Equity Markets for Dummies | Fundamental Analysis

Analysis Framework

Fundamental Analysis answers: “WHAT to buy?”

What it is: Studying the business, its financials, management, and industry to determine if the company is worth owning.

What it uses:

• Annual reports and financial statements
• Balance sheet, P&L, cash flow analysis
• Financial ratios (Current Ratio, Debt/Equity, ROCE, P/E, P/B, EPS, etc.)
• Management quality assessment
• Industry and economy trends

What it determines:

• Intrinsic value - The true worth of the business
• Is the company profitable and growing?
• Is management honest and capable?
• Does the business have competitive advantages?

When to use:

• Screening stocks - Finding quality companies worth investing in
• Finding undervalued gems - Identifying stocks trading below their true value
• Long-term investing - Building a portfolio for years
• Wealth creation - Compounding returns over time

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Technical Analysis answers: “WHEN to buy?”

What it is: Studying price charts, patterns, and trading volume to identify the right time to enter or exit positions.

What it uses:

• Price charts (candlesticks, patterns, trends)
• Technical indicators (EMA, MACD, RSI)
• Volume analysis
• Support and resistance levels

What it determines:

• Market sentiment - Are buyers or sellers in control right now?
• Is the stock in uptrend, downtrend, or sideways?
• Where are the key support/resistance levels?
• What’s the optimal entry and exit price?

When to use:

• Timing your entry/exit - Getting the best price for buying/selling
• Riding momentum - Catching stocks in strong trends
• Risk management - Setting precise stop loss levels
• Short-term trading - Intraday or swing trading strategies

The Power of Technical Analysis:

Advantage #1: Works on ANY Stock

• Don’t need to understand the business deeply
• Can trade sectors you’re not expert in
• Even works on stocks with no fundamentals (penny stocks, momentum plays)

Advantage #2: Faster Decisions

• Fundamental analysis takes hours/days (reading annual reports, calculating ratios)
• Technical analysis takes minutes (check chart, indicators, volume)
• Perfect for part-time investors with day jobs

Advantage #3: Clear Entry/Exit Rules

• Fundamentals say “TCS is a good company” but don’t tell you when to buy
• Technicals say “Buy TCS at ₹3,450 support, sell at ₹3,650 resistance” - Specific!

Advantage #4: Risk Management

• Fundamentals can’t tell you where to place stop loss
• Technicals give you exact levels based on support zones

Advantage #5: Works in Bear Markets Too

• Fundamental investors struggle when everything falls
• Technical traders can short sell and profit from falling prices

The BEST Approach: Combine Both!

Real Example:

Asian Paints Analysis:

• ✅ Fundamental Check: ROCE 35%, debt-free, consistent profit growth → Quality stock
• ⚠️ Current Price: ₹3,200
• 📉 Technical Check: Stock in downtrend, 5 EMA below 13 EMA, breaking support
• Decision: Good company, WRONG time. Wait for uptrend reversal.
• Action: Add to watchlist, buy when chart turns bullish (maybe at ₹2,900 support)

The Mistake Most Investors Make:

• Buying fundamentally strong stocks at technically wrong levels
• Result: Stuck in losses for months even though company is great
• Solution: Use fundamentals to pick stocks, technicals to time entries

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Fundamental Analysis: Understanding Business Value

1. Quantitative Analysis (Number-driven)

• Economy Analysis - Is the overall economy growing?
• Industry Analysis - Is the sector doing well?
• Company Analysis - Are the company’s numbers strong?

2. Qualitative Analysis (Quality-driven)

• Management Analysis - Is the leadership honest and capable?

Financial Statements Deep Dive

Annual reports contain comprehensive business information through standardized financial statements:

1. Balance Sheet Structure

The Balance Sheet Equation: Assets = Liabilities + Equity

Left Side - What the Company OWNS (Assets):

Non-Current Assets (Long-term, can’t convert to cash quickly)

• Fixed Assets: Land, buildings, machinery
• Intangible Assets: Patents, trademarks, goodwill
• Long-term Investments: Shares in other companies

Current Assets (Short-term, can convert to cash within a year)

• Inventories: Goods ready to sell
• Trade Receivables: Money customers owe you
• Cash & Cash Equivalents: Bank balance
• Short-term Investments: FDs, liquid funds

Right Side - What the Company OWES + OWNS (Liabilities + Equity):

Shareholder’s Funds (Owner’s money)

• Share Capital: Initial investment by shareholders
• Reserves & Surplus: Accumulated retained profits

Non-Current Liabilities (Long-term debt, payable after 1 year)

• Long-term loans, debentures, bonds

Current Liabilities (Short-term debt, payable within 1 year)

• Trade Payables: Money you owe suppliers
• Short-term loans and dues

Key Balance Sheet Terms:

Shareholder’s Funds (Equity) - Owners’ capital investment forming the foundation.

