Understanding the distinction between capital expenses and revenue expenses is crucial in the context of business accounting and financial management. Here's a breakdown of each:

Capital Expenses

• Definition: Capital expenses (CapEx) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, industrial buildings, or equipment. This can also include the cost of major repairs that extend the useful life of an asset.

• Characteristics:

  • Long-term in Nature: Capital expenses are typically long-term investments and provide benefits over several years.

  • Depreciation: These assets depreciate over their useful life. Depreciation is the method of allocating the cost of the asset over its useful life.

  • Improves Future Earnings: The aim of capital expenditure is to improve the future earning capacity of the company.

  • Capitalization: The cost is capitalized, meaning it is recorded as an asset on the balance sheet and not expensed immediately on the income statement.

• Examples: Purchasing machinery, buildings, upgrading technology systems, acquiring new vehicles for business use.

Revenue Expenses

• Definition: Revenue expenses (OpEx) are the costs that are incurred during the regular course of business operations. These expenses are short-term costs and are used to manage day-to-day operations of the business.

• Characteristics:

  • Short-term in Nature: Revenue expenses are typically for the current business period and are not carried forward.

  • Immediate Impact: These expenses are fully expensed in the accounting period they are incurred.

  • Necessary for Daily Operations: These are essential for the maintenance and administration of the business and do not improve the long-term value of any asset.

  • Expensed on Income Statement: These costs are recorded on the income statement and affect the net income of the company.

• Examples: Salaries and wages, utility bills, rent, routine maintenance and repairs, office supplies.

Key Differences

• Duration: Capital expenses are for long-term assets, whereas revenue expenses are for short-term operations.

• Financial Statements: CapEx is capitalized on the balance sheet, while OpEx is expensed on the income statement.

• Purpose: CapEx is for acquiring or improving fixed assets, and OpEx is for day-to-day operations.

• Depreciation: Only capital expenses are depreciated over time.

Understanding these distinctions is essential for proper accounting, tax planning, and financial analysis, as they impact a company's cash flow and profitability in different ways.

Balance Sheet and P&L account:

A balance sheet and a profit and loss (P&L) account are fundamental financial statements used in accounting to track a company's financial performance and position. Each serves a distinct purpose and offers unique insights into the financial health of a business:

Balance Sheet & Profit and Loss Account:

• Definition: A balance sheet is a financial statement that provides a snapshot of a company's financial position at a specific point in time. It lists the company's assets, liabilities, and shareholders' equity.

• Components:

  • Assets: Resources owned by the company, including both current assets (like cash and inventory) and non-current assets (like property and equipment).

  • Liabilities: Obligations owed to external parties, including both current liabilities (like accounts payable) and long-term liabilities (like bank loans).

  • Shareholders' Equity: The residual interest in the assets of the company after deducting liabilities. It includes items like common stock and retained earnings.

• Purpose: To provide stakeholders with information about the company's resources (assets), obligations (liabilities), and the ownership's stake in the company (equity).

Profit and Loss Account (Income Statement)

• Definition: A P&L account is a financial statement that summarizes the revenues, costs, and expenses incurred during a specific period of time, usually a fiscal quarter or year.

• Components:

  • Revenues: Income earned from the company's core business operations.

  • Expenses: Costs incurred in the process of earning revenue, including cost of goods sold, operating expenses, taxes, and interest.

• Purpose: To show how revenues are transformed into the net income or loss, providing insights into the company's operational efficiency and profitability.

Treatment of Capital and Revenue Expenses

• Capital Expenses (Assets):

  • Definition: "Any expenditure the benefit of which goes beyond the balance sheet date is a capital expenditure."

  • Explanation: This means that if a company incurs an expense and the benefits from this expense extend beyond the current accounting year (the date of the balance sheet), it is considered a capital expenditure

  • Recording: Capital expenses are capitalized, meaning they are recorded as assets on the balance sheet. They are not expensed immediately.

  • Depreciation: Over time, these assets are depreciated or amortized (for intangible assets), and this depreciation is recorded as an expense on the income statement.

  • Example: Purchasing a new piece of machinery is a capital expense and is recorded as an asset on the balance sheet.

• Revenue Expenses:

  • Definition: "Any expenditure the benefit of which gets exhausted before the balance sheet date is revenue expenditure."

  • Explanation: This indicates that if the benefits of the expenditure are limited to the current accounting year and do not extend beyond the balance sheet date, then it is classified as a revenue expenditure.

  • Recording: Revenue expenses are recorded on the income statement. They are expensed in the period they are incurred.

  • Impact on Profit/Loss: These expenses reduce the company's net income or increase its net loss for the period.

  • Example: Monthly utility bills are revenue expenses and are recorded as expenses on the income statement.

