THEORETICAL BACKGROUND

FUNDAMENTAL ANALYSIS:
Fundamental analysis is the examination of the
underlying forces that affect the well being of the
economy, industry groups, and companies. As with most
analysis, the goal is to derive a forecast and profit from
future

price

fundamental
financial

movements.
analysis

data,

At

may

management,

the

involve

company

level,

examination

business

concept

of
and

competition. At the industry level, there might be an

examination of supply and demand forces for the
products offered. For the national economy, fundamental
analysis might focus on economic data to assess the
present and future growth of the economy. To forecast
future stock prices, fundamental analysis combines
economic, industry, and company analysis to derive a
stock's current fair value and forecast future value. If
fair value is not equal to the current stock price,
fundamental analysts believe that the stock is either over
or under valued and the market price will ultimately
gravitate towards fair value. Fundamentalists do not
heed the advice of the random walkers and believe that
markets are weak form efficient. By believing that prices

do not accurately reflect all available information,

fundamental analysts look to capitalize on perceived
price discrepancies.
STRENGTHS AND WEAKNESS OF FUNDAMENTAL
ANALYSIS
Long-term Trends:
Fundamental

analysis

is

good

for

long-term

investments based on long-term trends, very long-term.

The ability to identify and predict long-term economic,
demographic, technological or consumer trends can
benefit patient investors who pick the right industry
groups or companies.
Value Spotting:
Sound

fundamental

analysis

will

help

identify

companies that represent good value. Some of the most

legendary investors think long-term and value. Graham
and Dodd, Warren Buffett and John Neff are seen as the
champions of value investing. Fundamental analysis can
help uncover companies with valuable assets, a strong
balance sheet, stable earnings and staying power.
Business Acumen:

One of the most obvious, but less tangible, rewards

of fundamental analysis is the development of a thorough
understanding of the business. After such painstaking
research and analysis, an investor will be familiar with
the key revenue and profit drivers behind a company.
Earnings and earnings expectations can be potent
drivers of equity prices. Even some technicians will
agree to that. A good understanding can help investors
avoid companies that are prone to shortfalls and identify
those

that

continue

to

deliver.

In

addition

to

understanding the business, fundamental analysis allows

investors to develop an understanding of the key value
drivers and companies within an industry. Its industry
group heavily influences a stocks price. By studying
these groups, investors can better position themselves to
identify opportunities that are high-risk (tech), low-risk
(utilities), growth oriented (computer), value driven (oil),
non-cyclical (consumer staples), cyclical (transportation)
or income oriented (high yield).
Knowing Who's Who:

Stocks move as a group. By understanding a

company's

business,

investors

can

better

position

themselves to categorize stocks within their relevant

industry group. Business can change rapidly and with it
the revenue mix of a company. This happened to many of
the pure internet retailers, which were not really
internet companies, but plain retailers. Knowing a
company's business and being able to place it in a group
can make a huge difference in relative valuations.
WEAKNESS
Time Constraints:
Fundamental analysis may offer excellent insights,
but it can be extraordinarily time consuming. Timeconsuming models often produce valuations that are
contradictory to the current price.
Industry/Company Specific: Valuation techniques vary
depending on the industry group and specifics of each
company. For this reason, a different technique and
model is required for different industries and different

companies. This can get quite time consuming and limit

the amount of research that can be performed.
Subjectivity:
Fair value is based on assumptions. Any changes to
growth or multiplier assumptions can greatly alter the
ultimate valuation. Fundamental analysts are generally
aware of this and use sensitivity analysis to present a
base-case valuation, a best-case valuation and a worstcase valuation. However, even on a worst case, most
models are almost always bullish, the only question is
how much so.
Analyst Bias:
The majority of the information that goes into the
analysis comes from the company itself. Companies
employ

investor

relations

managers

specifically

handle the analyst community and release information.