Reserves & Surplus - Retained profits reinvested rather than distributed, including:

• General Reserves
• Retained Earnings
• Securities Premium

Non-Current Liabilities - Debt payable beyond one year (debentures, long-term loans).

Critical Warning: If loan funds significantly exceed equity, extreme caution required. Historical disasters: Jet Airways, Suzlon, Reliance Communications.

2. Profit & Loss Statement

The P&L Waterfall (Example with ₹100 Crores revenue):

Key Terms Explained:

• EBITDA - Core business profitability (most important for operations)
• EBIT - Operating profit after accounting for asset depreciation
• PBT - Profit before paying taxes
• PAT - The bottom line - actual profit available to shareholders

3. Cash Flow Statement Components

Operating Activities - Cash from core business operations

• Negative = Core business burning cash (danger signal)
• Positive = Healthy operational cash generation

Investing Activities - Capital expenditure and asset sales

• Negative = More investments than divestments (often positive signal)
• Positive = Asset liquidation (context-dependent)

Financing Activities - Debt, equity, and dividend transactions

• Negative = Debt repayment or dividend distribution
• Positive = Fresh borrowing or equity raising

Important Financial Ratios

1. Current Ratio - Liquidity Assessment

Formula: Current Ratio = Current Assets ÷ Current Liabilities

What it measures: Can the company pay its short-term bills?

Example Calculation:

Interpretation Guide:

Real-world example:

• Company has ₹200 Cr in current assets
• Owes ₹100 Cr in short-term liabilities
• Current Ratio = 200/100 = 2.0 ✅
• Interpretation: Company can comfortably pay all short-term dues

Why 2:1 is ideal: Provides safety buffer. Even if assets lose 50% value, company can still pay all bills.

2. Debt to Equity Ratio - Leverage Analysis

Formula: Debt to Equity = Long-term Debt ÷ (Share Capital + Reserves)

What it measures: How much the company relies on borrowed money vs owner’s money

Example Calculation:

Interpretation Guide:

Why it matters:

• High debt = High interest payments
• Economic slowdown → Can’t pay loans → Bankruptcy risk
• Remember: Jet Airways, Suzlon had debt/equity > 3!

Sector exceptions: Banks and NBFCs naturally have high debt (it’s their business model), so ignore this ratio for financial companies.

3. Return on Capital Employed (ROCE)

Formula: ROCE = (EBIT ÷ Capital Employed) × 100

Capital Employed = Share Capital + Reserves + Long-term Debt

What it measures: How efficiently is the company using its capital to generate profits?

Example Calculation:

Interpretation Guide:

Why it matters:

• Compares profit generation across different capital structures
• Higher ROCE = Better management efficiency
• Always compare with industry average and competitors
• Asian Paints has ROCE ~35%, cement companies ~15-18%

4. Free Cash Flow - Cash Generation Power

Formula: Free Cash Flow = Operating Cash Flow - Net Capital Expenditure

What it measures: Real cash left after running and maintaining the business

Example Calculation:

Multi-Year Trend Analysis:

Interpretation:

• 3+ consecutive negative years = ❌ DANGER - Business burning cash
• 1-2 negative years = ⚠️ CAUTION - Monitor closely
• Consistently positive = ✅ Healthy cash generation

Why FCF matters:

• Profit can be manipulated, but cash flow doesn’t lie
• Negative FCF = Company needs external funding to survive
• Positive FCF = Can pay dividends, reduce debt, or expand
• Growth companies may have negative FCF temporarily (expansion phase)

5. Inventory Turnover Ratio

Formula: Inventory Turnover = Cost of Goods Sold ÷ Average Inventory

What it measures: How many times inventory is sold and replaced in a year

Example Calculation:

What it means: The company sells and replaces its entire inventory 8 times in a year, or every 45 days.

Sector Benchmarks:

Interpretation:

• Higher turnover = Goods sell quickly, less capital stuck
• Lower turnover = Inventory piling up, potential obsolescence risk
• Compare ONLY within same sector
• Increasing trend over years = ✅ Good
• Declining trend = ⚠️ Demand issues or poor management

6. Reserves & Surplus Growth

What it measures: Is the company consistently retaining and growing profits year-over-year?

Formula: Track absolute reserves value over 5+ years

5-Year Trend Example:

Interpretation Guide:

Why it matters:

• Growing reserves = Company keeping profits for expansion
• Declining reserves = Warning sign - losses or cash distribution
• Consistent growth over 5+ years = Quality compounding business
• Compare trend, not absolute value

Red flag: If reserves decline while profit is positive, where’s the money going?

7. Price to Earnings (P/E) Ratio

Formula: P/E Ratio = Market Price per Share ÷ Earnings Per Share (EPS)

What it measures: How much you’re paying for each rupee of company earnings

Example Calculation:

What it means: You’re paying ₹15 for every ₹1 of annual earnings

Comparative Analysis (Example: IT Sector):

CRITICAL: Always Compare with Industry, Not Absolute Numbers

Interpretation Framework:

Scenario 1: Low P/E + Strong Fundamentals (all 7 ratios good)

• Verdict: ✅ OPPORTUNITY - Undervalued gem

Scenario 2: Low P/E + Weak Fundamentals (poor ratios)

• Verdict: ❌ VALUE TRAP - Cheap for a reason

Scenario 3: High P/E + Strong Fundamentals

• Verdict: ⚠️ Fairly valued or expensive - Market expects growth

Why P/E is the LAST ratio to check:

• First verify business quality (ratios 1-6)
• Then check if price is reasonable (P/E)
• Low P/E alone means NOTHING without context

8. Earnings Per Share (EPS)

Formula: EPS = Profit After Tax (PAT) ÷ Total Outstanding Shares

What it measures: Company’s profit allocated to each share

Example Calculation:

5-Year EPS Growth Tracking:

Interpretation Guide:

Why EPS matters:

• Direct indicator of per-share profitability
• Growing EPS → Stock price usually follows up
• Declining EPS → Even if cheap, avoid!
• Check 5-year trend, not just one year

Watch out for: EPS can increase artificially through share buybacks (reducing denominator). Check if PAT is also growing!

Stock Valuation: EV/EBITDA Method

Enterprise Value to EBITDA is a popular valuation method used to calculate fair value of stocks.

Step-by-Step Valuation Process:

Step 1: Gather Historical Data (Go to MoneyControl → Ratios → Valuation)

Step 2: Calculate EBITDA for each year

• Formula: EBITDA = EV ÷ EV/EBITDA ratio
• Example 2024: 80,000 ÷ 18.5 = 4,324

Step 3: Determine Average EBITDA Growth

• Average of growth rates = (11.8 + 14.4 + 9.6 + 14.1) ÷ 4 = 12.5% average growth

Step 4: Forecast Next Year EBITDA

• Expected EBITDA (2025) = 4,324 × (1 + 0.125) = 4,865 Cr

Step 5: Calculate Forecasted Enterprise Value

• Forecasted EV = Expected EBITDA × Current EV/EBITDA
• Forecasted EV = 4,865 × 18.5 = 90,000 Cr

Step 6: Adjust for Debt to Get Equity Value

• Equity Value = Forecasted EV - Total Debt
• Equity Value = 90,000 - 15,000 = 75,000 Cr

Step 7: Calculate Target Price

• Target Price = Equity Value ÷ Outstanding Shares
• Target Price = 75,000 Cr ÷ 10 Cr shares = ₹750 per share

Step 8: Entry Price with Margin of Safety (30% discount)

• Recommended Entry = Target Price × 0.70
• Recommended Entry = 750 × 0.70 = ₹525

Final Verdict:

• Target Price: ₹750
• Buy if below: ₹525 (30% margin of safety)
• Current Price: ₹600 → BUY (below ₹750, room for upside)

Sector-Specific Analysis

Different industries require tailored analytical approaches:

Banks & NBFCs

Standard ratios DON’T apply to banks - Don’t check Debt:Equity ratio or operating cash flows. Instead focus on:

Banking-Specific Metrics:

1. CASA Ratio (Current Account + Savings Account)

Example: HDFC Bank CASA ~45% (Excellent), Small bank CASA ~25% (Poor)

2. NIM (Net Interest Margin)

Higher NIM = Bank earns more on each rupee lent

3. NPA Ratio (Non-Performing Assets)

NPA = Loans not being repaid → Lower profits → Avoid banks with rising NPAs

FMCG Companies

Focus on inventory turnover - fast-moving goods should have high turnover ratios (8x+ annually).