In summary, capital expenses are recorded as assets on the balance sheet and depreciated over their useful life, affecting the income statement gradually. In contrast, revenue expenses are recorded directly on the income statement and impact the company's profitability in the period they are incurred.

quantitative analysis:

quantitative analysis in fundamental analysis of the stock market:

1. Economy Analysis

The economy analysis looks at the broader economic environment impacting all industries and companies. Here, investors examine several macroeconomic factors:

• GDP Growth Rates: This is a primary indicator of economic health. A growing GDP indicates an expanding economy, often correlating with increased corporate earnings.

• Inflation and Interest Rates: Inflation affects consumer purchasing power and can lead to changes in central bank interest rates. Rising interest rates can dampen economic growth, affecting corporate borrowing costs and investment decisions.

• Unemployment Rates: High unemployment can signal economic trouble, reducing consumer spending and impacting businesses.

• Government Policies: Fiscal (government spending and tax) and monetary (central bank's control over money supply) policies significantly influence economic conditions. For example, a government increasing spending can stimulate economic growth, while tightening monetary policy (increasing interest rates) might slow down inflation but also economic growth.

• External Trade and Balance of Payments: A country’s trade balance (exports vs. imports) and international economic relations influence its economic stability.

2. Industry Analysis

Industry analysis involves examining specific sectors within the economy, and understanding their unique dynamics:

• Sector Growth Trends: Certain sectors might outperform others based on the economic cycle. For example, consumer staples tend to be more resilient during economic downturns than luxury goods.

• Regulatory Environment: Industries like banking, energy, and healthcare are heavily regulated, which can impact their profitability and operations.

• Technological Changes: Rapid advancements in technology can disrupt traditional industries, benefiting some while harming others.

• Supplier and Buyer Power: An industry's profitability can be affected by the bargaining power of suppliers and buyers. If suppliers can demand higher prices or buyers can demand lower prices, the industry’s profitability may be squeezed.

3. Company Analysis

This step is the most detailed, involving a deep dive into a company’s financial and operational metrics:

• Financial Ratios: Investors look at various ratios like P/E, debt-to-equity, return on equity (ROE), current ratio, and more to assess a company’s financial health. These ratios help in comparing companies within the same industry.

• Revenue and Earnings Analysis: Consistent revenue and earnings growth over time are positive indicators. Seasonality in earnings and revenue should also be considered.

• Cash Flow Analysis: Examining a company’s cash flow statements helps understand how it generates and uses cash. It is crucial to assess whether a company is generating sufficient cash to sustain operations and grow.

• Operational Efficiency: Metrics like inventory turnover, sales per employee, and cost of goods sold (COGS) as a percentage of sales help evaluate how efficiently a company is operating.

• Management Effectiveness: The competence and experience of the management team can significantly influence a company's success. Leadership decisions, corporate governance, and strategic direction are critical factors.

• Competitive Positioning: This includes analyzing a company's market share, its competitive advantages (like proprietary technology or brand value), and its position relative to competitors.

• Investor Sentiment and Market Trends: Sometimes, the market’s perception of a company or industry can affect stock prices independently of fundamental factors.

Conclusion

Quantitative analysis in stock market fundamental analysis requires a meticulous examination of a myriad of factors from the macro (economic indicators) to the micro (company-specific metrics). It involves not just looking at the numbers but understanding the stories behind these numbers – how a company operates, how it generates profits, how it manages its resources, and how it stands in relation to the broader market dynamics. This comprehensive approach enables investors to make informed decisions based on solid data and rigorous analysis.

same topic class notes:

Economy Analysis

When analyzing the economy for investment decisions, several key indicators are crucial:

GDP (Gross Domestic Product)

• Definition: Measures the total value of all goods and services produced over a specific time period.

• Relevance: Indicates the size and health of an economy. High GDP growth is often positive for corporate earnings and the stock market.

Inflation

• Definition: The rate at which the general level of prices for goods and services is rising.

• Impact: Moderate inflation is normal, but high inflation can erode purchasing power and profit margins. It also influences central bank policies.

Interest Rates

• Role of Central Banks: Central banks, like the RBI in India, use interest rates to control inflation and stabilize the economy.

• Impact on Investments: Higher interest rates can lead to higher borrowing costs for companies, reducing their profitability. They also affect consumers' spending power.

Forex Reserves

• Definition: The reserves a country holds in foreign currencies.

• Importance: High forex reserves imply economic stability and the ability to manage external shocks. They influence exchange rates and import-export dynamics.

Balance of Payments

• Definition: The record of all economic transactions between the residents of a country and the rest of the world.

• Components: Includes trade balance, foreign investments, and loans.

• Significance: A positive balance indicates more money coming into the country than going out, which is generally favorable for the currency and economy.

Industry Analysis

When the government decides to provide electricity to rural areas, the analysis can shift toward the power sector, encompassing generation, transmission, and distribution.

Power Generation Companies

• Factors to Consider: Capacity utilization, fuel supply agreements, and regulatory environment.

• Potential Impact: Increased demand for electricity generation.

