SOME OF THE USEFUL FUNDAMENTAL FACTORS
It is not easy to make money from the market. All are not lucky to get the money out from there. No doubt some people have earned a lot but some have lost. It is very indefinite. While investing we never consider factors, which are beneficial for the investment. Even you could see how Reliance power Ltd. IPO was successful in collecting amounts. Investors are expecting to collect huge out from here. But the question here arises how will we earn money from the volatile market. In this article I am forwarding following some of the fundamental factors to improve investment Purely from fundamental point of view.
Sales/Revenue Growth
Sales growth is the foundation for the overall investment case. At the most fundamental level, revenues measure the economic acceptance of the company’s products and services and the competitiveness of the offerings relative to its peers. It is also easy to identify and measure. Components to consider in looking at sales/revenue growth include:
-Historical growth rates: A company that learns how to generate consistent year-over-year growth is a winner in anyone’s eyes. Stable sales growth provides powerful insight into data regarding the acceptance and growth of a company’s products.
-Industry growth rate, influences, and trends: The real measure of a company’s revenue growth is its ability to continue growing even as a market begins to mature, when pricing, promotion and positioning come into greater and greater play than product quality alone. Investors should not only examine absolute year over- year growth, but also comparative growth within industry and product groups.
-Declining, stable, or improving competitive position: Companies are expected to use all means available to generate long-term sales growth, and their results are based upon where they are in the marketplace. It’s important for investors to know that a company is doing the things which it needs to in order to improve its competitive position, such as making alliances with channel partners, improving the product range, strengthening the brand/franchise and so on. When measuring competitive positioning, look at a company’s market share data and sales growth in comparison to its competitors. It is also important to qualitatively evaluate how fast the company is innovating and adding new products, as well as if the company is entering new markets.
Operating Margins
Operating margins are a simple but fairly accurate measure of profitability. Stabilizing or improving margins, particularly for value stocks, indicate well for upward valuation adjustments as the firm’s competitive position is seen to stabilize and hopefully strengthen over time. For value managers who are typically accumulating stocks in periods of depressed margins, stabilization is an important sign that fundamentals are improving. In evaluating operating margins, consider the following issues:
-A firm’s operating margins relative to industry margins: Just as with sales growth, comparing a company to its competitors suggests a lot. Investors should look for the best companies within any given industry sector, because stock value is likeliest to rebound among the companies that have the best operating conditions- good operating margins give the management flexibility to use pricing to gain market share in difficult periods.
-A firm’s operating margins, assuming a normal operating environment: Sometimes the operating margins of either a firm or its industry sector will decline from a long-term trend line. If this is the case, look at the current operating margins and business environment to assess whether the company’s operation is temporarily being impacted, or if the industry is in a secular decline. It is not unusual for us to buy a stock that is experiencing a temporary decline in operating margins.
-The level of revenue and assets necessary to sustain operating margins: These are the ratios of sales-to-margin and assets-to-margin. A firm may be maintaining its operating margins, or even improving them, and still be in declining health if it takes an increasing amount of revenue to produce each incremental gain in margin. The same thing is true for assets. A company may be spending more and more on its next generation of plant and equipment for smaller and smaller incremental gains in operating margin, as the company’s leverage begins to disappear in the face of market saturation, and increased competition.
Relative P/E
The price-earnings ratio is the most frequently used and misused valuation ratio. Prudent valuation of a company’s earnings potential includes market and peer group comparisons, factoring in past cycle valuations and growth rate assumptions. In evaluating the price-earnings ratio, consider the following issues:
-Trailing, current, and forward P/E relative to the market and the peer group: Market has long had varying opinions about the value of earnings from company to company, and industry to industry. The value of earnings in an industry such as automobiles, which is capital intensive, versus the value of earnings in an innovative technology company with low to no levels of debt are different, and they should be. Therefore, when looking at earnings, it is important for investors to differentiate between individual company and industry dynamics.
-Trough earnings and peak earnings multiple for the company: Many companies have earnings ranges that rise and fall with various factors, such as economic or industry cycles. The relative P/E of the company is of primary interest. Investors should look at historical P/Es over a long period and compare them to the market and the company’s own history to identify peaks and relative valuation ranges.
-Projected earnings in a “normal” operating environment: Most companies examined are in a state of depressed earnings due to various factors including economic downturns. At these times it is important to look at what the earnings multiple would be in “normal” times, in order to estimate what the company might be worth under better business conditions (based on its own valuation history and industry benchmarks). This figure can then be compared to the current valuation to determine the relative attractiveness of the valuation.
-Improving or deteriorating normalised earnings relative to the last cycle: This is an extension of the point previously made. Once investors come up with normalised earnings, they can plot normalized earnings over time as a set of moving averages, and then calculate the percentage increase or decrease from normalized earnings. This shows the company’s long-term ability to generate earnings in good times or bad, which provides some clues about its future value. Investors should look for companies that have a consistent ability to improve their earnings at a faster rate than the industry as a whole in good times, and that do not deteriorate as rapidly as the industry as a whole in bad times. Investors will pay more for the next rupee of earnings than the last, if they believe that a company can sustain its growth better than the competition.
Positive Free Cash Flow
The greater the cash flow, the greater the opportunity for management to increase shareholder value by either redeploying the proceeds into strategic growth areas or by simply returning the cash to shareholders via share repurchases or dividends. Improving working capital turnover and operating cash flow yield both signal financial flexibility. Issues to examine regarding positive free cash flow include:
-The free cash flow trend: Cash is almost always king in the market. The more cash a company has, the more it can do to improve its competitive position. Investors should look at cash flow on a five-year basis, and look for companies that are increasing their ability to generate cash flow year-over-year.
–Trend in operating cash flow per share relative to EPS: In the best companies, cash flow will rise at least as fast as earnings per share. Investors can calculate the percentage rise year-over-year for both and compare them.Again, the faster that cash flow rises, the more money that is available both for expansion and raising the dividend.
–Working capital turnover trend analysis relative to historic trends and the industry: Working capital turnover is an indication of a company’s operating efficiency and ability to internally fund new growth initiatives. Investors should compare a company’s working capital turnover rate both with the company’s own long-term averages, and with the industry’s long-term average. The best companies will usually be turning capital over at a faster rate.
Conclusion: These are some of the fundamental factors to search good stocks and where we can invest but there are also lots of techniques to identify good stocks in this market so work on your own decision.