Introduction to Investment Valuation

to

Every asset, financial as well as real, has value. The

key to successfully investing in and managing these
assets lies in understanding not only what the value is,
but the sources of the value. Any asset can be valued,
but some assets are easier to value than others, and the
details of valuation will vary from case to case. Thus, the
valuation of a share of a real estate property will require
different information and follow a different format from
the valuation of a publicly traded stock. What is
surprising; however, is not the difference in valuation
techniques across assets, but the degree of similarity in
basic

principles.

There

is

undeniably

uncertainty

associated with valuation. Often that uncertainty comes

from the asset being valued, although the valuation
model may add to that uncertainty.
A PHILOSOPHICAL BASIS FOR VALUATION
A surprising number of investors subscribe to the
bigger fool theory of investing, which argues that the
value of an asset is irrelevant as long as there is a
bigger fool around who is willing to buy the asset from
them. While this may provide a basis for some profits, it

is a dangerous game to play, since there is no guarantee

that such an investor will still be around when the time
to sell comes.
A postulate of sound investing is that an investor
does not pay more for an asset than its worth. This
statement may seem logic and obvious, but it is forgotten
and rediscovered at some time in every generation and
in every market. There are those who are disingenuous
enough to argue that value is in the eyes of the beholder,
and that any price can be justified if there are other
investors willing to pay that price. That is patently
absurd. Perceptions may be all that matter when the
asset is a painting or a sculpture, but investors do not
(and should not) buy most assets for aesthetic or
emotional reasons; financial assets are acquired for the
cash flows expected from owning them. Consequently,
perceptions of value have to be backed up by reality,
which implies that the price that is paid for any asset
should reflect the cash flows it is expected to generate.
The models of valuation described in this book attempt
to relate value to the level and expected growth of these
cash flows.

There are many areas in valuation where there is

room for disagreement, including how to estimate true
value and how long it will take for prices to adjust to true
value. But there is one point on which there can be no
disagreement. Asset prices cannot be justified merely by
using the argument that there will be other investors
around willing to pay a higher price in the future.
THE ROLE OF VALUATION
Valuation is useful in a wide range of tasks. The role
it plays, however, is different in different arenas. The
following section lays out the relevance in portfolio
management, in acquisition analysis, and in corporate
finance.
Valuation and Portfolio Management
that

valuation

plays

in

portfolio

The role

management

is

determined in large part by the investment philosophy of

the investor. Valuation plays a minimal role in portfolio
management for a passive investor, whereas it plays a
larger role for an active investor. Even among active
investors, the nature and role of valuation are different

for different types of active investors can be categorized

as either market timers, who trust in their abilities to
foresee the direction of the overall stock or bond
markets, on security selection who believe that their
skills lie in funding under or over valued securities.
Market timers use valuation much less than do investors
who pick stocks, and the focus is on market valuation
rather than on firm specific valuation. Among security
selectors, valuation plays a central role in portfolio
management for fundamental analysts and a peripheral
role for technical analysis.
The following subsections describe, in broad terms.
Different philosophies and the role played by valuation in
each.
Fundamental Analysts
The underlying theme in fundamental analysis is
that the true value of the firm can be related to its
financial characteristics- its growth prospects, prospects,
risk profile, and cash flows. Any deviation from this true
value is a sign that a stock is under or overvalued. It is a
long-term investment strategy and the assumptions
underlying it are that:

(a) The relationship between value and the underlying

financial factors can be measured.
(b) The relationship is stable over time.
( c ) Deviations from the relationship are corrected in a
reasonable time period.
Valuation is the central focus in fundamental analysis.
Some analysts use discounted cash flow models to value
firms, while others use multiples such as price/earnings
and price/book value ratios. Since investors using this
approach hold a large number of "undervalued' stocks in
their portfolios, their hope is that, on average, these
portfolios will do better than the market.
Franchise Buyers
The

philosophy

of

franchise

buyer

is

best

expressed by an investor who has been very successful

at it -Warren Buffet. We try to stick to businesses we
believe we. Understand, Mr.Buffett writes. That means
they must be relatively simple and stable in character. If
a business is complex and subject to constant change,
we're not smart enough to predict future cash flows.
Franchise buyers concentrate on a few businesses they
understand well and attempt to acquire undervalued