Transmission Companies

• Analysis Points: Grid expansion projects, efficiency in transmission, loss reduction initiatives.

• Opportunities: New projects for grid expansion to rural areas can boost revenues.

Distribution Companies

• Considerations: Tariff structures, efficiency in distribution, and reduction in theft or loss.

• Impact: Expanding services to rural areas might increase operational complexities but also open up new revenue streams.

Company Analysis

When analyzing individual companies, investors look at several financial statements and metrics:

Cash Flow Analysis

• Importance: Assesses the company's ability to generate cash to fund operations, pay debts, and invest in growth.

• Key Metrics: Operating cash flow, investing cash flow, and financing cash flow.

Profit and Loss Account (Income Statement)

• Key Components: Revenue, cost of goods sold (COGS), operating expenses, taxes, and net income.

• Analysis Goals: Understanding the company's profitability trends, margins, and expense management.

Balance Sheet

• Components: Assets, liabilities, and shareholders' equity.

• Analytical Focus: Liquidity position, capital structure, asset quality, and financial health.

Ratios and Metrics

• Examples: Return on Equity (ROE), Debt-to-Equity ratio, Current ratio, Earnings Per Share (EPS), Price to Earnings (P/E) ratio.

• Purpose: To compare financial health, profitability, efficiency, and valuation across companies and over time.

Conclusion

In-depth economic, industry and company analyses involve a comprehensive examination of various metrics and factors. Economic analysis provides a backdrop against which industry and company performances are gauged. Industry analysis helps understand sector-specific dynamics and potential impacts of macro developments. Company analysis dives into financial health, operational efficiency, and future growth prospects. This multi-layered approach is essential for making informed investment decisions in the stock market.

Lecture 3:

Things to be checked in the annual report:

• If an auditor resigns, then it will be a bad sign. Because he might be threatened to give a report in favor of promotor or company.

• If the promoter pledges his shares(takes a loan against his shares) then it is a bad sign. This can be seen under the shareholding option.

• If a bulk deal happens, where the promoter buys shares it is a good sign. If a promoter sells his share then it is a bad sign.

• The auditor’s report discloses important facts of the audit to shareholders. When the report contains ‘true and fair view’ phrase, it is considered as reliable. ‘Opinion paragraph’ and ‘Key audit matters’ paragraphs are very important in the auditor’s report. Just go through it even if you don`t understand anything. In some cases, you will see -ve info in there. This is the auditor's opinion which he shared with the promoter.

Understanding balance sheet:

Equity Share Capital

• Equity Share Capital refers to the amount of money that a company raises through the sale of shares to shareholders. It represents the ownership interest in a company. Here’s a simplified example to illustrate how equity share capital works and how it changes with investment and a share buyback:

  Starting the Company

  • Initial Investment (X): Suppose you start a company and invest ₹10,000. This is your initial equity share capital.

  • Ownership: At this point, you own 100% of the company.

  • Equity Share Capital on Balance Sheet: ₹10,000.

Gaining Investment from Investors

• Investment from Investors (Y): Let's say investors put in ₹40,000 in exchange for shares in your company.

• Total Equity Share Capital Now: Your initial ₹10,000 + Investor's ₹40,000 = ₹50,000.

• Ownership Post Investment:

  • Your ownership: Your investment (₹10,000) / Total Equity Share Capital (₹50,000) = 20%.

  • Investors' ownership: Their investment (₹40,000) / Total Equity Share Capital (₹50,000) = 80%.

• Equity Share Capital on Balance Sheet: ₹50,000.

Company Performs Well and Buys Back Shares

• Buyback Scenario: Now suppose your company performs well, and you decide to buy back ₹20,000 worth of shares from investors.

• New Total Equity Share Capital: Original total (₹50,000) - Buyback amount (₹20,000) = ₹30,000.

• Ownership Post Buyback:

  • Assuming the buyback is from the investors’ shares, the investors now hold shares worth ₹20,000.

  • Your ownership: Your investment (₹10,000) / New Total Equity Share Capital (₹30,000) = ~33.33%.

  • Investors' ownership: Their remaining investment (₹20,000) / New Total Equity Share Capital (₹30,000) = ~66.67%.

• Equity Share Capital on Balance Sheet Post Buyback: ₹30,000.

Key Points

• Value of Shares: The example doesn’t account for any change in the value of the shares. In real scenarios, the value per share may increase if the company is doing well.

• Share Buyback Impact: When a company buys back shares, it reduces the total equity share capital in the market, which can affect the ownership percentage.

• Profit Retention: If the company retains profits instead of distributing them, these retained earnings increase the shareholders' equity but don’t change the share capital unless new shares are issued.

This example provides a basic understanding of how equity share capital works and how it's reflected on the balance sheet. In real-world scenarios, additional factors like share price fluctuations, types of shares issued (like preferred stock), and more complex financial structures can further influence these dynamics.

