EIC Analysis

Introduction
➢ EIC analysis is the abbreviation of Economic, Industry and Company
analysis
➢ EIC analysis is which analysts always consider before choosing or
reaching any decision about any business
➢ It is also the components of Fundamental Analysis
➢ Fundamental analysis consists of three main parts:
▪ Economic analysis
▪ Industry analysis
▪ Company analysis
Introduction (contd…)
Fundamental Analysis
➢ Fundamental analysis of a business involves analyzing its financial statements and
health, its management and competitive advantages, and its competitors and
markets
➢ Fundamental Analysis aims to understand and forecast the intrinsic value of stocks
based on a thorough analysis of various macro, company-specific as well as
qualitative and quantitative factors
➢ The end goal is to arrive at a number that an investor can compare with a
security's current price in order to see whether the security is undervalued or
overvalued
➢ Fundamental analysis is performed on historical and present data, but with the
goal of making financial forecasts
➢ There are 2 approaches to fundamental analysis as well. They are:
❑ Top-Down approach and
❑ Bottom-up Approach
Fundamental Analysis (contd…)
➢ Fundamental analysis maintains that markets may misprice a security in the short
run but that the "correct" price will eventually be reached. Profits can be made by
trading the mispriced security and then waiting for the market to recognize its
"mistake" and reprice the security
➢ Technicalanalysis maintains that all information is reflected already in the stock
price. Trends 'are your friend' and sentiment changes predicate and predict trend
changes. Investors' emotional responses to price movements lead to recognizable
price chart patterns. Technical analysis does not care what the 'value' of a stock is.
Their price predictions are only extrapolations from historical price patterns
➢ Investors can use any or all of these different but somewhat complementary
methods for stock picking. For example, many fundamental investors use technical
for deciding entry and exit points. Many technical investors use fundamentals to
limit their universe of possible stock to 'good' companies
Fundamental Analysis (contd…)
➢ The choice of stock analysis is determined by the investor's belief in the
different paradigms for "how the stock market works“
➢ Fundamental analysis includes:
✓Economic analysis
✓Industry analysis
✓Company analysis
➢ On the basis of these three analysis the intrinsic value of the shares are
determined. This is considered as the true value of the share. If the intrinsic
value is higher than the market price it is recommended to buy the share. If it is
equal to market price hold the share and if it is less than the market price sell
the shares
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Competitive Advantage
Intrinsic Value
Economic Analysis
➢ The economy is studied to determine if overall conditions are good for
the stock market
➢ Some of the questions that the fundamental analysts would ask to
determine if economic conditions are right for the stock market:
▪ Is inflation a concern?
▪ Are interest rates likely to rise or fall?
▪ Are consumers spending?
▪ Is the trade balance favourable?
▪ Is the money supply expanding or contracting?
Economic Analysis Factors
➢ Macro Economic Factors: The macro economy is the study of all the firms
operates in economic environment. The key variables to describe the state of
economy are,
▪ Growth rate of Gross Domestic Product (GDP)
✓The GDP is a measure of all currently produced goods and services valued at
market prices
✓An economy's overall economic activity is summarized by a measure of
aggregate output
✓As the production or output of goods and services generates income, any
aggregate output measure is closely associated with an aggregate income
measure
✓All goods and services included in the GDP are evaluated at market prices.
Thus, these prices reflect the prices consumers pay at the retail level
Economic Analysis Factors (contd…)
▪ Savings and investment
✓ Growth of an economy requires proper amount of investments which in turn is
dependent upon amount of domestic savings
✓ The amount of savings is favourably related to investment in a country
✓ The level of investment in the economy and the proportion of investment in capital
market is major area of concern for investment analysts
✓ The level of investment in the economy is equal to: Domestic savings + inflow of
foreign capital - investment made abroad
✓ Stock market is an important channel to mobilize savings, from the individuals who
have excess of it, to the individual or corporate, who have deficit of it
✓ Savings are distributed over various assets like equity shares, bonds, small savings
schemes, bank deposits, mutual fund units, real estates, etc.