firms. Often, as in the case of Mr. Buffet, franchise

buyers wield influence on the management of these firms
and can change financial and investment policy. As a
long-term strategy, the underselling assumptions are
that:
(a) Investors who understand a business well are in a
better position to value it correctly.
(b) These undervalued businesses can be acquired
without driving the price above the true value.
Valuation plays a key role in this philosophy, since
franchise buyers arc attracted to a particular business
because they believe it is undervalued. They are also
interested in how much additional value they can create
by restructuring the business and running it right.
Chartists
Chartists believe that prices are driven as much by
investor psychology as by any underlying financial
variables. The information available from trading - price
movements, trading volume, short sales, and so forth gives an indication of investor psychology and future
price movements. The assumptions here are that prices

move in predictable patterns, that there are not enough

marginal investors taking advantage of these patterns to
eliminate them, and that the average investor in the
market is driven more by emotion than by rational
analysis.
While valuation does not play much of a role in
charting, there are ways in which an enterprising
chartist can incorporate it into analysis. For instance
valuation

can

be

used

to

determine

support

and

resistance lines4 on price chart.

Information Traders
Prices

move

on

information

about

the

firm.

Information traders attempt to trade in advance of new

information or shortly after it is revealed to financial
markets, buying on good news and selling on bad. The
underlying

assumption

is

that

these

traders

can

anticipate information announcements and gauge the

market reaction to them better than the average investor
in the market.
For

information

trader

the

focus

is

on

the

relationship between information and changes in value,

rather than on value per se. Thus an information trader

may buy an overvalued firm if he or she believes that

the next information announcement is going to cause the
price to go up because it contains better-than-expected
news. If there is a relationship between how undervalue
or overvalued a company is and how its stock price
reacts to new information then valuation could play a
role in investing for an information trader.
Market Timers
Market timers note, with some legitimacy, that the
payoff to calling turns in markets is much greater than
the returns from stock picking. They argue that it is
easier to predict market movements than to select stocks
and that these predictions can be based upon factors
that are observable.
While valuation of individual stocks may not be of any
use to a market timer, market timing strategies can use
valuation in at least two ways:
(a) The overall market itself can be valued and compared
to the current level.
(b) A valuation model can be used to value all stocks, and
the results from the cross-section can be used to
determine whether the market is over or undervalued.

For example, as the numbers of stocks that are

overvalued using the dividend discount model increases
relative to the numbers that are undervalued, there may
be reason to believe that the market is overvalued.
Efficient Marketer
Efficient marketers believe that the market price at
any point in time represents the best estimate of the true
value of the firm and that any attempt to exploit
perceived market efficiencies will cost more than it will
make in excess profits. They assume that markets
aggregate

information

quickly

and

accurately,

that

marginal investors promptly exploit any inefficiencies,

and that any inefficiencies in the market are caused by
friction, such as transaction costs, and cannot be
arbitraged away.
For

efficient

marketers,

valuation

is

useful

exercise to determine why, stock sells for the price it

does. Since the underlying assumption is that the market
price is the best estimate of the true value of the
company,

the

objective

becomes

determining

what

assumptions about growth and risk are implied in this

market

price,

rather

than

on

finding

under-

or

overvalued firms.
Valuation in Acquisition Analysis
Valuation should play a central part in acquisition
analysis. The bidding firm or individual has to decide on
a fair value for the target firm before making a bid, and
the target firm has to determine a reasonable value for
itself before deciding to accept or reject the offer.
There are also special factors

to consider in

takeover valuation. First, the effects of synergy on the

combined value of the two firms (target plus bidding
firm) have to be considered before a decision is made on
the bid. Those who suggest that synergy is impossible to
value and should not be considered impossible to value
should not be considered in quantitative terms are
wrong.