Analysis using equity share capital value:

1. Issuing New Shares

• Indication: A company may issue new shares to raise capital for various reasons like funding expansion, paying off debt, or acquiring another company.

• Potential Conclusion:

  • Positive View: If the capital is used for growth-oriented activities like expansion or acquisitions, it could signal future growth potential.

  • Negative View: Continual reliance on equity financing might indicate poor cash flow management or difficulty in generating profits. It might also lead to earnings dilution if the additional capital doesn’t lead to proportionate growth in earnings.

2. Share Buybacks

• Indication: Companies buy back shares when they have excess cash and believe their stock is undervalued or to consolidate ownership.

• Potential Conclusion:

  • Positive View: Share buybacks can be seen as a sign of confidence by management in the company’s future. It often leads to an increase in the earnings per share (EPS) and can provide support to the share price.

  • Negative View: If not done for the right reasons, buybacks could indicate a lack of profitable investment opportunities for the excess cash or a way to artificially inflate share prices.

3. Equity Reduction

• Indication: This could be due to share buybacks or restructuring of capital.

• Potential Conclusion: Reduction in equity capital might signal a strategy to improve return on equity (ROE) metrics. However, it could also suggest that the company is shrinking or divesting assets.

4. Frequent Changes in Share Capital

• Indication: Regular increases or decreases in equity share capital could indicate instability in financial strategy.

• Potential Conclusion: Investors might view frequent changes as a sign of uncertainty or poor planning, impacting the company's perceived risk.

5. Stability in Equity Share Capital

• Indication: A stable equity share capital over time suggests no significant new equity issuance or buybacks.

• Potential Conclusion: This can be viewed as a sign of financial stability and operational self-sufficiency, indicating that the company is able to fund its operations and growth from its earnings and cash flows.

Key Considerations

• Context is Crucial: It's important to understand the context behind the changes in equity share capital. For instance, a tech startup might frequently issue new shares for growth, which is typical for its lifecycle stage.

• Complementary Analysis: Equity capital changes should be analyzed in conjunction with other financial metrics like debt levels, cash flow, earnings performance, and overall market conditions.

In summary, changes in equity share capital can provide valuable insights into a company's financial health, growth prospects, and management’s confidence in the company. However, these changes must be interpreted in the context of the overall financial strategy and market conditions.

Note: Generally constant and a decrease in this value means it is a good sign. The continuous increase is a red flag(unless they raise money for a good reason like expansion, acquisition etc)

Reserves and surplus:

• Reserves and surplus – Profits generated from the business which are retained with the company is known as reserves and surplus. General reserves, retained earnings and Securities premium are the most important factors under reserves and surplus. The term Reserves & Surplus is also often called as Other Equity.

  Note: Cash Accounting is not counted only Accrual Accounting is used. So you need to check liquidity or cash flow.
  Definition :
  The accrual system of accounting is a method where revenue and expenses are recorded when they are earned or incurred, regardless of when the cash is actually received or paid. This contrasts with the cash basis of accounting, where transactions are recorded only when cash is exchanged.

  Scenario: Imagine a business, ABC Corp, provides consulting services. In December, they complete a project for a client but don't receive payment until January.

  Accrual Accounting:

  1. Revenue Recognition (December): Even though the cash hasn't been received, ABC Corp records the revenue in December, when the service was completed. Assume the project was for $1,000. So, they record $1,000 as revenue in December.

  2. Receipt of Payment (January): When they receive the payment in January, it does not affect the revenue account since the revenue was already recognized. Instead, it increases their cash or bank balance and decreases their accounts receivable.

Contrast with Cash Accounting:

In cash accounting, ABC Corp would not record the $1,000 as revenue in December. Instead, they would record it in January when they actually receive the cash.

The key difference is the timing of when revenue and expenses are recognized. In accrual accounting, it's when they are earned or incurred, regardless of when the cash transaction happens.

• Format of balance sheet: A balance sheet is a financial statement that provides a snapshot of a company's financial position at a particular point in time. It lists the company's assets, liabilities, and shareholders' equity. The format and specific requirements for balance sheets can vary depending on the regulatory framework and accounting standards in different countries.

  1. Schedule III: In India, Schedule III refers to the format for financial statements prescribed under the Companies Act, 2013. It specifies how the balance sheet and profit and loss statement should be prepared and presented by companies in India. Schedule III is designed to bring uniformity in the presentation of financial statements among different companies in India.

  2. Ind AS (Indian Accounting Standards): Ind AS is a set of accounting standards in India, converging with the International Financial Reporting Standards (IFRS). These standards dictate how various types of transactions and other events should be reflected in financial statements. Companies following Ind AS may have a different presentation of balance sheets compared to those using other accounting standards.

