value differentiator to the
customers
Moat Analysis

Commercials: Land value, building worth, cost of other assets,

Buying a Commercial Property / Business expected earnings and the duration of such earnings

• Assets Analysis, Earnings Analysis (Both current and Future)

• Duration of earnings – Longevity of Growth
• Future Earnings – Earnings Growth
@EWFA_
 What is Valuation?
Every investor wants to beat the market knows that it is essential to master the skill of stock valuation.

Mostly asked question… diFFeRent Valuation aPPRoaCHes…

• What is the value of a stock XYZ? • Relative Valuation
• How to value a stock? • Absolute Valuation
• What are the different valuation tools/models?
• Buffettology based Valuation Methods
• Which model or ratio to use for valuation?

How to Value a stock

what is Valuation?
• Complicated process, combination of both art and
Valuation essentially is a fundamental assessment of intrinsic value
of a stock science part of investing
• Need certain data to decide on the valuation
model to use
HOW INVESTORS use VALUATION?
• Use suitable stock valuation model/method based
• The valuation is compared with the current market price
• This helps to determine, if a stock is overvalued or undervalued on available data
• These data come from analyzing the previous 5
❖ Overvalued: Intrinsic Value << Current Market Price
❖ Undervalued: Intrinsic Value >> Current Market Price
steps that we did in stock analysis
• Use possible multiple models – Best case

@EWFA_
 How Previous Steps Help
STEP 5 – FINANCIAL STATEMENT ANALYSIS
• Why so many steps prior to • Business insights: Loans, Assets, Profitability and turn over ratios. Cash flows (CFO, FCF)
valuation? and CAPEX
STEP 4 - DISRUPTION
• What can cut short the predicted growth
• Most of the inputs for
valuations comes from the
STEP 3 – LENGTH OF GROWTH PERIOD
previous stages
• How long can the predicted growth sustain

• DCF needs future expected growth rates STEP 2 - GROWTH

and duration of the growth • Predicable Growth

STEP 1 – QUALITY
• Both these values can be reasonably arrived from previous
• Poor Business Dynamics,
steps rather than pure assumption Competition no pricing
power
• Fraud management
• What purpose does valuation serve for a company that has a poor business
dynamics or management or stagnant growth?

Valuation without a due diligence about the company is a recipe for disaster !!!!!
@EWFA_
You are Set to Go

You Are Ready to Start Valuation, If Your Stock Has Successfully

Passed All The Previous Steps

By Now, Even Without Any Excel Or Valuation Models, You Will Have A Fair
Idea Of Value Of The Company 😊

Valuation Is The Last Step to calculate After completing all the Previous
Steps…
 P/E Ratio!

• Traditionally used ratio / Every new investor starts from this

• Interesting Numerator & Denominator, where one is dynamically varies

• PE ratio swings with the mood of market, one day showing high and other day low with CMP

• A commonly used thumb rule: But a company selling below a particular PE levels as cheap and above a particular value
as expensive / No Bench mark

• Misconception, that people buying low PE are Value investors

• High PE ratio could come down with increasing earnings

• A low or high PE value does not give a conclusive evidence - Can be a rough barometer

• Not valuable, if earnings fluctuate i.e. Cyclicals

@EWFA_
 P/E Ratio! (Contd.)
• This valuation does not capture :
o Growth (Past / Future growth)
o High / Less ROE
o Cash flow, Free cash flow
o CAPEX spend/requirements

Factoring Earnings Growth

Purchase price: 100, Growth: 10% and longevity of this growth: 8 years

Never in the past, did Investors have Challenging Time. It is high time to look beyond P/E for other valuation
metrics
@EWFA_
 Relative Valuation Models
• In this method, Price is the primary variable

• These models value companies by comparing them to other companies on metrics such as EV/Revenue,
EV/EBITDA, and P/E ratios. Various Tools
❖ Competitors companies
❖ Companies with similar business dynamic - Price Books Multiple
❖ Industrial Average - Price Earnings Multiple
- Price FCF Multiple
• The logic for determination of valuation or overvaluation - Price Sales Multiple
- Price Cash Multiple
❖ Your company has 10x in one of the variable
- Dividend Yield
❖ Your company is overvalued, if comparable company/average is <10x
❖ Your company is undervalued, if comparable company/average is >10x many more…

Disadvantage Remedy
• Subjective, depends on entity being compared i.e. Industry average / similar company • Perform Absolute valuation
• Company being compared becomes benchmark without analysing it! • Analyse compared companies /
• Does not answer the intend of what your company is worth Competitive Analysis

@EWFA_
 Absolute Valuation Models
• These valuation models attempt determine the intrinsic value of company in absolute terms

• This method relies on the company’s fundamental information, i.e. various

financial information published or derived from a company’s financial Various Tools
statements - Discounted Cash Flow (DCF)
- Reverse DCF
• Supported by these details are your own insights and assumptions i.e. - Discounted Dividend Model
- Discounted Asset Model
Expectations on Growth, dividends etc.
- Discounted FCF Model

• There is no comparison with the Competitor company or Industry averages many more…

Remedy
Disadvantage
• Analyse compared companies
• Heavily dependant on published numbers – Possible of numbers being fraud
• Accounting Forensics
• Your estimates and assumptions have a greater impact on this valuation
• Circle of Competence

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 Which one to use?
• There are many tools and methodologies available
• Not a single model or approach is suitable for every company, sector or situation
• Finance stocks: Price Book Multiple suitable

Absolute Valuation Models Relative Valuation Models

- Discounted Cash Flow (DCF) - Price Books Multiple

- Reverse DCF - Price Earnings Multiple
- Discounted Dividend Model - Price Sales Multiple
- Discounted Asset Model - Price Cash Multiple
- Discounted FCF Model and many more - Dividend Yield and many more

@EWFA_
 Buffettology Based Valuation

• Three models on how Buffett Approaches Valuation • Estimation of future Earnings / Share

• Two of them very effective • Checklist kind of approach with some 10-15 questions
mostly covering what we discussed in the previous steps
• Estimation of future book value

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 Additional Reading

There are huge resources (Books, Videos and Lessons) available in the open domain on valuation and all the
models.
@EWFA_
 A Quick Recap

Importance of previous
stePs…
• Outcome of each step contributes to
valuation
• Weed out companies that do not
worth to valued!

WHAT IS VALUATION? DIFFERENT VALUATION

aPPRoaCHes…

• Relative Valuation
HOW TO VALUE A STOCK
• Absolute Valuation

GOOD READS • Buffettology based Valuation Methods

Practical Approach…

@EWFA_
 Margin of Safety
Simple concept: Protects investors from big mistakes

If a stock price is significantly below the actual fair value of a company, that percentage difference is
known as the Margin of Safety.

Margin of Safety is the percentage difference between a company’s Fair Value per share (Investors
estimate) and its actual stock price.

The percentage that a company is undervalued by the stock market.

Margin of Safety = (Intrinsic Value Per Share – Stock Price) / Intrinsic Value Per Share

@EWFA_
 Margin of Safety…Views from the Father of Investing
The Idea of concept first came from Benjamin Graham

Central Concept of Investment, dedicated Chapter 20:“Margin of

Safety” in his book Intelligent Investor

Past earnings are used to project into future – Do conservative

projection of future earnings

This margin of safety is always dependent on the price paid. Thus for any stock, it will be large
at one price, small at some higher price, non existent at some still higher price.

Graham really was a pioneer in behavioural finance before behavioural finance was even a thing, and the
margin of safety concept was one of the first tools that allowed investors to overcome their own biases,
creating a protection against the “unknown unknowns” of an investment.
@EWFA_
Margin of Safety…View from the Zen

When you build a bridge, you insist it

can carry 30,000 pounds, but you only
drive 10,000 pounds truck across it. And
that same principle works in Investing.

Image source of the bridge art: https://www.vintagevalueinvesting.com/what-

is-margin-of-safety/

“You also have to have the knowledge to enable you to make a very general
estimate about the value of the underlying businesses. But you do not cut it close.
That is what Ben Graham meant by having a margin of safety. You don’t try and
buy businesses worth $83 million for $80 million. You leave yourself an enormous
margin.”

Buying a dollar for 50 Cents Image source: ValueWalk Blog

https://www.valuewalk.com/2018/04/best-warren-
buffett-speech/
Margin of Safety…More Views

…most investors think quality, as opposed to price, is the determinant

of whether something’s risky. But high quality assets can be risky, and
low quality assets can be safe. It’s just a matter of the price paid for
them…

One of “The Six Commandments of Value Investing”

Margin of safety – leave room in your buy price for being wrong
Margin of Safety…More Views

Because investing is as much an art as a science, investors need a margin of

safety. A margin of safety is achieved when securities are purchased at prices
sufficiently below underlying value to allow for human error, bad luck, or
extreme volatility in a complex, unpredictable, and rapidly changing world.
 Is it required? How much…?
Is this required in the first place?
• Good Quality Business (with moats, pricing power, less or no competition)
• Good Quality Management
• Predictive Growth

It is a humble way of accepting to yourself, that you… How Much MOS?