Second,

the

effects

on

value

of

changing

management and restructuring the target firm will have

to be taken into account in deciding on a fair price. This
is of particular concern in hostile takeovers.
Finally, there is a significant problem with bias in
takeover

valuations.

Target

firms

may

be

overly

optimistic in estimating value, especially when the

takeover is hostile and they are trying to convince their

stockholders that the offer price is too low. Similarly, if
the bidding firm has decided, for strategic reasons, to do
an acquisition, there may be strong pressure on the
analyst to come up with an estimate of value that backs
up the acquisition decision.
Valuation in Corporate Finance
The

objective

in

corporate

finance

is

the

maximization of firm value, and then the relationship

between financial decisions, corporate strategy, and firm
value has to be delineated. In recent years, managementconsulting firms have started offering companies advice
on how to increase value. Their suggestions have often
provided the basis for the restructuring of these firms.
The value of a firm can be directly related to
decisions that it makes-on that projects it takes, on how
it

finances

them,

and

on

its

dividend

policy.

Understanding this relationship is key to making valueincreasing

decisions

restructuring.

and

to

sensible

financial

Equity represents a residual cash flow rather than a

promised cash flow.
You can value equity in one of two ways:
By discounting cash flows to equity at the cost of
equity to arrive at the value of equity directly.
By discounting cash flows to the firm at the cost of
capital to arrive at the value of the business. Subtracting
out the firms outstanding debt should yield the value of
equity.
Two Measures of Cash Flows
Cash flows to Equity: These are the cash flows
generated by the asset after all expenses and taxes, and
also after payments due on the debt. This cash flow,
which is after debt payments, operating expenses and
taxes, is called the cash flow to equity investors.
Cash flow to Firm: There is also a broader definition of
cash flow that we can use, where we look at not just the
equity investor in the asset, but at the total cash flows
generated by the asset for both the equity investor and
the lender. This cash flow, which is before debt payments

but after operating expenses and taxes, is called the cash

flow to the firm.
Two Measures of Discount Rates
Cost of Equity: This is the rate of return required by
equity investors on an investment. It will incorporate a
premium for equity risk the greater the risk, the greater
the premium.
Cost of capital: This is a composite cost of all of the
capital invested in an asset or business. It will be a
weighted average of the cost of equity and the after-tax
cost of borrowing.
FREE CASH FLOWS TO THE FIRM
The best things in life are free, and the same holds
true for cash flow. Smart investors love companies that
produce plenty of free cash flow (FCF). It signals a
company's ability to pay debt, pay dividends, buy back
stock and facilitate the growth of business - all important
undertakings from an investor's perspective. However,
while free cash flow is a great gauge of corporate health,

it does have its limits and is not immune to accounting

trickery.
What Is Free Cash Flow? By establishing how much
cash a company has after paying its bills for ongoing
activities and growth, FCF is a measure that aims to cut
through the arbitrariness and "guesstimations" involved
in reported earnings. Regardless of whether a cash
outlay is counted as an expense in the calculation of
income or turned into an asset on the balance sheet, free
cash flow tracks the money.
To calculate FCF, make a beeline for the company's cash
flow statement and balance sheet. There you will find the
item cash flow from operations (also referred to as
"operating cash"). From this number subtract estimated
capital expenditure required for current operations:
- Cash Flow from Operations (Operating Cash)
- Capital Expenditure
To do it another way, grab the income statement and
balance sheet. Start with net income and add back
charges for depreciation and amortization. Make an
additional adjustment for changes in working capital,
which is done by subtracting current liabilities from

current assets. Then subtract capital expenditure, or

spending on plants and equipment:
- Net income
+ Depreciation/Amortization
- Change in Working Capital
- Capital Expenditure
It

might

seem

odd

to

add

back

depreciation/amortization since it accounts for capital

spending.

The

reasoning

behind

the

adjustment,

however, is that free cash flow is meant to measure

money being spent right now, not transactions that
happened in the past.