In terms of the Indian stock market, companies listed on Indian stock exchanges follow the requirements of Schedule III and Ind AS for the preparation and presentation of their financial statements. This ensures a standardized and transparent approach to financial reporting, facilitating easier understanding and comparison for investors and other stakeholders.

• Reserves and surplus is the name as per records Schedule III(which is old format). In Ind AS(which is a new format) we will call this "other equity"

• Analyze the 5-year trend for Reserves and surplus if it is continuously increasing then it is a good sign. Example. Larsen and co. Similarly if continuously decreases then it is a bad sign. Eg: Infosys, and Jet airways.

• 3 most important factors inside Reserves and surplus we need to check(you will find them in the note next to Reserves and surplus or other equity value in balance sheet):

  1. General Reserve

  2. Retained Earnings

  3. Securities premium

All these values should be higher and should form 80% of the reserves and surplus value.

1. General Reserve: This is a portion of the profits that a company decides to retain rather than distribute as dividends. The purpose of general reserves is to strengthen the financial position of the company and provide a cushion against future financial contingencies or unexpected liabilities. General reserves are not earmarked for any specific purpose and can be used for any general business need, including future expansion or to offset future losses.

2. Retained Earnings: This is the portion of net profits that is retained by the company after paying out dividends to shareholders. Retained earnings accumulate over time and represent the total profits that have been reinvested in the business rather than distributed. They can be used for a variety of purposes, such as funding business growth, paying off debt, or covering operating expenses. Retained earnings are a critical indicator of a company's financial health and its capacity to self-finance its operations and growth.

3. Securities Premium: When a company issues shares at a price higher than their face value, the extra amount received over and above the face value is known as the securities premium. For instance, if the face value of a share is $10 and the company issues it at $15, the $5 excess is the securities premium. This amount is recorded in the securities premium account, which is a part of the shareholders' equity. The securities premium can be used for various purposes as prescribed by law, such as issuing fully paid bonus shares to shareholders or writing off preliminary expenses of the company.

These components are integral to the equity structure of a company as reflected in its balance sheet and provide insights into how a company manages and allocates its profits

• Equity share capital to reserves to surplus ratio: Lower share capital and higher reserves to surplus means a good sign. Because the company was able to generate nice profits using the small capital they had.

Sample financial metrics for the company:

Here's a table showing the calculation of various financial metrics for the company, along with the explanations for each term:

Explanations:

• Revenue: The total amount earned from sales, here it's 100.

• Cost of Goods Sold (COGS): The direct costs attributable to the production of the goods sold, in this case, 60.

• Gross Profit: Revenue minus COGS, which equals 40.

• EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): This measures a company's overall financial performance and is used as an alternative to simple earnings or net income. Here, it's the same as Gross Profit, 40.

• Depreciation: The reduction in the value of an asset over time, here considered as 10.

• EBIT (Earnings Before Interest and Taxes): A measure of a firm's profit that includes all expenses except interest and income tax expenses. Calculated as EBITDA minus Depreciation, giving 30.

• Interest: The cost incurred by an entity for borrowed funds, here it's 10.

• Profit Before Tax (PBT): It's the profit earned by a company before paying income taxes. EBIT minus Interest, which is 20.

• Tax (30%): Assuming a tax rate of 30%, it's the tax on the PBT, amounting to 6.

• Profit After Tax (PAT): This is the net profit after all expenses, including taxes, have been deducted from revenue. Here, it's PBT minus Tax, which equals 14

In the above example, cash flow from operational activities is 24.(PAT + Depreciation)

• EBIT is also called operating profit. It is crucial to compare company performances.
  Eg:

  

  In the above example, if you consider PAT, you will easily say that company A is performing better than company B. But you should see EBIT because B is managing well with less operating costs. It can payoff interest in the future.(Because it has higher operating profit it can use that to payoff loan)

Return on Capital Employed (ROCE):

Return on Capital Employed (ROCE) is a financial ratio that helps in evaluating the profitability and capital efficiency of a company. Essentially, it measures how well a company is generating profits from its capital employed. The formula for ROCE is:

ROCE=Earnings Before Interest and Tax (EBIT)Capital EmployedROCE=Capital EmployedEarnings Before Interest and Tax (EBIT)​

Capital Employed can be calculated as Total Assets minus Current Liabilities, or as Non-Current Assets plus Working Capital.

Here's an example to illustrate how ROCE is calculated:

Suppose we have a company, XYZ Pvt. Ltd., with the following financials for a given year:

• Earnings Before Interest and Tax (EBIT): ₹50 million

• Total Assets: ₹300 million

• Current Liabilities: ₹100 million

First, we calculate the Capital Employed:

Capital Employed=Total Assets−Current Liabilities=₹300 million−₹100 million=₹200 million capital Employed=Total Assets−Current Liabilities=₹300million−₹100million=₹200million

Now, we calculate the ROCE:

ROCE=EBITCapital Employed=₹50 million₹200 million=0.25 or 25%ROCE=Capital EmployedEBIT​=₹200million₹50million​=0.25 or 25%

This means that for every rupee of capital employed, XYZ Pvt. Ltd. is generating a return of 25 paise. A higher ROCE indicates a more efficient use of capital in generating profits.

