Different approaches to Fundamental Analysis

Frens,

Carrying on from where we left we will discuss in brief about 1. Top Down and 2. Bottom Up approach to picking stocks using Fundamental Analysis.

Top Down approach:

In top down approach, an investor tries to identify those economies (countries) of the world, which are expected to grow at a faster pace than other counties. Within these economies, the investor tries to identify the industries, which are expected to witness higher growth than other industries. After that the investor tries to find out the companies in these high growth industries. Investor now buys stocks of these companies. The investor expects to benefit from the higher earnings, which these companies are expected to create over next many years. In essence, here the investor will have a portfolio of stocks from faster growing economies (countries)

Bottom Up approach:

Bottom up approach involves finding companies, which are expected to grow their business without restricting the stock-picking search to any particular country or industry. Its Open mind no holds barred! All the stocks listed in all the stock exchanges in the world, irrespective of country or industry of operation, are open for selection to the investor. The investor uses various selection criteria to search for the best stocks even if its in an economy or country which doesn't have a growth outlook. All she cares here is she wants to invest in a great company and the belief is that great companies will be profitable immaterial of economic cycles or industry sector. Any industry is fine here; doesnt need to be a high growth industry. You may find a awesome company ina not so high growing industry. Once the investor finds a good company basis his definition, he buys its stock and expects to benefit from the future growth of the business of the company.

Comparison between Top Down and Bottom Up approaches:

Top down approach limits an investor’s analysis to stocks of only a few countries and a few industries. It also needs you to be tracking economies and industry outlook very closely. However, bottom up approach does not have this limitation. Bottom up approach provides an investor the option of investing in those companies, which are doing very good but they could also be in an  industry sector, which is currently not doing well even though the overall economy of that country may be doing well. Such companies are known to make huge wealth for investors when the tide turns around. Here you may chance upon boaring companies with boaring names, but as per Peter Lynch these are the hidden gems! Who knew PAGE industries which sells undergarments would be such a big firm now...was then boaring now interesting, everyone wants to own PAGE Industries share if not wear a JOCKEY!. Too late the train has left!

Hence my viewpoint is that bottom up approach gives the investor more options to choose his stocks and is fairly easier than top down where in you need to be adept at assessing the economy and industry sector etc. The only criteria here is to find a great company, without worrying too much of the industry in which it operates or if the economic cycle of the country in which it operates is favourable or not.

In the next post we will look at the 4 pillars of Fundamental Analysis I follow, by detailing each pillar.

Untill then, have a nice time!

Technical Analysis v/s Fundamental Analysis

Dear Stocks enthusiasts,

My apologies for not being in touch for sometime. Joined a new job and was busy trying to get settled down!

Today I am going to tell you how I analyze companies for long term investing, using the bottom up  fundamental analysis approach. How I go about separating the wheat from the chaff!

First lets understand the TWO approaches that can be used for stock picking

1. Technical Analysis  (Short term view hence a trader)

• Technical analysis is all about studying stocks price movements viewed using charting tools. It involves analyzing charts of the past movements of a stock’s price and its trading volume (total number of transactions, buy/sell) over the different time ranges - days, weeks and months mostly. 
• The investor then tries to predict future price movement of the stock based on these past patterns. Once the investor finds a stock whose price is expected to move higher, she buys it and holds it until the chart patterns indicate that the price is expected to fall or become stable. 
• The investor following technical analysis is concerned only with the past prices and trading volume data of the stock. 
• The investor is indifferent to whether the stock is of a manufacturing, an agricultural or a financial services company or this company is making good sales and profits etc

2. Fundamental Analysis (Long term view hence an investor)

• Fundamental analysis of a stock involves understanding the underlying business of a company. While conducting fundamental analysis, the investor tries to find out a company, which has a very good product, well-known customers, stable suppliers, honest & capable management etc. 
• This is not an easy job as it takes a lot of patience and passion to do this. Even the best of fundamental investors can manage to find at the most 1-2 such companies in a quarter as he/she keeps screening the company through the various filter criteria's that he/she wants the company to meet before going ahead and investing the hard earned money
• This is the reason most people find it better off delegating this job to an expert called as Fund Manager who runs a mutual fund scheme under a ABC or XYZ Asset Management company. This is what is called passive investing in equities. This isnt a bad approach at all, end of the day stick to whatever works for you!
• Anyway, going back, once the (active) investor finds such a company, he/she can invest in its stock and expect to benefit from the future long term growth prospects of the business of the company
• The premise here is that when the business of the company grows, the demand for the companies stock goes up since more people what a portion of the profits it makes (called as tax free dividends), since the number of outstanding shares of a company is mostly constant, investors are willing to pay higher price for the stock, the stock price then shoots up (as its a auctions marketplace), and then the existing investor who had bought the stock early anticipating all this, now gets benefits not only from the dividends earned but also the higher price of the stock eventually. This whole process may take from as early as 1 year to 5 years and sometime even a decade - hence "long term"
• Fundamental investing is hence a great example of capital compounding - there by beating inflation and giving higher returns than bank FD's and other fixed investment instruments. Wih higher risk (stocks can go other way round and become half or 1/10th the value too!) comes higher rewards

In the next post I will explain the Top Down and Bottom Up approach to fundamental analysis.

Until then..Chao!

Words of wisdom from a young turk!

Frens,

Take a read at this Economic Times (ET) article on Jatin Khemani, the 28-year old young investor from Delhi. Check out some of the illustrious books he mentioned that he read in young age. Few of the books have been recommended by me on this blog.

Click here - http://stocksmojo.blogspot.in/p/books.html to check out the books.

Click here - Jatin Khemani to read the ET article.




Great day!
Sandesh

Annual Reports - Do not skip them

Hello Folks,

I wanted to draw your attention to this article published in Economic Times today regarding Annual Reports.

Courtesy: IPH India

I agree some of you may shy away from reading the article till the end due to the financial jargon's there, but its all in the mind. Read it a couple times and do a google search on those jargonic words to understand more of it. You do not need a Finance degree to understand them.

Over time, you will become a pro!

Click here to read the article.

Happy compounding.

A Thought for the weekend

Hello Friends,

Enjoying the long weekend huh!? That is awesome, leveraging these long weekend time offs and recharging your batteries is important.

Indian markets are hovering at all time highs. You will see that even companies with very poor fundamentals - poor financial record, zero moat, high debt and no earnings visibility etc. have also run up a lot in their stock price. This is the very nature of the markets - an auctions marketplace.

Some of my blog readers asked me this question - What do you do when the markets are overvalued with NIFTY PE Ratio = 23.63!

Here is my view on this - Firstly whether the market is overvalued or undervalued is a subjective view, depending on each investor as to how he views it. In the market when one buys another sells the same company stock!

In my view the markets are overvalued. I am right now finding it difficult to find stocks that meet my investing principle - Growth at a Reasonable Price (GARP)

So what do I do?
Investing is not a 20-20 Cricket match, its a Test match. Neither its a baseball game, you dont need to swing at the ball every time.

In a bear market - my focus is on BUYING...

In an overvalued, overheated market, I - READ, in some cases would BOOK PROFITS if the price of any of my stocks have run up way too much above its intrinsic value due to the overall GREED of the market participants!

Chao!

Why and How to do Management Analysis of a Company

Friends,

We all have heard this adage "A man is known by the company he keeps". In the same way, it wont be wrong to say that "A company is known by the management team it keeps".

Management refers to the people involved in running the company. These are the CXO level employees of the company e.g CEO, COO, CFO and also the VPs and Directors.

Courtesy: Kunal Updadhyay

Importance of Management

1. These individuals are responsible for looking after the operations of the company and have the biggest impact on the company's performance
2. They take key decisions - how much to capital to invest, where to invest, what products or services to sell, how to sell it, how many people to hire so on and so forth
3. Two companies that look identical on paper in terms of size, products it sells and geographies it serves may perform differently due to different management teams. So its one of the determinant of how well the company performs
4. When the industry in which it operates or if the economy goes through a rough patch, its the business acumen and experience of the management that keeps the company going in terms of sales and profits. A recent examples of this is Nestle India (Maggi Noodles lead content issue)

Due to the above reasons, management plays a HUGE factor in a company's performance. We know that the performance will ultimately reflect in the stock price of the company. Hence its a no-brainer that we MUST do thorough analysis of the management team in order to be a successful stocks investor. A stock trader does not need to do this analysis since a trader is taking his buy/sell decisions basis the stocks chart pattern i.e price/volume action only.

Analyzing Management - key point to note:

Unlike the other 3 pillars of fundamental analysis which I follow - Business & Industry Analysis, Financial Analysis and Valuation Analysis; Management analysis is mostly a QUALITATIVE (hence subjective) approach than QUANTITATIVE (objective approach).