This makes FCF a useful

instrument for identifying growing companies with high

up-front costs, which may eat into earnings now but have
the potential to pay off later.
What Does Free Cash Flow Indicate?
Growing free cash flows are frequently a prelude to
increased earnings. Companies that experience surging
FCF - due to revenue growth, efficiency improvements,
cost reductions, share buy backs, dividend distributions
or debt elimination - can reward investors tomorrow.

That is why many in the investment community cherish

FCF as a measure of value. When a firm's share price is
low and free cash flow is on the rise, the odds are good
that earnings and share value will soon be on the up.
By contrast, shrinking FCF signals trouble ahead. In
the absence of decent free cash flow, companies are
unable to sustain earnings growth. An insufficient FCF
for earnings growth can force a company to boost its
debt levels. Even worse, a company without enough FCF
may not have the liquidity to stay in business.

RESEARCH DESIGN OF THE STUDY

INTRODUCTION:
Every stock available in the markets has a value
called market price, which is the indicator of the

companys

performance.

According

to

fundamental

analysis we will try to find the intrinsic value of a

particular stock, which is the true value of the stock,
based on which investment arguments take place.
STATEMENT OF PROBLEM:
Every asset, financial as well as real, has value. The
key to successfully investing in and managing these
assets lies in understanding not only what the value is,
but the sources of the value. Any asset at can be valued
but some assets are easier to value than others, and the
details of the valuation will vary from case to case. Thus,
the valuation of a share of a real estate property will
require different information and follow a different
format from the valuation of a publicly traded stock.
What is surprising; however, is not the difference in
valuation techniques across assets, but the degree of
similarity

in

uncertainty

basic

principles.

associated

with

There

is

valuation.

undeniably
Often

the

uncertainty comes from the asset being valued, although

the valuation model may add to that ascertained.

A postulate of sound investing is that an investor

does not pay more for asset than its worth. This
statement may seem logical and obvious as financial
assets are acquired for the cash flows expected from
owning them, which implies that the price that is paid
for any asset should reflect the cash flows it is expected
to generate.
The problem in valuation is not that there are not
enough models to value an asset; it is that there are too
many. Choosing the right model to use in valuation is as
critical

to

arriving

at

reasonable

value

as

understanding how to use the model. Analysts use a wide

variety of models from simple to the sophisticated. These
models often make different assumptions about pricing,
but they do share some common characteristics so in the
study we tried to use price-earning multiples and
discounted cash flow models of valuation.

OBJECTIVES OF THE STUDY:

To understand the macroeconomic variables those
will an impact on the company
To

study

the

various

progress.

trends,

opportunities,

challenges of the industry in which the company

operates.
To understand the various policies of the company
those have impact on the financial performance of
the company.
To understand the various investment valuation
models that can be used.
To select the appropriate model that suits the stock.
Find the intrinsic value of the stock and compare
with market value of the study.
To recommend whether to buy, hold or sell the stock
based on the analysis.

SCOPE OF THE STUDY:

The study basically tries to identify the intrinsic
value of the company by using the published financial
details of the company. The study is restricted to one
particular company in the sector. The study
includes testing the intrinsic value of the company.

also

RESEARCH METHODOLOGY:
Type of research:
Research design is the conceptual structure within
which research is conducted. It constitutes the blue print
for the collection, measurement, and analysis of data.
The type of research adopted for the study is descriptive
research

as

the

research

does

not

require

any

manipulation of variables and does not establish causal

relationship between events; it just simply describes the
variables.
Sources of data:

Primary data
Those are the data that are obtained by a study
specially designed to fulfill the data needs of the
problem. Meeting the company professionals personally
collected the information necessary for the study.
Secondary data
Data, which are not originally collected but rather
obtained from published or unpublished sources, are
known as secondary data. In this research secondary
data

was

collected

through

sources

like

Internet,

research reports, magazines, and company journals.

Sampling plan:
Type of sampling

: Non-probabilistic judgment

sampling.
Sample size

: One company from automobile

sector.
RESEARCH INSTRUMENTS:

Financial calculations: - This was done to find the

various valuation ratios and necessary

calculations to

find the intrinsic value of the company.