When analyzing companies, it's important to compare the ROCE with industry averages or direct competitors to understand the relative performance. Also, it's beneficial to look at the trend in ROCE over time to gauge whether the company's efficiency in using its capital is improving or deteriorating.

P/E Ratio:

P/E Ratio = (Current Market Price of a Share / Earnings per Share)

Price to Earnings Ratio is one of the most widely-used metrics by analysts and investors across the world. It signifies the amount of money an investor is willing to invest in a single share of a company for Re. 1 of its earnings. For instance, if a company has a P/E Ratio of 20, investors are willing to pay Rs. 20 in its stocks for Re. 1 of their current earnings.

Hence, when a company demonstrates high P/E Ratio, it means that either the company is overvalued or is on a trajectory to growth. Another interpretation of a high P/E ratio could be that such a company is expected to have increased revenue in the future and speculation of the same by analysts and investors has led to a surge in its current stock prices.

On the other hand, a low Price to Earnings Ratio signifies undervaluation of stocks, due to any systematic or unsystematic risk of the market. Considering a different interpretation of a low P/E ratio, it could also signify that a company shall perform poorly in the future due to which its stock prices are falling in the present.

Grow blogpost

• Earning per share(EPS): Earnings Per Share (EPS) is a key financial indicator used to measure the profitability of a company. It represents the portion of a company's profit that is allocated to each outstanding share of common stock. EPS is an important metric for investors as it gives a direct insight into the company's profitability on a per-share basis. It's commonly used in valuing and comparing companies in the stock market.

• EPS = PAT(Profit After Tax) / Total number of shares

• For example we calculate EPS of 2023 March for Larsen & Toubro Ltd:
  PAT can be found in profit and Loss statement in money control or Annual report: 7,848.97
  Total number of shares(Can be found in money control under shareholdings tab): 1,405,482,190

  EPS= 7,848.97(cr)/1,405,482,190 = 55.8(approx)

Definition

P/E stands for Price-to-Earnings ratio, a crucial metric in stock market analysis, particularly in the Indian context. Here's a breakdown of what it means and why it's important:

• Price: This refers to the current market price of a company's stock.

• Earnings: This is the profit a company makes, usually considered on a per-share basis (Earnings Per Share, or EPS).

Formula

P/E Ratio= Price per Share (Market price)/Earnings per Share (EPS)

Interpretation

1. High P/E: A high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E ratio. However, it could also indicate that a stock is overvalued.

2. Low P/E: A low P/E ratio could mean the stock is undervalued or that the company is potentially facing difficulties.

Context in the Indian Market

• Different sectors have different average P/E ratios. For instance, technology companies might have higher P/E ratios compared to manufacturing firms.

• The overall market P/E (like Nifty 50's P/E) gives an idea about the valuation of the broader market. A very high market P/E might indicate an overvalued market.

Limitations

• P/E does not account for growth. A company with a high P/E might be growing quickly (growth stocks).

• It doesn’t consider debt. Companies with high debt might have a lower P/E, but that doesn’t necessarily mean they are a better buy.

• P/E is less useful for companies with no earnings (loss-making).

Usage

• It's a quick tool for comparing the valuations of different companies or the market as a whole.

• Often used in conjunction with other financial metrics and qualitative factors for investment decisions.

Remember, while P/E is a handy tool, it's important not to rely on it solely for investment decisions. It's most effective when used in combination with other analysis methods.

P/B and Book Value:

Book value: grow blog

The P/B (Price-to-Book) ratio is a financial metric used to compare a company's market capitalization with its book value. Here's a more detailed explanation and a sample calculation:

Explanation of P/B Ratio:

1. Formula: The P/B ratio is calculated as: P/B Ratio=Market Price per ShareBook Value per ShareP/B Ratio=Book Value per ShareMarket Price per Share​

2. Market Price per Share: This is the current trading price of the company's stock.

3. Book Value per Share: This is calculated by dividing the company's total book value (total assets minus total liabilities) by the number of outstanding shares.

Importance:

• Assessment of Value: It helps investors understand if the stock is undervalued (P/B < 1) or overvalued (P/B > 1) relative to its book value.

• Sector Comparisons: Useful for comparing companies within the same industry.

• Financial Health Indicator: Offers insights into the company's financial stability.

Sample Calculation:

Let's consider a hypothetical company, XYZ Corp.

