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Fundamental Analysis 1:
Economic Analysis

Security Analysis and Investment Decision

Investment decision-making is an important area probing further.
Investment decision-making being continuous in nature should be
attempted systematically. Broadly approaches are suggested in the
literature. These are: fundamental analysis and technical analysis.

Fundamental Analysis and Chemistry of Earnings

Factors Affecting Distributable Earnings
Board
Source/Form
of Earnings

Company Specific
Factors

Sales

Competitive strength

Industry demand/
supply

National income, sp..

savings, Monetary policy
credit, Export-import
policies, Population,
price level.

Less Costs
of sales

Operating efficiency

Industry wage
Levels:
Industrial
infrastructure
Import-export policy

National wage policy

price levels, Economic
infrastructure,
Raw materials, production

Capital
Structure/financial
leverage policy

Industry cost of
capital

Interest rates in the

Economy, Capital
conditions

Earnings Before
Interest
Depreciation
& Taxes (EBIDT)
Less Interest

Industry
Factors

Macro-Economic

Cont.

Less
Depreciation
Less Tax

Operational leverage
policy
Tax Planning and
Management

Industry practices

Capital goods import

Industrial lobby

Fiscal Policy

Net Earnings
After Tax
(NEAT)
Less
(Preference
Dividend)

Capital Structure
Policy

Industry Practices

Interest Rate
Structure, Capital
Conditions

Distributable
Earnings
Less
Equity Dividend

Dividend Policy

Industry Practices

Fiscal Policy, Credit

Capital Market conditions

Retained
Earnings

Macro Economic Analysis

The analysis of the following factors indicates the trends in macro
economic changes that effect the risk and return on investments.

Money supply

Industrial production

Capacity utilisation

Unemployment

Inflation

Growth in GDP

Cont.

Institutional lending

Stock prices

Monsoons

Productivity of factors of production

Fiscal deficit

Credit/Deposit ratio

Stock of food grains and essential commodities

Industrial wages

Foreign trade and balance of payments position

Status of political and economic stability

Industrial wages

Technological innovations
Cont.

Infrastructural facilities

Economic and industrial policies of the government

Debt recovery and loans outstanding

Interest rates

Cost of living index

Foreign investments

Trends in capital market

Stage of the business cycle

Foreign exchange reserves

Cont.

Macroeconomic Analysis
The government employs two broad classes of macroeconomic policies,
viz. demand-side policies and supply-side policies.
Fiscal Policy
Fiscal policy is concerned with the spending and tax initiatives of the
government. It is the most direct tool to stimulate or dampen the economy.
Monetary Policy
The main tools of monetary policy are:

Open market operation

Bank rate

Reserve requirements

Direct credit controls

Economic Forecasting
Economic forecasting is a must for making investment decision.
Forecasting techniques can also be divided and categories: Short-term
forecasting techniques and Long-term forecasting techniques.
Techniques used

Economic indicators

Diffusion index

Surveys

Economic Model Building

Cont.

Anticipatory Surveys
This is very simple method through which investors can form their
opinion/expectations with respect to the future state of the economy. This
is a survey of expert opinions of those prominent in the government,
business, trade and industry. Generally, it incorporates expert opinion with
construction activities, plant and machinery expenditure, level of inventory
etc. that are important economic activities. Anticipatory surveys can also
incorporate the opinion or future plans of consumers regarding their
spending. So long as people plan and budget their expenditure and
implement their plans accordingly, such surveys should provide valuable
input, as a starting point.

Barometric or Indian Approach

In this approach, various types of indicators are studied to find out how
the economy is likely to behave in future. For meaningful interpretations,
these indicators are roughly classified into leading, lagging and
coincidental indicators.

Diffusion index

A diffusion index is an indicator of the extensiveness or spread of

an expansion or contraction.

It has been developed by the National Bureau of Economic

Research, USA.

There are two main categories of diffusion index.

1. Composite or Consensus Index

2. Component Evaluation Index

Geometric Model Building Approach

The various steps while using this approach are:
1.

Hypothesize the total demand in the economy as measured by its total

income (GNP) based on likely conditions in the country like war,
peace, political instability, economic changes, level and rate of inflation etc.
2. Forecast the GNP figure by estimating the levels of its various
components like:
Consumption expenditure
Private cosmetic investment
Government purchases of goods and services
Net exports

Cont.

3.

Forecasting the individual components of GNP, the analysis then adds

them up to obtain a figure of the GNP.

4.

The analyst compares the total of GNP and arrives at an independent

estimate appropriately. The forecast of GNP is an overall forecast for
internal consistency. This is done to ensure that both his total forecast
and permanent forecast make sense and fit together in a reasonable
manner.

5. Thus the GNP model building involves all the details described
above with a considerable amount of judgment.
6. What has accounted for this suddenly revived economy? One
likely answer is definitely a cut in customs and a corresponding
reduction in excise, which has helped reduce the cost structure of a
number of products. This has made a number of products cheaper in
domestic market and expanded the demand for them in the process.

the