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Fundamental analysis�April 2021�Trương Quang Binh MSc

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Objectives

  • By the end of this session, you should be able to understand the key concepts behind fundamental analysis
    • Fundamental analysis – topdown approach
    • Industry analysis
    • Company analysis
    • Financial analysis
    • Risk and return
    • Valuation

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Fundamental Analysis – A topdown approach

Financial statements Analysis

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Economic analysis

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Fiscal policy

“The government taxing and spending policies” (Block & Hirt, 2008, p.118)

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  • Revenue > Expenditure Surpluses

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  • Revenue< Expenditure Deficits

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Reduce deficits by: (1) increase taxes; (2) reduce expenditure; (3) mix of (1) & (2)

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Monetary policy

  • Monetary policy determines the “appropriate” levels for the money supply and interest rates that accomplish the economic goals of the Employment Act of 1946 ((Block & Hirt, 2008, p.122)

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  1. Reserve requirements
  2. Discount rate
  3. Open Market Operation (OMO)

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Industry analysis

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Industry Life Cycle

Sales/ Profit

Revenue

Profit

Development

Growth

Expansion

Maturity

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Competitive structure

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Company analysis

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Value chain analysis

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Competitive advantage

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Corporate governance

  • "Corporate governance can be defined narrowly as the relationship of a company to its shareholders or, more broadly, as its relationship to society -….”

Source: FT article, 1997

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Corporate governance

Effects of poor corporate governance can destroy wealth for shareholders through:

• Equity and debt de-ratings (worst case – bankruptcy)

• Lack of controls on businesses

• Conflicts between goals of management and shareholders

• Enrichment of management at the expense of shareholders

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Financial analysis

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Financial statement analysis

Financial statement analysis

Profitability

Liquidity/Efficiency

Gearing

Investment

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Limitations of financial statements and�ratio analysis

Source: Kaplan, 2021

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Creative accounting

  • Creative accounting refers to the accounting practices that are designed to mislead the view that the user of financial statements has on an entity’s underlying economic performance.
  • Typically creative accounting is used to
  • increase profits,
  • inflate asset values or
  • understate liabilities.

Source: Kaplan, 2021

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Risk and required return

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Risk and Return relationship

  • Risks: two types of risk
    • Systematic risk: The risk inherent to the entire market or entire market segment. Also known as "un-diversifiable risk"�
    • Unsystematic risk: Company or industry specific risk that is inherent in each investment�
  • Return: The gain or loss of a security in a particular period. The return consists of the income and the capital gains relative on an investment. It is usually quoted as a percentage. �

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The required rate of return

  • Real rate of return: is the return investor require for allowing others to use their money for a time given period (exclude inflation)

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  • Risk Free rate (Rf)

Risk-free rate = (1+real rate)(1+inflation)-1

Or Risk-free rate = real rate + inflation rate

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The theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time.

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  • Risk premium: The return in excess of the risk-free rate of return that an investment is expected to yield. Vietnam: 10.8%

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The required rate of return

  • The require rate of return = real rate of return + inflation + risk premium

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Risk Premium

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+Real rate of return

2%

+Anticipated inflation

3%

= risk-free rate

5%

+Risk premium

6%

=Required rate of return

11%

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Risk and Required rate of return

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  • Ke = required rate of return
  • Rf = Risk Free Rate
  • β = Beta coefficient
  • Rm = the expected return on the market portfolios
  • (Rm – Rf) = Equity risk premium

Ke = Rf + β (Rm – Rf)

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The term beta (β)

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βA = COV (A, M)/VAR (M)

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  • Beta denotes the systematic or non-diversifiable risk and this is the only factor that decides the return of the considered security.

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  • Beta measures how stock A and market M move together

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Valuation techniques

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Company valuation methods

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Methods

Features

Multiples

P/E

Commonly used. This method is applicable to small & medium enterprises of which revenue and profit may be estimated

P/B

Suitable for capital oriented and financial organizations

EV/EBITDA

This method is not subject to bias due to difference in tax, capital structure. This method is convenient to compare globally

Discount

DCF

Sensitive with assumptions especially with terminal growth rate.

DDM

Depending on the first estimate, growth factor and required rate of return.

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General Dividend model

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  • Po = D1 + D2 + …….+ D∞

(1+ Ke)1 (1 + Ke)2 (1 + Ke)∞

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Po = Present value of stock price

Di = Dividend for each year

Ke = Required rate of return (discount rate)

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Gordon Growth Model

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  • g (growth rate) must be constant
  • k > g

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Discounted cashflow

Where:

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CF is the cash flow for each consecutive period

r is the discount rate (big companies often use WACC)

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Example

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