1. Assumptions:

   • Market Price per Share: $50

   • Total Assets: $1,000,000

   • Total Liabilities: $300,000

   • Number of Outstanding Shares: 10,000

2. Calculate Book Value per Share:

   • Book Value = Total Assets - Total Liabilities = $1,000,000 - $300,000 = $700,000

   • Book Value per Share = Book Value / Number of Outstanding Shares = $700,000 / 10,000 = $70

3. Calculate P/B Ratio:

   • P/B Ratio = Market Price per Share / Book Value per Share = $50 / $70 = 0.71

Interpretation of the Sample P/B Ratio:

• The P/B ratio of XYZ Corp is 0.71, which suggests that the company's stock might be undervalued, as the market price is less than the book value per share.

• This can indicate a potentially good investment opportunity, but it's also essential to consider other factors like the company's future growth prospects, industry conditions, and overall market sentiment.

Caveats:

• The P/B ratio can vary significantly between industries. For instance, tech companies often have higher P/B ratios due to high intangible assets.

• A low P/B ratio does not always mean a stock is undervalued; it might also reflect fundamental issues within the company.

In summary, while the P/B ratio provides useful insights into a company's valuation relative to its book value, it should be used as part of a broader analysis involving various financial metrics and market conditions.

Analysis based on P/B:

For a layman investor, the P/B (Price-to-Book) ratio can offer a relatively straightforward but important assumption or insight about a stock. Here's how to interpret it in simple terms:

1. Basic Understanding:

   • The P/B ratio compares the market's valuation of a company (through its stock price) with its book value (what the company is worth on paper in terms of its assets minus liabilities).

   • A simple way to think about it is how much investors are willing to pay for each dollar of the company's book value.

2. High P/B Ratio (Above 1):

   • When the P/B ratio is high, it suggests that the market price of the stock is much higher than the book value of the company.

   • This can imply that investors expect the company to grow significantly, have strong future earnings, or have valuable intangible assets (like brand reputation or intellectual property) that aren’t fully reflected in the book value.

   • However, it might also signal overvaluation, meaning the stock price might be higher than what the company's financials can justify.

3. Low P/B Ratio (Below 1):

   • A low P/B ratio indicates that the market price is lower than the company’s book value.

   • This could mean the stock is undervalued and potentially a good investment if the market hasn’t recognized the company’s true worth.

   • Alternatively, it could also reflect underlying problems in the company, such as poor future prospects or inefficient management.

4. Use as a Comparative Tool:

   • The P/B ratio is particularly useful when comparing companies within the same industry, as industry standards for this ratio can vary widely.

5. Limitations:

   • The P/B ratio doesn’t work well for all companies, especially those with significant intangible assets (like tech firms) or companies in industries where physical assets aren’t a major factor.

6. Investor Caution:

   • Layman investors should use the P/B ratio as one of many tools for evaluating stocks. It’s important to consider other financial metrics and understand the broader context of the company and its industry.

In summary, for a layman investor, the P/B ratio can offer a quick snapshot of how the market values a company in relation to its book value, which can be a starting point for deciding whether a stock might be undervalued or overvalued. However, it’s important to use this tool in conjunction with other forms of analysis.

Return on Equity (ROE) vs Return on Capital Employed (ROCE):

Return on Equity (ROE) and Return on Capital Employed (ROCE) are both important financial metrics, but they measure different aspects of a company's financial performance.

Return on Equity (ROE)

• Definition: ROE measures the profitability of a company relative to shareholder equity. It's calculated as Net Income divided by Shareholder's Equity.

• Focus: It focuses specifically on the return that a company generates on the equity invested by its shareholders.

• Indication: A high ROE indicates that a company is efficient at generating profits from the equity invested in it. It's particularly important for evaluating the profitability for equity investors.

• Calculation: ROE=Net IncomeShareholder’s EquityROE=Shareholder’s EquityNet Income​

Return on Capital Employed (ROCE)

• Definition: ROCE measures the profitability of a company relative to all of its capital employed, including both equity and debt. It's calculated as Earnings Before Interest and Tax (EBIT) divided by Total Capital Employed (Equity + Debt).

• Focus: It focuses on the return generated from the total capital employed by the company, providing a more comprehensive view of overall operational efficiency.

• Indication: A high ROCE suggests that a company is using its total capital base (both equity and debt) effectively. It's a key metric for evaluating the efficiency of a company in using its capital to generate profits.

• Calculation: ROCE=EBITTotal Capital EmployedROCE=Total Capital EmployedEBIT​

Key Differences

• Scope of Measurement: ROE measures profitability relative to shareholders' equity only, while ROCE measures it against the entire capital employed (equity plus debt).

• Suitability: ROE is more relevant for equity investors as it indicates the return on their investment. ROCE is important for all stakeholders (including creditors) as it assesses overall capital efficiency.

• Risk Consideration: ROE doesn't account for debt, so a high ROE might be achieved through high levels of borrowing, which can be risky. ROCE includes debt in its calculation, providing a more balanced view of profitability relative to all sources of funding.

