A Report

On Company Analysis
Course Title: Investment Analysis Course Code: F-604

Submitted to:
Dr. M Farid Ahmed Professor Dept. of Finance University of Dhaka

Submitted By:
S. M. Morsed Al Mamun ID # 22075

Date of submission: 27 December, 2013

ACKNOWLEDGEMENT
At first, all praises belong to Almighty Allah, the most Merciful, who has given me the chance to work on this report. Next, I would like to thank all the speakers whose valuable, resourceful and informative lectures and contents have helped me a lot to work on this report. Their suggestions and cordial help has been of paramount importance. But for their help, the report would have been incomplete. I also express our gratitude to all of our classmates for their cordial help and inspiration. Finally, I do strongly believe that this report will help me a lot to understand different parameters of company analysis. I would like to express sincere gratitude and thankfulness to the Department of Finance, University of Dhaka, for the extended support and specially Professor Dr M Farid Ahmed for his vast supervision, advice, and guidance for the preparation of this report as well as giving me the opportunity to have valuable experiences throughout the work.

EXECUTIVE SUMMARY
Company analysis is the creation of an in-depth evaluation of a corporate entity. In most situations, the analysis will cover all aspects of the company, including finances, profit margins, organizational structure, growth opportunities, market capabilities, diversification/expansion/ strategic plans. The idea behind this type of detailed corporate analysis is to gain an understanding of the general corporate health and prospects for future growth of the corporation. In financial markets, stock valuation is the method of calculating theoretical values of companies and their stocks. The main use of these methods is to predict future market prices, or more generally, potential market prices, and thus to profit from price movement stocks that are judged undervalued (with respect to their theoretical value) are bought, while stocks that are judged overvalued are sold, in the expectation that undervalued stocks will, on the whole, rise in value, while overvalued stocks will, on the whole, fall. In the view of fundamental analysis, stock valuation based on fundamentals aims to give an estimate of their intrinsic value of the stock, based on predictions of the future cash flows and profitability of the business. Fundamental analysis may be replaced or augmented by market criteria what the market will pay for the stock, without any necessary notion of intrinsic value. These can be combined as "predictions of future cash flows/profits (fundamental)", together with "what will the market pay for these profits?" These can be seen as "supply and demand" sides what underlies the supply (of stock), and what drives the (market) demand for stock? In the view of others, such as John Maynard Keynes, stock valuation is not a prediction but a convention, which serves to facilitate investment and ensure that stocks are liquid, despite being underpinned by an illiquid business and its illiquid investments, such as factories. The concern of this report titled Company Analysis and Stock Valuation to convey the idea that the common stocks of good companies are not necessarily good investments. The point is, after analyzing a company and deriving an understanding of its strengths and risks, we need to compute the fundamental intrinsic value of the firms stock and compare the intrinsic value of a stock to its market value to determine if the companys stock should be purchased. The stock of a wonderful firm with superior management and strong performance measured by sales and earnings growth can be priced so high that the intrinsic value of the stock is below its current market price and should not be acquired. In contrast, the stock of a company with less success based on its sales and earnings growth may have a stock market price that is below its intrinsic value. In this case, although the company is not as good, its stock could be the better investment. The classic confusion in this regard concerns growth companies versus growth stocks. The stock of a growth company is not necessarily a growth stock. Recognition of this difference is absolutely essential for successful investing

Introduction to company analysis

Company analysis is a process carried out by investors to evaluate securities, collecting info related to the companys profile, products and services as well as profitability. It is also referred as fundamental analysis. A company analysis incorporates basic info about the company, like the mission statement and apparition and the goals and values. During the process of company analysis, an investor also considers the companys history, focusing on events which have contributed in shaping the company. Also, a company analysis looks into the goods and services proffered by the company. If the company is involved in manufacturing activities, the analysis studies the products produced by the company and also analyzes the demand and quality of these products. Conversely, if it is a service business, the investor studies the services put forward.