✓ The demand for corporate securities has an important bearing on stock prices
movements. Greater the allocation of equity in investment, favourable impact it have
on stock prices
Economic Analysis Factors (contd…)
▪ Industry Growth Rate
✓The stock market analysts focus on the overall growth of different industries
contributing in economic development. The higher the growth rate of the
industrial sector, other things being equal, the more favourable it is for the
stock market
▪ Price Level and Inflation
✓The inflation rate is defined as the rate of change in the price level. Most
economies face positive rates of inflation year after year. The price level, in
turn, is measured by a price index, which measures the level of prices of goods
and services at given time
▪ Agriculture and monsoons
✓Agriculture is directly and indirectly linked with the industries. Hence
increase or decrease in agricultural production has a significant impact on the
industrial production and corporate performance
Economic Analysis Factors (contd…)
▪ Interest Rate
✓The nominal interest rate does not represent the real cost of borrowing or the
real return on lending
✓To understand the real cost or return, one must consider the inflation-
adjusted nominal rate, called the real interest rate
✓Tax and other considerations also influence the real cost or return
✓Nevertheless, the real interest rate is a very important concept in
understanding the main incentives behind borrowing or lending
▪ The Tax Structure
✓The business community eagerly awaits the government announcements
regarding the tax policy in March every year. The type of tax exemption has
impact on the profitability of the industries. Concession and incentives given
to certain industry encourages investment in that industry and have
favourable impact on stock market
Economic Analysis Factors (contd…)
▪ Government Budget and Deficit
✓Government plays an important role in the growth of any economy
✓The government prepares a central budget which provides complete
information on revenue, expenditure and deficit of the government for a given
period
✓Government revenue come from various direct and indirect taxes and
government made expenditure on various developmental activities
✓The excess of expenditure over revenue leads to budget deficit
✓For financing the deficit the government goes for external and internal
borrowings. Thus, the deficit budget may lead to high rate of inflation and
adversely affects the cost of production and surplus budget may results in
deflation
✓Hence, balanced budget is highly favourable to the stock market
Economic Analysis Factors (contd…)
▪ Balance of Payment, Forex Reserves and Exchange Rate
✓Balance of payment is the record of all the receipts and payment of a country
with the rest of the world
✓This difference in receipts and payments may be surplus or deficit
✓Balance of payment is a measure of strength of rupee on external account
✓The surplus balance of payment augments forex reserves of the country and
has a favourable impact on the exchange rates; on the other hand if deficit
increases, the forex reserve depletes and has an adverse impact on the
exchange rates
✓The industries involved in export and import are considerably affected by
changes in foreign exchange rates. The volatility in foreign exchange rates
affects the investment of foreign institutional investors in Indian Stock Market
✓Thus, favourable balance of payment renders favourable impact on stock
market
Economic Analysis Factors (contd…)
▪ Infrastructural Facilities and Arrangements
✓Infrastructure facilities and arrangements play an important role in growth
of industry and agriculture sector
✓A wide network of communication system, regular supply or power, a well
developed transportation system (railways, transportation, road network,
inland waterways, port facilities, air links and telecommunication system)
boost the industrial production and improves the growth of the economy
✓Banking and financial sector should be sound enough to provide adequate
support to industry and agriculture
✓The government has liberalized its policy regarding the communication,
transport and power sector for foreign investment
✓Thus, good infrastructure facilities affect the stock market favourable
Economic Analysis Factors (contd…)
▪ Demographic factors
✓The demographic data details about the population by age, occupation,
literacy and geographic location. These factors are studied to forecast the
demand for the consumer goods. The data related to population indicates
the availability of work force. The cheap labour force in India has
encouraged many multinationals to start their ventures. Population, by
