The Fundamental Analysis of a Company

This topic provides a comprehensive overview of fundamental analysis, focusing on the financial statements, management team, and business model of a company. It equips you with the knowledge and skills to evaluate the intrinsic value of a company and make informed investment decisions. By analyzing financial ratios, assessing management quality, and understanding the company's business model, you will be able to identify undervalued or overvalued securities and build a strong investment portfolio.

Financial Statements

Financial statements are like a snapshot of a company's financial health. They provide insights into a company's assets, liabilities, income, expenses, and cash flow. There are three main types of financial statements: the balance sheet, the income statement, and the cash flow statement.

The Balance Sheet

Think of the balance sheet as a snapshot of a company's financial position at a specific point in time. It shows the company's assets, liabilities, and equity.

• Assets: These are what the company owns, such as cash, inventory, and property.
• Liabilities: These are what the company owes, such as loans and accounts payable.
• Equity: This is the owner's stake in the company.

The balance sheet equation is:

Assets = Liabilities + Equity.

The Income Statement

The income statement shows a company's financial performance over a period of time, typically a year. It shows the company's revenue, expenses, and profit or loss.

• Revenue: This is the money a company earns from selling its products or services.
• Expenses: These are the costs incurred by the company, such as salaries, rent, and materials.
• Profit or loss: This is the difference between revenue and expenses.

The Cash Flow Statement

The cash flow statement shows the flow of cash in and out of a company. It helps you understand how a company generates and uses cash.

• Operating activities: This includes cash flows from day-to-day operations, such as sales and expenses.
• Investing activities: This includes cash flows from buying or selling assets, such as property or equipment.
• Financing activities: This includes cash flows from borrowing money or issuing new shares.

Financial Ratios

Financial ratios are like a magnifying glass for a company's financial statements. They help you see a clearer picture of a company's financial health and performance.

Liquidity Ratios

These ratios measure a company's ability to pay its short-term debts.

• Current Ratio: This ratio compares a company's current assets (like cash and inventory) to its current liabilities (like accounts payable). A higher current ratio indicates a stronger ability to pay its short-term debts.
  Current Ratio = Current Assets / Current Liabilities
  

• Quick Ratio: This ratio is similar to the current ratio but excludes inventory, which can be less liquid.
  Quick Ratio = (Current Assets - Inventory) / Current Liabilities
  

Solvency Ratios

These ratios measure a company's ability to meet its long-term debts.

• Debt-to-Equity Ratio: This ratio compares a company's total debt to its total equity. A higher debt-to-equity ratio means the company is relying more on debt financing.
  Debt-to-Equity Ratio = Total Debt / Total Equity
  

• Interest Coverage Ratio: This ratio measures a company's ability to cover its interest expenses with its earnings before interest and taxes (EBIT). A higher interest coverage ratio indicates a stronger ability to meet its debt obligations.
  Interest Coverage Ratio = EBIT / Interest Expense
  

Profitability Ratios

These ratios measure a company's ability to generate profits.

• Profit Margin: This ratio shows how much profit a company makes for every dollar of sales.
  Profit Margin = Net Income / Revenue
  

• Return on Equity (ROE): This ratio measures how efficiently a company uses its shareholders' equity to generate profits.
  ROE = Net Income / Average Shareholders' Equity
  

• Return on Assets (ROA): This ratio measures how efficiently a company uses its assets to generate profits.
  ROA = Net Income / Average Total Assets
  

Efficiency Ratios

These ratios measure how efficiently a company uses its assets and manages its operations.

• Asset Turnover Ratio: This ratio measures how efficiently a company uses its assets to generate sales.
  Asset Turnover Ratio = Revenue / Average Total Assets
  

• Inventory Turnover Ratio: This ratio measures how quickly a company sells its inventory.
  Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
  

Financial Statement Analysis Techniques

Financial statement analysis techniques are tools that help you compare financial statements over time or to industry benchmarks. Here are some common techniques:

Horizontal Analysis

This technique compares financial statements from different periods. It helps you see how a company's financial performance has changed over time.

Percentage change = (Current year amount - Previous year amount) / Previous year amount x 100

For example, if a company's revenue increased from RM100 million to RM120 million, the percentage change would be:

(RM120 million - RM100 million) / RM100 million x 100 = 20%

Vertical Analysis

This technique expresses each item on a financial statement as a percentage of a total amount. It helps you compare the relative importance of different items within a statement.

For example, on a balance sheet, you could express each asset as a percentage of total assets.

Common-Size Analysis

This technique is similar to vertical analysis, but it's used to compare different companies or industries. It involves expressing all items on a financial statement as a percentage of a common base, such as total revenue or total assets.

Trend Analysis

This technique involves analyzing financial statements over a period of time to identify trends and patterns. It can help you identify areas of improvement or concern.

Management Analysis

Management analysis is like assessing the people who are running a company. It helps you understand how well they are managing the business and whether they are making good decisions.

Management Team Evaluation

Corporate Governance

Management Philosophy and Culture

Business Model Analysis

A business model is like a blueprint for a company. It outlines how a company creates value for its customers and generates revenue.

Key Components of a Business Model

The Business Model Canvas

The business model canvas is a visual tool that helps you organize and visualize the key components of a business model. It is a helpful way to understand and communicate a business's strategy.

Competitive Advantage Analysis

To assess a company's competitive advantage, you can use tools like:

• Porter's Five Forces Model: This model analyzes the competitive intensity of an industry by considering factors such as the threat of new entrants, bargaining power of buyers, bargaining power of suppliers, threat of substitute products, and intensity of rivalry.
• SWOT Analysis: This analysis identifies a company's strengths, weaknesses, opportunities, and threats.
• Core Competencies: These are the unique skills and capabilities that a company possesses and that give it a competitive advantage.

By analyzing a company's business model and competitive advantage, you can gain a better understanding of its potential for success and profitability.

Valuation Techniques

Valuation techniques are used to estimate the fair value of a company or its securities. There are two main approaches: intrinsic value estimation and relative valuation.

Intrinsic Value Estimation

This approach aims to determine a company's true value based on its underlying fundamentals.

• Discounted Cash Flow (DCF) Analysis: This method estimates the present value of future cash flows generated by a company.
  DCF = ∑ (CFt / (1+r)^t)
  

  • CFt = Cash flow in year t
  • r = Discount rate
  • t = Time period
• Dividend Discount Model (DDM): This model is used for companies that pay dividends. It estimates the present value of future dividends.
  DDM = D1 / (r - g)
  

  • D1 = Dividend expected in the next period
  • r = Discount rate
  • g = Expected growth rate of dividends
• Comparable Company Analysis: This method compares the valuation of a company to similar companies in the same industry.
• Comparable Transaction Analysis: This method compares the valuation of a company to recent mergers, acquisitions, or IPOs of similar companies.

Relative Valuation

This approach compares a company's valuation to a benchmark, such as the market or other companies in the same industry.

• Price-to-Earnings (P/E) Ratio: This ratio compares a company's stock price to its earnings per share.
  P/E Ratio = Price per Share / Earnings per Share
  

• Price-to-Book (P/B) Ratio: This ratio compares a company's stock price to its book value per share.
  P/B Ratio = Price per Share / Book Value per Share
  

• Price-to-Sales (P/S) Ratio: This ratio compares a company's stock price to its sales per share.
  P/S Ratio = Price per Share / Sales per Share