Understanding Equity Analysis

Investing has always attracted people who had savings in hand and wanted to earn higher profits at minimum/acceptable risk. Since early nineteenth century people used to invest in properties, precious metals, spices and other valuable assets/businesses either to earn periodic returns (viz. rents, interest, dividends) or to sale the asset/business interest on appreciation in its value.

images%20(1)

Later, on the onset of public companies and trading of their shares on stock exchanges, investment in listed companies attracted general public for they could buy shares (and become part owner) in the company by investing very small amounts and earn as the company grew.

To ensure the security of their investment, it required the analysis of the company’s potential to earn profits. Hence, Equity analysis is the primary tool for those aspiring to be a successful investor. It helps investors taking decisions with respect to buying, holding (staying invested) and selling a particular stock based on the analysis.

*What is Equity AnalysisPreformatted text

Equity analysis primarily means analysing company’s financial statements by studying and evaluating past and current data, performing ratio analysis and developing financial forecast for near future based on management commentary (financial modelling). It also includes measuring the company’s profitability, liquidity, efficiency in utilization of assets, growth plans and comparing it with other companies of the same industry.

Analysing financial information including financial statements, management discussions/ interviews, ratio analysis etc helps in answering questions like –

  • Does the business have earning quality?

  • Will the earnings sustain over long time?

  • Will it survive the fast-changing business environment and forthcoming competitiveness?

  • Does the company have tools to innovate/improve their products/services as per changing user needs?

  • Is the management dedicated towards achieving company’s goals?

  • Ensuring that the management is not involved in unethical practices which are hurting the company.

Types of equity analysis

Majorly, there are two types of analysis which are used by most analyst –

a) Fundamental analysis –

Fundamental analysis focuses on determining that whether the asset is of more value than its cost.

Fundamental analysis helps the analyst to arrive at the intrinsic value of the company based on the financial data, macro-economic conditions and other quantitative and qualitative analysis. Any news/information which can affect the value of the company is analysed under the fundamental analysis.

b) Technical analysis

Technical analysis is the analysis of price movements in the market. It helps in determining the entry and exit points for the stock. It requires to review historical charts, understand demand-supply dynamics and the impact of available news/ information related to the company/industry. There are various indicators available which helps analysing the long term as well as short term trend in the market.

How it helps in value investing

The premise of value investing is that one should invest in the company when its market price is much lesser than its intrinsic value i.e. the asset is undervalued. Mr. Warren Buffet, an ace value investor, has popularised the concept of value investing. A value investor keeps an eye open for the opportunities where due to any short-term reason the price of an asset is slashed and invests when the investor believes that the reason for downtrend in the price is going to be short-lived and the asset will, in long term, have the higher value than it is going to be paid now. Equity analysis is used in calculating the value of an asset in quantitative terms and to compare it with current market price if the asset is undervalued (Market price < intrinsic value) or overvalued (Market price > intrinsic value).

Is it one time or a continuous process

Equity analysis is a continuous process and requires assessment on periodic basis to assess –

  • Any change in fundamentals of the company

  • Change in earning capacity

  • Change in Product mix and competitive environment

  • Change in management

  • Domestic/global Marco economic changes affecting the business

Above assessment helps in deciding the approach towards investment viz. to continue to hold, to sell or to increase the stake.