• Might not have all the available information No Bench mark or recommended
values
• Not connected the dots/picked insights from available information
Again a Art – Science debate

• You would have been biased to the industry Level of risk one is comfortable

• We ourselves could make errors (Over and under estimation of Growth Risk averse: More MOS
or Pricing power, competition, remember many in the art part of Risk taker: Less MOS
investing are estimates
@EWFA_
 Now what next?
Now you have used the applicable models and arrived at the valuation with MOS. There could
be three scenarios as below. What to do in the three scenarios?

1. Add this to your investible universe of stocks and watchlist

2. Monitor the price regularly to check if it comes down to your valuation
3. Particularly check at times of panic sell offs

What is the big fun in paying 100 rupees for a 100 rupee bill? Not a buy

• All three actions as above

• Congratulations - You have identified a value stock.

• So what next? Should you place a bulk tomorrow at 9 AM?

@EWFA_
What Next?... Cooling Period
Give a cooling period (2 weeks) after this research.
• Revisit the Investment thesis
o Revisit the estimates and assumptions. Have all the assumptions considered conservatively for valuation?
o One last MOST IMPORTANT STEP, that you can do as you buy… ☺ SELL DECISION TRIGGERS!

• Make sure that all available positive/negative information and risks has been factored in valuation.

• It is quite possible, that you had spend a good time analyzing the stock for weeks/months and got emotionally
attached.

• This could have led to UNCONSCIOUSLY lowering the Margin of Safety or having a higher growth rate or any other
assumptions to tilt your valuation plate higher than price

Go ahead and buy the stock. NOT IN BULK. But in a staggered manner to have sufficient "Dry Gun Powder" to EXPLOIT the
situation in case of panic selling in the markets.
 Caution
Even with all that this accurate estimation, the market prices can go below estimated values + MOS in the event of a financial
melt down or any other unforeseen circumstances like how see in 2020

2008 2020

Positive aspect is such a rigorous analysis gives investor the confidence to navigate the crisis and also…once the crisis is
resolved the stock will get back and much stronger business fundamentals/managements due to lesson from crisis

@EWFA_
Additional Readings
Additional Readings (Contd.)
https://www.liberatedstocktrader.com/margin-of-safety/ https://www.johnenglander.net/margin-of-safety-applies-to-
investing-and-flooding/
 Step 7: Reflect On Yourself
YouTube Video:

https://youtu.be/NGeix4iP5Oc?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson
https://youtu.be/pirTK9WR1ec?list=PL9QC_19RB6uWQ3lQPSviGI5Pe77aGXson

Image courtesy: Slidecarnival.com

7-STEPS IN STOCK ANALYSIS
STEP 5 – FINANCIAL STATEMENT ANALYSIS
• Analyze Financial Statements of the Company

@EWFA_ STEP 4 - DISRUPTION

STEP 6 - VALUATION
• Identify disruption to Growth rate and period
• Appropriate Valuation
Models
• Use Margin of Safety STEP 3 – LENGTH OF GROWTH PERIOD
• Identify years of sustained growth - Estimated

STEP 2 - GROWTH
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• Opportunity Size
STEP 7 – REFLECT ON YOURSELF
• Growth rate – Future Growth
• Check Behavioral Aspects / Bias
STEP 1 – QUALITY
• Create Investment Thesis
• Identify Sell Triggers • Quality of Business
• Quality of Management

STEP 0 – STOCK IDEA / SCREENING

• Fish for Ideas

• Initial Screening
• Story behind the Idea
INVESTMENT
THESIS
 Investment Thesis
How to handle this Information overload?