providing labour and demand for products, affects the industry and stock
market
▪ Sentiments
✓The sentiments of consumers and business can have an important
bearing on economic performance. Higher consumer confidence leads to
higher expenditure and higher business confidence leads to greater
business investments. All this ultimately leads to economic growth
Central Government Policy
➢ Fiscal policy
✓ It refers to the government’s spending & tax actions
✓ It is part of demand-side management, a direct way to stimulate or slow the
economy
✓ Decrease in government spending deflate the demand for goods and services
✓ Increase in tax immediately drain off income of consumers and result in rapid
decrease in consumption
✓ It is created slowly because fiscal policy requires large amount of compromise
between executive & legislative institutions
✓ To summarize the impact of government fiscal policy look at the government’s
budget deficit or surplus (it is simply difference between revenues and
expenditures)
✓ Large deficit = government spends more than it should be taken. The effect is the
increasing demands for goods (via spending)
Central Government Policy (contd…)
➢ Monetary policy
✓ Refers to the manipulation of the money supply to affect the macro
economy
✓ Works largely through its impact on interest rates
✓ Increases in money supply lower short-term interest rate, encouraging
investment and consumption demand
✓ However, higher money supply leads to a higher price level, and does not
have a permanent effect on economic activity
✓ Other tool is the discount/interest rate that charges banks on short-term
loans and the reserve requirement
✓ Declines in the rate of growth of the money supply business contractions
✓ Increases in the growth rate of money supply business expansions
Industry Analysis
➢ Industry analysis is a market assessment tool used by businesses and analysts to
understand the competitive dynamics of an industry
➢ It helps them get a sense of what is happening in an industry, e.g., demand-supply
statistics, degree of competition within the industry, state of competition of the
industry with other emerging industries, future prospects of the industry taking
into account technological changes, credit system within the industry, and the
influence of external factors on the industry
➢ Industry analysis, for an entrepreneur or a company, is a method that helps to
understand a company’s position relative to other participants in the industry. It
helps them to identify both the opportunities and threats coming their way and
gives them a strong idea of the present and future scenario of the industry
➢ The key to surviving in this ever-changing business environment is to understand
the differences between yourself and your competitors in the industry and use it
to your full advantage
Industry Analysis (contd…)
➢ Industry analysis, as a form of market assessment, is crucial because it helps a
business understand market conditions. It helps them forecast demand and
supply and, consequently, financial returns from the business
➢ Analysis helps to identify which stage an industry is currently in; whether it is
still growing and there is scope to reap benefits, or has it reached its saturation
point
➢ With a very detailed study of the industry, entrepreneurs can get a stronghold
on the operations of the industry and may discover untapped opportunities
➢ It is also important to understand that industry analysis is somewhat
subjective and does not always guarantee success. It may happen that incorrect
interpretation of data leads entrepreneurs to a wrong path or into making
wrong decisions. Hence, it becomes important to collect data carefully
Characteristics of an Industry Analysis
➢ In an industry analysis, the following key characteristics should be considered by the
analyst
✓ Nature of Competition
✓ Raw Material and Inputs
✓ Post sales and Earnings performance
✓ Attitude of Government towards Industry
✓ Management
✓ Labour Conditions and Other Industrial Problems
✓ Nature of Product Line
✓ Capacity Installed and Utilized
✓ Industry Share Price Relative to Industry Earnings
✓ Research and Development
✓ Pollution Standards
Industry Life Cycle Analysis
Industry Life Cycle Analysis (contd…)
➢ Many industrial economists believe that the development of almost every
industry may be analysed in terms of following stages
▪ Embryonic – slow growth, high prices, low volumes until customers
become familiar with the product and companies are able to get
meaningful economies of scale
▪ Growth – rapidly increasing demand, improving profitability, falling
prices, and relatively low competition among companies in the industry.