Telecom Sector

Key Metric: ARPU (Average Revenue Per User)

Formula: ARPU = Total Revenue ÷ Total Subscribers

Example Calculation:

Why ARPU Matters:

• Rising ARPU = Company increasing prices OR customers using more services
• Falling ARPU = Price war OR customers downgrading plans
• Compare quarter-over-quarter trends

Real Example:

• Jio ARPU: ₹175/month (rising trend = good)
• Airtel ARPU: ₹200/month (rising trend = excellent)

Infrastructure Companies

Key Metric: Order Book Analysis

Order book = Confirmed future projects/orders yet to be executed

Formula: Order Book to Revenue Ratio = Current Order Book ÷ Annual Revenue

Example:

Interpretation:

Why it matters:

• Infrastructure projects take years to complete
• Higher order book = Predictable future revenue
• L&T typically maintains 2.5-3x order book

Industry & Economy Analysis

Economic Indicators Impact

GDP Growth - Aggregate economic output affecting overall market sentiment.

Repo Rate - RBI’s lending rate to banks influencing borrowing costs.

The Domino Effect of Repo Rate Increase:

1. RBI increases Repo Rate (e.g., from 6% to 6.5%) ↓
2. Banks increase lending rates (home loans, business loans become expensive) ↓
3. Companies borrow less (expansion plans delayed) ↓
4. Production decreases (less capacity addition) ↓
5. GDP growth slows (economy cools down) ↓
6. Stock market falls (negative sentiment)

Impact: Repo rate hike = Generally negative for stock markets Exception: Banking stocks may benefit (higher lending margins)

CRR (Cash Reserve Ratio) - Percentage of deposits banks must maintain with RBI.

SLR (Statutory Liquidity Ratio) - Percentage banks must keep in liquid assets.

Monetary Policy Impact on Markets:

Balance of Payments (BoP)

Formula: BoP = Exports - Imports

Scenario Analysis:

Surplus BoP (Exports > Imports):

• Status: ✅ Trade Surplus
• Forex Impact: Rising foreign currency reserves
• Currency: Rupee strengthens
• Market Sentiment: Bullish for equity markets
• Example: India exports $50B, imports $45B → $5B surplus

Deficit BoP (Imports > Exports):

• Status: ❌ Trade Deficit
• Forex Impact: Depleting reserves
• Currency: Rupee weakens
• Market Sentiment: Cautious, potential FII outflows
• Example: India exports $40B, imports $55B → $15B deficit

Why it matters: Sustained deficits lead to rupee depreciation → Higher inflation → RBI forced to raise rates → Negative for markets

Cyclical Industries

Industries performing strongly during economic booms but struggling in recessions:

• Automobiles
• Real Estate
• Infrastructure
• Consumer Durables

Investment Strategy: Buy during recession lows, sell during boom peaks.

Management Quality Assessment

Quantitative metrics alone insufficient - qualitative management analysis critical:

Due Diligence Checklist:

1. Background Verification

• Google search: ”[Company Name] + fraud” or ”+ scam” or ”+ cases”
• Check LinkedIn profiles of CEO, CFO, MD
• Verify educational credentials and past experience
• Research track record at previous companies
• Any past failures or regulatory issues?

2. Annual Report Deep Dive

• Read Management Discussion & Analysis (MD&A) section
• Understand future projects and strategic vision
• Check for penalties and regulatory actions disclosed
• Scrutinize Related Party Transactions (RPTs)
  • High RPTs = Red flag (promoters doing self-dealing)

3. Auditor’s Report (First 3 pages of Annual Report)

• Look for phrase “True and Fair View” = Clean report
• Read Key Audit Matters (KAM) - Areas of concern
• Check for “Going Concern” issues
• Any Qualified Opinion = Major red flag, avoid!

4. Shareholding Pattern

• Promoter holding trends:
  • Increasing = Good (confidence in business)
  • Decreasing = Warning (promoters exiting?)
• Pledged shares:
  • < 10% = Acceptable
  • 20-50% = Caution

  • 50% = Danger (promoters need cash badly)

• Check for insider trading charges
• Monitor bulk deals by promoters (selling or buying?)

5. Investor Communications

• Read quarterly earnings call transcripts
• How does management respond to tough questions?
• Do they provide clear guidance or dodge questions?
• Compare past promises vs actual delivery

Management Red Flags Checklist:

Decision Matrix:

Real Examples:

• Yes Bank: Multiple red flags ignored → Collapsed
• Satyam: Qualified audit opinion → Massive fraud
• Jet Airways: High debt + pledged shares → Bankruptcy

Consolidated vs Standalone Financials

Standalone Financial Statements - Parent company only (head office + domestic/international branches)

Consolidated Financial Statements - Includes:

• Parent company
• Subsidiary companies (>50% ownership)
• Associate companies (20-50% ownership)
• Joint ventures

Analysis Tip: Always analyze consolidated statements for complete business picture, especially for holding companies with significant subsidiaries.