How to do a company analysis

It is essential for a company analysis to be comprehensive to obtain strategic insight. Being
a thorough evaluation of an organization, the company analysis provides insight to rationalize processes and make revenue potentials better. The process of conducting a company analysis involves the following steps: The primary step is to determine the type of analysis which would work best for your company. Research well about the methods for analysis. In order to perform a company analysis, it is important to understand the expected outcome for doing so. The analysis should provide answer about what is done right and wrong on the basis of a thorough evaluation. It is, therefore, important6 to make the right choice for the analysis methods. The next step involves implementing the selected method for conducting the financial analysis. It is important for the analysis to include internal and external factors affecting the business. As a next step, all the major findings should be supported by use of statistics. The final step involves reviewing the results. The weaknesses are then attempted to be corrected. The company analysis is used in concluding issues and determining the possible solutions. The company analysis is conducted to provide a picture of the company at a specific time, thus providing the best way of enhancing a company, internally as well as externally.

1. Types of Company and Stocks

1.1 Growth Companies and Growth Stocks

1.1.1. Growth Company

Management has the ability to consistently select investments (projects) that earn higher returns than are required by their risk.

1.1.2

Growth Stock

Earns higher returns than other stocks of equivalent risk. Observers have historically defined growth companies as those that consistently experience above-average increases in sales and earnings. This definition has some limitations because many firms could qualify due to certain accounting procedures, mergers, or other external events. In contrast, financial theorists define a growth company as a firm with the management ability and the opportunities to make investments that yield rates of return greater than the firms required rate of return. This required rate of return is the firms weighted average cost of capital (WACC). As an example, a growth company might be able to acquire capital at an average cost of 10 percent and yet have the management ability and the opportunity to invest those funds at rates of return of 15 to 20 percent. As a result of these investment opportunities, the firms sales and earnings grow faster than those of similar risk firms and the overall economy. In addition, a growth company that has aboveaverage investment opportunities should, and typically does, retain a large portion of its earnings to fund these superior investment projects (i.e., they have low dividend payout ratios). Growth stocks are not necessarily shares in growth companies. A growth stock is a stock with a higher rate of return than other stocks in the market with similar risk characteristics. The stock achieves this superior risk-adjusted rate of return because at some point in time the market undervalued it compared to other stocks. Although the stock market adjusts stock prices relatively quickly and accurately to reflect new information, available information is not always perfect or complete. Therefore, imperfect or incomplete information may cause a given stock to be undervalued or overvalued at a point in time. If the stock is undervalued, its price should eventually increase to reflect its true fundamental value when the correct information becomes available. During this period of price adjustment, the stocks realized return will exceed the required return for a stock with its risk, and, during this period of adjustment, it will be considered a growth stock. Growth stocks are not necessarily limited to growth companies. A future growth stock can be the stock of any

type of company; the stock need only be undervalued by the market. The fact is, if investors recognize a growth company and discount its future earnings stream properly, the current market price of the growth companys stock will reflect its future earnings stream. Those who acquire the stock of a growth company at this correct market price will receive a rate of return consistent with the risk of the stock, even when the superior earnings growth is attained. In many instances, overeager investors tend to overestimate the expected growth rate of earnings and cash flows for the growth company and, therefore, inflate the price of a growth companys stock. Investors who pay the inflated stock price will earn a rate of return below the risk-adjusted required rate of return, despite the fact that the growth company experiences the above-average growth of sales and earnings. Several studies that have examined the stock price performance for samples of growth companies have found that their stocks performed poorlythat is, the stocks of growth companies have generally not been growth stocks.

1.2. Defensive Companies and Stocks

1.2.1 Defensive companies:
A company that has earnings that are relatively insensitive to downturns in the economy. Defensive companies are those whose future earnings are likely to withstand an economic downturn. One would expect them to have relatively low business risk and not excessive financial risk. Typical examples are public utilities or grocery chainsfirms that supply basic consumer necessities.

