Page 116 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 4: Fundamental Analysis

though. Please remember, the use of an analytical framework does not guarantee an actual Notes
decision. However, it does guarantee an informed and considered investment decision, which
would hopefully be better as it based on relevant and crucial information.

Fundamental Analysis and Efficient Market

Before elaborating in detail on the economy-industry-company framework, it is pertinent to
mention that doubts are expressed about the utility of this approach in the contest of efficient
stock market set-up. Briefly, the market efficiency relates to the speed with which the stock
market incorporates the information about the economy, industry and company, in the share
prices, rather instantaneously. The above given view about share market efficiency implies that
no one would be able to make abnormal profits given such a set-up. Some research studies in the
literature also support the above view. Practitioners, however, do not agree to such conclusions
of an empirical nature.

Fundamental Analysis and Chemistry of Earnings

The logic for fundamental analysis becomes crystal clear once we understand the chemistry of
earnings and macro and macro factors which influence the future of earnings.
Table 4.1: Factors Affecting Distributable Earnings

Board Source/Form Company Specific Industry Factors Macro- Economic
of Earnings Factors
Sales Competitive Industry National income, sp.
strength demand/supply savings, Monetary policy
credit, Export-import
policies, Population, price
level.
Less Costs of sales Operating Industry wage National wage policy price
efficiency Levels: Industrial levels, Economic
Infrastructure infrastructure, Raw
materials production
Import-export policy
Earnings Before Capital Industry cost of Interest rates in the
Interest Structure/financial capital Economy, Capital
Depreciation & leverage policy conditions
Taxes (EBIDT)
Less Interest
Less Operational Industry practices Capital goods import
Depreciation leverage
policy
Less Tax Tax Planning and Industrial lobby Fiscal Policy
Management
Net Earnings After
Tax (NEAT)
Less Capital Structure Industry Practices Interest Rate Structure,
(Preference Policy Capital… Conditions
Dividend)
Distributable
Earnings
Less
Equity Dividend Dividend Policy Industry Practices Fiscal Policy, Credit Capital
Market conditions Contd...
Retained Earnings

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