Listed below are the questions I try to get answers for when researching a company for a potential investment:

Subjective:

1. Do the Promoters and the Board of Directors have a clean untarnished background; clear from fraud or any other crimes?
2. Is the Promoter also on the Board of other companies which are in similar businesses?
3. Do the Independent Directors on the companies board have sufficient credentials to be on the board?
4. Does the management team have a strong KNOWLEDGE, EXPERIENCE & PASSION for the business?
5. Does the management team show HONESTY & TRANSPARENCY in dealing with stakeholders?
6. Is the promoter/owner of the company also the CEO?
7. For how long the CEO and top management has been serving the company?
8. Does the company have succession plans in place for key management positions and how much salary is being paid to potential successors?
9. If the promoter/owner is not the CEO, then is he/she an employee who was groomed from within or hired from outside the company?
10. If the CEO is from outside does he/she have relevant experience in the industry in which the company operates?
11. Is the management teams pay linked to the performance of the company? Does their salary increase even when the companies profits have been sinking?
12. Does the management team have a fine balance of big picture thinking and hands-on operations?
13. Does the management report quarterly and annual earnings on time?
14. Is there too much bureaucracy in the company; especially to be watched out if its a government owned company?
15. Does the management make extravagant use of company's funds?
16. Does the management provide transparency in its communications during a time of crisis for the company or when they have couple of bad quarters of sales?
17. Does the management treat minority shareholders fairly in regards to its relations with its foreign parent MNC company and subsidiaries?
18. Is the company banking on a superstar CEO or an overall strong process and people oriented corporate culture?
19. Does the management of the company care for having a functional and updated company website?
20. Has the management used excess cash in the past for senseless "diworsefication" of business into area that is not their expertise?
21. Do the CXO level employees walk the talk and stick to what they comment/promise in the annual report?
22. Has the management in the past announced share buybacks when the stock was perceived to be undervalued by them and/or paid consistent dividends? Do they care for minority shareholders?
23. Is there a bureaucrat on the board? If Yes is there sufficient reasons for him/her to be on the board? Is the company in an industry where having them is value add? Does their presence add value or just crony capitalism?

Objective:

1. Is the Salary of promoters less than 11% of Net Profits?
2. Is the promoter shareholding greater than 51% or if its less than 51% then is the number consistent across last 5 years?
3. Has there been an increase in promoter shareholding in the last 4 quarters or even last 3-5 years?
4. Do large institutions like Mutual Funds, Insurance companies and HNIs have holdings or increased holding in the company in recent quarters?

While there are no right or wrong answers to these questions, as an investor I am not comfortable investing in a company's stock unless I asses the company on these questions. Some of the questions are non negotiable for me and few other may be negotiable but I will keep them in the back of my mind to monitor those closely.

Where will we find the answers to these questions?
Answer: Google!

You should find pieces of information in the companies website, annual report, BSE/NSE website, Credit reports published by ICRA, CRISIL and CARE, other blogs, equity research published by stock brokers and independent equity research analyst. The trick lies in gathering the pieces of information and then connecting the dots and putting the story together.

As I learn more in this space, during my journey, I will update this list with additional questions.

Happy Ugadi & Happy Investing!

Follow stocksmojo by email

Hello!

Few of my blog readers have asked a very apt question - Is there a way for me to get alerted whenever a new post is published in stocksmojo?

ANSWER: Yes!

If you are accessing over a mobile device, then go to the bottom of the page and click on "View web version". You will find this just above the About me section.

Once you are on the web version, go to the top corner of the blog site and look for "Follow by Email" option. Enter your email id in the text box provided and click on the Submit button.

You are now subscribed to the blog and will get an email when a new post is published.

If you are on a laptop or desktop, you are by default on the web version. Only the web version will show the "Follow by Email" option.

Have a great day!

Addition of PAGES

Hello Friends,

I had committed to you to improve on the blogs look & feel and ease of use as I learn how to use more features effectively. Happy to let you know that I have now added six PAGES to the blog. Check out my book recommendation in the BOOKS page!

Happy reading.

Stocksmojo welcomes YOU!

Hello Friends,

I am very excited to kick start "stocksmojo", a blog focused on Indian stock markets!

To begin with let me introduce myself.

I am a 100% self-learnt stocks investor and have been with the markets for last 5 years. I follow the fundamental analysis approach to investing. Everything what I learnt in this space is from the public domain: internet/blogs and books. I am an ardent fan of Robert Kiyosaki, Peter Lynch, Warren Buffett and Stan Weinstein. I have no degrees in Finance neither any certification from SEBI, although I do aspire to get Research Analyst Certification in future. I have an Engineering degree and working experience in large multi-national companies. Warren Buffet said "No Need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ". This is so true and I can totally relate to that thought.

I believe in the adage "If you WANT something you must first GIVE". This blog is an attempt to give back my learning and share my little knowledge to the lakhs of small retail investors like me, since I WANT to learn from our conversations.

stocksmojo will focus on:

1. General education, thoughts and observation on topics related to the markets

2. Occasional book reviews and YouTube videos recommendations

I am very new to blogging so we will start with a simple blog page and over time as I learn and with all the feedback and suggestions from you, I promise to improvise.

Have a nice rest of the week!