Four Pillars of Fundamental Analysis

Howdy!

Lets get into the core of fundamental analysis now:

Four pillars of analysis in bottom up fundamental analysis of a stock which I follow:

• Quantitative Analysis (Objective) - i) Financial Analysis ii) Valuation Analysis
• Qualitative Analysis (Subjective) - iii) Industry Analysis iv) Management Analysis

As an investor you want to invest in a handful of stocks to create wealth and to do that you need to able to filter or scan them through a series of filters. The above Objective and Subjective analysis does just that for you. Dont be surprised if you arent able to narrow down on even a single stock after taking the company through these filters! You just need to find one or two new companies every couple years to invest.

My belief is that the Financial Statement of a company in most cases reflects a lot about the company in itself. The reason I pick Financial Analysis as my first filter criteria to screen a stock is due to these reasons:-

• A company's economic moat will reflect in its Financial Statements
• If a company has top quality management, that too will reflect in the Financial Statements
• In most cases the industry in which the company operates can be guessed looking at the Financial Statements!

All the four pillars are essential; I prefer to start with Financial, if you prefer to start with management Analysis you wont hurt me; neither will hurt you. 

As an investor you need to stick to what best work for you. There is no one size fits all! 

Untill next time, Chao!

Industry/Sectors that I avoid

Frens,

Please accept my apologies for not staying in touch. I will continue on the bottom up investing approach in my next post, from where I left last. For now, I thought this one will be quick - the Industries and sectors I stay away from.

I have pledged to myself to stay away from the below Industries/Sectors simply because I cannot understand the business and hence cannot evaluate it or the business is highly regulated by the government and hence such companies have to price their products basis government controls.

1. Oil and Gas - Oil Marketing/Drilling/Refineries
2. Certain edible commodity business - Tea/Coffee producers. There are a lot of global demand and supply factors in these business which I cannot fathom! Drought in India, Flood in Brazil what not?
3. Mining - Gold/Iron ore/Coal/Copper etc - most of them are government run. I pay double attention before investing in a government run company
4. Airlines - Again some extent of government control + high dependency on crude oil price fluctuations
5. Telecom - Want to stay away from business that are subject to technology obsolescence
6. Power Generation - Again government controls are heavy here; I am fine with power distribution and power ancillary companies like transformers and electric cables
7. Cement - Too many players, too much competition
8. BioTech - Very complex products for me to understand - not within my circle of competence
9. Alcoholic Beverages  - Way too much social hoopla; lot of public emotions and some government control
10. Steel - A classic cyclical industry, entry and exit timing is critical, margin for error = 0, commodity business. Instead go for special steels and alloys if you want to. Check the charts of most steel companies - they are sinusoidal waves!
11. Generic Textiles - Plain Vanilla Cotton yarn and fabric manufacturers - no moat. India is one of the largest textiles player in the world. Now that means certainly a lot of players in this sector, which then means competition
12. Listing these down helps you cut noise! This also leaves you out with lesser industries/companies to filter on further.

Unless I understand exactly how the company makes money, who are its customers, raw materials, Its products, its clients, the business model, immaterial of if the company is run by a marquee businessman I will not buy that stock.

So sit back and introspect and make your "AVOID" list in mind and then stick to it. There are plenty of other industries and sectors still available for you to look into. If I understand chemicals business well you may not and vice versa.

See you all soon!

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