Conclusion

While both ROE and ROCE provide insights into a company's financial performance, they serve different purposes. ROE is useful for understanding the return on equity investment, while ROCE gives a broader view of how efficiently a company is using all its available capital. Investors and analysts often use both metrics in conjunction to get a more complete picture of a company's financial health.

Fundamental Analysis of a company using 8 factors:

We will compare all 8 points for Larsen & Toubro Ltd 2023 ,March:

1. Current ratio – Current ratio discusses the liquidity position of the company. An ideal current ratio is 2:1. A ratio below 1:1, where current assets are lower than current liabilities is dangerous for the company.

   

   Current ratio = current assets : current liabilities
   \= 222204: 162065
   \= 1.371079505136828(which is not above 2 buts still good as doesn`t go below 1)
   So it scored 1 point: Score: 1

2. Debt to Equity – The ratio of Long-Term Debt (Loan Funds) - Equity (Share Capital + Reserves and surplus) is known as the Debt to Equity Ratio. A debt-free company is an amazing position. The debt: equity ratio higher than 2:1 is considered to be dangerous.

   For Debt consider Long Term Borrowings under Non-current Liabilities(in money control or annual report of the balance sheet)

   

   Debt to Equity = Long Term Borrowings : Total Share Holders Funds
   \= 9,390.85 : 71527.95
   \= 0.13(which is very good, max 2 is allowed)
   So it scored another 1 point: Score: 2

3. ROCE (Return on Capital Employed) – It is calculated as Earnings Before Interest and tax (EBIT) EBIT divided by capital employed multiplied by 100. (Capital Employed = Shareholder’s fund + Non-current liabilities). ROCE = EBIT/CE *100
   You can calculate it or it is readily available on money control(Under Financials -> Ratios)

   

   Which Literally means this is the amount of profit(interest) you will get. It should be above 10%(If you get below 10% there is no point in entering into stock. You will get 9%+ in debentures, bonds, etc)

   ROCE= 14.63. Its value is above 10.
   So it scored another 1 point: Score: 3

4. Inventory turnover ratio – This ratio determines the number of times inventory (goods) is manufactured or sold. For example, If the inventory turnover ratio for the company is 8, it means that the cycle of manufacturing and selling the entire inventory (goods) happened 8 times within 1 year.

   

   Ideally, I should increase if we observe data from the last 5 years. Last 2 years turn over ratio has been poor. So it is a red flag.
   So it doesn`t score any point here: Score: 3

5. P/E ratio (Price to Earning) - P/E ratio is calculated as market price per share divided by earnings per share. An investor should always compare company’s PE with industry’s PE. If company’s PE is less than the industry’s PE, then an investor may buy such a share. This is because we are getting the share at cheaper valuations as compared to the industry. However, an investor must also understand the reason behind cheaper valuations. If all the other ratios are showing a negative picture, it means that the company does not deserve a good valuation and thus it is cheaper and thus the investor should not invest in the same.

   In simple words, it literally means the amount of money an investor is willing to invest in a single share of a company for Re. 1 of its earnings. For instance, if a company has a P/E Ratio of 20, investors are willing to pay Rs. 20 in its stocks for Re. 1 of their current earnings.

   You can find this in the overview of money control.

   

   The TTM(Trailing Twelve Months) PE is 35.36 which is lower than Sector PE i.e. 55.05. So it is a good sign.
   So it scored another 1 point: Score: 4

6. Share capital to reserves or % years trend in reserves: The trend of Reserves and Surplus(Other Capital) in Balance sheet over past 5 years should increase.

   Also, observe the share capital to reserves ratio which is also good.

   

   The trend is increasing over the last 5 years increase. So thumbs up.
   So it scored another 1 point: Score: 5

7. Free cash flow – Free Cash Flow is calculated as cash flow from operation less Net Investments in Fixed Assets. Negative free cash flow for back to back 3-4 years is considered to be dangerous. Free cash flow can be calculated only after downloading the annual report because the figures related to purchase and sales of fixed assets are available as a separate line item under cash flow from investing activity.

    Depreciation – Depreciation is the reduction in the value of assets due to wear ‘n’ tear and technological obsolescence.

    Amortisation – Reduction in the value of intangible assets

   

   Above snip is from annual report

   Free cash flow= Cash flow in operations - Purchase of fixed assets + Sale of fixed assets
   \= 7263.96 - 2396.90 + 161.18
   \= 5028.24 ( 5K crores of free cash flow. which is good )
   So it scored another 1 point: Score: 6

8. Share Holding pattern - Pledged shares: Get the amount of shares pledged by promoters from the share holding pattern. If promoter pledges shares then it is a bad sign.

   

   The shareholding pattern is not available in money control. I`ve got the list from the web. You can see no pledged shares. So it is a good sign.

   So it scored another 1 point: Score: 7

   Summary:
   To conclude it is a good pick. Wait don`t go and buy this. Do the prediction of the target price and also sector analysis. This stock is fundamentally good but also consider the sector growth and also future growth prediction