The threat of new competition entering the industry is usually highest at
this stage a sentry barriers are still relatively low. Industry profitability
tends to rise as economies of scale are attained
▪ Shakeout – slowing growth, intense competition, and declining
profitability. Growth depends increasingly on market share gains requiring
increased focus on reducing their cost structure and building brand loyalty
Industry Life Cycle Analysis (contd…)
▪ Mature – little or no growth, industry consolidation, and relatively
high barriers to entry. Industry growth limited to replacement
demand and population expansion as at this stage the market is
completely saturated. Efficient cost structures and brand loyalty are
significant barriers to entry during this stage and avoiding price
wars maintains stability
▪ Decline – industry growth turns negative, excess capacity develops,
and competition increases. Technological substitution (i.e., cable
news for newspapers), social changes and global competition (i.e.,
low cost foreign textiles) often results in weaker companies exiting
the industry, merging, or redeploying capital
Types of Industry Analysis
➢ There are three commonly used and important methods of performing
industry analysis
➢ The three methods are:
✓ Competitive Forces Model (Porter’s 5 Forces)
✓ Broad Factors Analysis (PEST Analysis)
✓ SWOT Analysis
Competitive Forces Model (Porter’s 5 Forces)
➢ One of the most famous models ever developed for industry analysis,
famously known as Porter’s 5 Forces, was introduced by Michael Porter in
his 1980 book “Competitive Strategy: Techniques for Analyzing Industries
and Competitors”
➢ According to Porter, analysis of the five forces gives an accurate impression
of the industry and makes analysis easier
✓ Intensity of industry rivalry
✓ Threat of potential entrants
✓ Bargaining power of suppliers
✓ Bargaining power of buyers
✓ Threat of substitute goods/services
Competitive Forces Model (Porter’s 5 Forces)
(contd…)
Competitive Forces Model (Porter’s 5 Forces)
(contd…)
➢ Porter identified five determinants of the intensity of competition in an
industry:
▪ Threat of entry – depends on barriers to entry or how difficult it would be
for new competitors to enter the industry
▪ Power of suppliers – they may be able to raise prices or restrict the supply
of key inputs to a company
▪ Power of buyers – this can affect the intensity of competition by exerting
influence on suppliers regarding prices (and possibly other factors such as
product quality)
▪ Threat of substitutes – this can negatively affect demand if customers
choose other ways of satisfying their needs. Low price brands can impact
premium brands when consumer budgets are constrained
▪ Rivalry among existing competitors – a function of the industry's
competitive structure
Broad Factors Analysis (PEST Analysis)
➢ Broad Factors Analysis, also commonly called the PEST Analysis stands for
Political, Economic, Social and Technological. PEST analysis is a useful
framework for analyzing the external environment
SWOT Analysis
➢ SWOT Analysis stands for Strengths, Weaknesses, Opportunities, and Threats. It can be
a great way of summarizing various industry forces and determining their implications
for the business in question
Company Analysis
➢ A thorough company analysis as presented in a research report should:
▪ Provide an overview of the company (corporate profile), including a basic
understanding of its business, investment activities, corporate governance,
and perceived strengths and weaknesses
▪ Explain relevant industry characteristics
▪ Analyze the demand for the company's products and services
▪ Analyze the supply of products and services, which include an analysis of
costs
▪ Explain the company's pricing environment; and
▪ Present and interpret relevant financial ratios, including comparisons over
time and comparisons with competitors
➢ Fundamental analysis is the method of analyzing companies based on factors
that affect their intrinsic value
Company Analysis (contd…)
Company Analysis (contd…)
➢ For company analysis, the internal and external information need to be
studied
➢ Internal information consists of data and events made public by firms
concerning their operations. The principle information sources
generated internally by a firm are its financial statements
➢ External sources of information are those generated independently
outside the company. They provide supplement to internal sources
➢ A good analyst must train himself to understand the kind of flexibility
permitted in accounting and the effect of this flexibility on his
interpretation of what he sees
➢ Followers of fundamental analysis use the quantitative information
gleaned from financial statements to make investment decisions
Company Analysis (contd…)
➢ The main techniques of financial analysis are:
✓ Comparative Financial Statements
✓ Trend Analysis
✓ Common Size Statement
✓ Fund Flow Statement
✓ Cash Flow Statement
✓ Ratio Analysis
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