Z Test: - This test was used to test the hypothesis.
PLAN OF ANALYSIS:
After having collected the financial data related to
the entities i.e., the sample selected from the selected
sector. Calculate the various valuation ratios and other
financial calculations that will help in the company
valuation. This helps in finding out the intrinsic value of
the

companys

share.

Then hypothesis

was

tested

whether the company is under or over valued.

LIMITATIONS OF THE STUDY:

The study was confined only to one particular sector.
The study was more confined with secondary data.

 The study assumes no changes in the tax rates in the

country.
The study was done for a short period of time, which
might not hold true over a long period of time.
As the scope is defined by the researcher it restricts
the number of variables which
Influence the industry.

OPERATIONAL DEFINITIONS OF THE CONCEPTS:

1) BETA:

A measure of a security's or portfolio's volatility, or

systematic risk, in comparison to the market as a whole.
It is also known as "beta coefficient."
2) CAPEX:
Funds used by a company to acquire or upgrade
physical assets such as property, industrial buildings, or
equipment.
3) CAGR:
The year over year growth rate of an investment
over a specified period of time.
Calculated by taking the nth root of the total
percentage growth rate where n is the number of years
in the period being considered.
This can be written as:

4) COST OF EQUITY:
The return that stockholders require for a company
for the capital invested. The traditional formula is the
dividend capitalization model:

5) DEBT/EQUITY RATIO:
A

measure

of

company's

financial

leverage

calculated by dividing long-term debt by shareholders

equity. It indicates what proportion of equity and debt
the company is using to finance its assets.
Note: Sometimes investors only use interest bearing
long-term debt instead of total liabilities.

6) DEPRECIATION:
An expense recorded to reduce the value of a longterm tangible asset. Since it is a non-cash expense, it
increases free cash flow while decreasing reported
earnings.
7) DIVIDEND PAYOUT RATIO:
The percentage of earnings paid to shareholders in
dividends.
9) DUPONT ANALYSIS:
A method of performance measurement that was
started by the DuPont Corporation in the 1920s, and has

been used by them ever since. With this method, assets

are measured at their gross book value rather than at
net book value in order to produce a higher ROI.
10) EPS:
The portion of a company's profit allocated to each
outstanding share of common stock. Calculated as:

11) EFFECTIVE TAX RATE:

The portion of a company's profit allocated to each
outstanding share of common stock. Calculated as:

12) EQUITY MULTIPLIER:

A measure of financial leverage calculated as:
Total Assets divided by Total Stockholders' Equity.
Like

all

debt

management

ratios,

the

equity

multiplier is a way of examining how a company uses

debt to finance its assets. It is also known as the
financial leverage ratio or leverage ratio.

13) ASSET TURN OVER RATIO:

The amount of sales generated for every dollar's
worth of assets. It is calculated by dividing sales in
rupees by assets in rupees.
Formula:

14) FUNDMENTAL ANALYSIS:

The amount of sales generated for every dollar's
worth of assets. It is calculated by dividing sales in
rupees by assets in rupees.
Formula:

15) MARKET CAPITALISATION:

It is the total value of all outstanding shares of
particular company, which is represented in the market.
It's calculated by multiplying the number of shares times
the current market price. This term is often referred to
as market cap.

16) PE (PRICE EARNING MULTIPLES):

A valuation ratio of a company's current share price
compared to its per-share earnings. A valuation ratio of a
company's current share price compared to its per-share
earnings.
Calculated as:

17) PEG (PRICE EARNING TO GROWTH):

A valuation ratio of a company's current share price
compared to its per-share earnings.

18) ROE:
A measure of a corporation's profitability, calculated as:

19) WACC: A calculation of a firm's cost of capital that

weight each category of capital proportionately. Included
in the WACC calculations are all capital sources,

including common stock, preferred stock, bonds, and any

other long-term debt.
WACC is calculated by multiplying the cost of each
capital component by its proportional weighting and
then summing: