Addition of 2 books to my library

Frens,

I got sometime to upgrade my knowledge thanks to these two books I read in the last 2 weeks

• Romancing the Balance Sheet by Dr Anil Lamba
• Security Analysis by Ben Graham & David L Dodd

The link to my book recommendations is here http://stocksmojo.blogspot.in/p/books.html

Remember if you want to be a leader in a subject you need to be a voracious reader of that subject!

Chao!

Fundamental Analysis - Pillar 1 - Financial Analysis

Investofreaks!

Financial Analysis is one of the two Quantitative means to analyze a company. The other is Valuation Analysis. Its Quantitative hence very Objective number driven - numbers mostly dont lie and even if they do as a small retail investor, in most cases, we can build screening methods in our analysis to have checks to see if they are cooking the books of accounts. Also we have the market regulator SEBI who is also keeping an eye.

To know the 4 pillars to Fundamental Analysis click here

Financial Analysis constitutes the analysis of 3 Financial Statements:

1. Profit & Loss Statement (Income Statement)
2. Balance Sheet
3. Cash Flow Statement

If I am given 100 minutes to analyse all 3 statements and give a analysis report on the company, then I would spend 80% of the time on Balance Sheet and Cash Flow Statement. The reason I want to spend time this way is because "Cash is King" and these two statements tell me exactly this!

Profit & Loss Statement (P&L) (Income Statement) - Here we get answers to the following questions (not an exhaustive list)

• Is the company able to increase the sales of it products/services at a reasonable rate a.k.a Are the sales growing?
• While selling more are they able to maintain profitability if not increase?
• Do the products of the company have a seasonal demand within a 12 month time frame?
• Is the company operating in a cyclical business? Please google what a cyclical business means! 
• Is the company paying corporate taxes per the rules of the government for the industry it operates in?
• Is the company paying a share of its profits to shareholders on a consistent basis? 

Non Finance folks can understand it this way to keep it simple - no rocket science!

The P&L statement tells us about the "financial performance" of the company, while the Balance sheet will tell you about the "financial position" of the company at a point in time and the Cash Flow Statement will tell you if the company is a "cash cow" (google this terms again, very important)

I will write another detailed post on "How to Analyze the P&L Statement" and which free tools on the internet you can use to keep it simple yet effective.

Adieu!

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!