INVESTMENT THESIS

o Quality of Business: Moat, Pricing power,

Insights efficiency ratios etc
o Management Actions: Acquisitions /
Buybacks
o Management Quality: Experience, RPT,
Your Compensation
o Observations own… o Inferences from Financial Statement and
o Queries
Ratio Analysis / Forensics
o Remarks on findings Data from Six o Growth of Industry / Company
o Assumptions (Art part!)
o Risks / Flags
Steps o Longevity of Growth
o Disruptors to Growth
o Various News & Articles
o Areas to deep dive o Competition analysis
o Unknowns o Valuation insights with Margin of Safety
@EWFA_
 Investment Thesis (Contd.)
• This document is written and dynamic/running document and shall be updated on a ongoing basis as new information is
available and during the course of this 6 step analysis

• Remember! Investment Thesis is not a analyst report

• An investment Thesis format - No universal standards for the contents, but you can align to the 6 steps and the analysis from
the six steps

• Since lot of data is evaluated over a long period of time which spans for weeks, a Investment Thesis helps to record the
findings and revisit when needed

• It helps to look back and analyze why a particular decision was made in the first place—and whether it was the right one.

1. Quality 4. Disruption
…and also guide you
This document will be
when there is Panic in
helpful in analysis, 2. Growth 5. Valuation
Market or a situation to
buying decision…
sell arises.
3. Longevity 6. Sell Trigger

@EWFA_
 Investment Thesis (Contd.)

• The summary of a Investment thesis should ultimately have atleast

5 – 10 points as to why that stock is a Buy idea or why the idea
should be rejected

• Rationale for the Buy Price / Holding period

• Should you exit the holdings…What should be the reason – Sell

Triggers

@EWFA_
 When to Sell a Stock

• The decision and point to Sell a stock is much difficult to identify and execute than the decision to
Buy a stock.
• Much has been discussed on this by various Investment Gurus.

One General rule is you could have gone wrong in your analysis about the stock. Once it becomes
clear that
• The analysis you did is wrong or
• The initial Investment Thesis has changed and no longer valid

In this circumstance, without further hesitation (or ego) sell the stock irrespective of whether the
stock shows a gain or a deep loss. Just get out of it.

This is like a situation where you go to a city and stay in a Hotel. You realize that something illegal happening and all is
not well in that lodge. You are not in the right place. Will you stay because you have paid the money or just get out of it
to save yourself from any further trouble?

@EWFA_
How to approach Sell?

What else can guide a

investor to make a
rationale sell decision

Let us quickly look at a Aircraft Pilot and come back to Investor!

 A Pilot Takes Off and Lands…
• Imagine how would it be, if a pilot takes-off and flies a aircraft. But does not
know when, where and how to land.
• The very thought is absurd ☺
• So a Pilot does not get trained to “Land” not in the air, just before arriving at
the destination…
• His training for landing is done even before he takes-off
• When we started to learn driving a bike or car, were we not first thought how
to use the brakes?
• The pilot is allowed to fly only when they are confident to land safely.
• Infact it is much more…The training includes not only regular landing, but special situation landings like:
o Landing in complete darkness (No Runway lights),
o Landing in Bad weather and
o Emergency landing procedures (Lighting strike, Shortage of fuel, landing in sea/ocean, if needed)

Think over this and try to relate with Investing Buy and Sell Aspect
@EWFA_
 Sell Triggers in Investment Thesis
• The same analogy can be replicated for Selling a Investment

• As a Investor gets ready to buy a stock after analysis they MUST also identify the
triggers/conditions/risks in the Industry or the company that should make the stock a “SELL”
candidate. A few sample pointers:
o Competitor gaining ground – Loss of market share
o Structural changes in the sector/company leading to declined growth rates / Different business dynamics
o Changes in management which is not in the best interest of Shareholders

• These triggers must be captured well in their investment thesis made before purchase

• This list of triggers must also be updated regularly in light of the new facts and changing
reality in the industry or the stock – Running document

• Should any (or multiple) of the triggers become a reality, a investor must make a
judgement/call and sell the stocks WITHOUT EMOTIONS!
@EWFA_
 Sell Triggers in Investment Thesis

• Ideally for a “Quality Business/Management”, it may take years for the triggers to become a
reality (or) it may never happen at all, making it a perfect long term investment candidate.

• BUT…not all factors are in our control. The triggers could happen very soon due to change
in Technology or regulation or any thing else forcing us to make a SELL decision.

• Also note, that Price levels targets (i.e. 200% gains or 50% loss) are NOT “Sell Triggers”

@EWFA_
Sum Up… 182

2. Growth 5. Valuation

Investment Thesis
Additional Readings

http://www.streetofwalls.com/finance-
training-courses/hedge-fund-
training/building-an-investment-thesis/
 Links to my
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Image courtesy: Slidecarnival.com