1.2.2 Defensive stock:

There are two closely related concepts of a defensive stock. First, a defensive stocks rate of return is not expected to decline during an overall market decline, or decline less than the overall market. Second, our CAPM discussion indicated that an assets relevant risk is its covariance with the market portfolio of risky assetsthat is, an assets systematic risk. A stock with low or negative systematic risk (a small positive or negative beta) may be considered a defensive stock according to this theory because its returns are unlikely to be harmed significantly in a bear market.

1.3 Cyclical Companies and Stocks

1.3.1 Cyclical Companies

A cyclical companys sales and earnings will be heavily influenced by aggregate business activity. Examples would be firms in the steel, auto, or heavy machinery industries. Such companies will do well during economic expansions and poorly during economic

contractions. This volatile earnings pattern is typically a function of the firms business risk (both sales volatility and operating leverage) and can be compounded by financial risk.

1.3.2 Cyclical stock:

A cyclical stock will experience changes in its rates of return greater than changes in overall market rates of return. In terms of the CAPM, these would be stocks that have high betas. The stock of a cyclical company, however, is not necessarily cyclical. A cyclical stock is the stock of any company that has returns that are more volatile than the overall marketthat is, high-beta stocks that have high correlation with the aggregate market and greater volatility.

1.4 Speculative Companies and Stocks

1.4.1 Speculative company:
A speculative company is one whose assets involve great risk but that also has a possibility of great gain. A good example of a speculative firm is one involved in oil exploration.

1.4.2 Speculative stock:

A speculative stock possesses a high probability of low or negative rates of return and a low probability of normal or high rates of return. Specifically, a speculative stock is one that is overpriced, leading to a high probability that during the future period when the market adjusts the stock price to its true value, it will experience either low or possibly negative rates of return. Such an expectation might be the case for an excellent growth company whose stock is selling at an extremely high price/earnings ratioi.e., it is substantially overvalued.

1.5 Value versus Growth Investing

Some analysts also divide stocks into growth stocks and value stocks. As we have discussed, growth stocks are companies that will have positive earnings surprises and above-average risk adjusted rates of return because the stocks are undervalued. If the analyst does a good job in identifying such companies, investors in these stocks will reap the benefits of seeing their stock prices rise after other investors identify their earnings growth potential.

1.5.1 Value stocks:

Value stocks are those that appear to be undervalued for reasons other than earnings growth potential. Value stocks are usually identified by analysts as having low price-earning or price-book value ratios. Notably, in these comparisons between growth and value stocks, the specification of a growth stock is not consistent with our preceding discussion.

1.5.2 Growth stock:

A growth stock is generally specified as a stock of a company that is experiencing rapid growth of sales and earnings (e.g., Intel and Microsoft). As a result of this company

performance, the stock typically has a high P/E and price-book-value ratio. Unfortunately, the specification does not consider the critical comparison between intrinsic value and market price. Exhibit 15.1 shows the recent performance of a growth and value stock index for the period 19912001. The two series were very close during 19911996. Growth outperformed during 19981999 but declined substantially in 20002001. Thus, for the total period, value stocks were superior. The major point of this section is that you must initially examine a company to determine its characteristics and subsequently derive an estimate of the intrinsic value of its stock. When you compare this intrinsic value of the stock to its current market price you decide whether you should acquire itthat is, will the stock provide a rate of return equal to or greater than what is consistent with its risk? ECONOMIC, INDUSTRY, AND

STRUCTURAL LINKS TO COMPANY ANALYSIS

2. Economic, Industry and Structural Influence to the Company Analysis

The analysis of companies and their stocks is the final step in the top-down approach to investing. Rather than selecting stocks on the basis of company-specific factors (as with bottom-up analysis), top-down analysts review the current state and future outlook for domestic and international sectors of the economy. On the basis of this macroeconomic analysis, they identify industries that are expected to offer attractive returns in the expected future environment. Following this microanalysis, we value the firms in the selected industries. Our analysis concentrates on the two significant determinants of a stocks intrinsic value: (1) growth of the firms expected cash flows and (2) its risk and the appropriate discount rate.

2.1

Economic and Industry Influences:

If economic trends are favorable for an industry, the company analysis should focus on firms in that industry that are well positioned to benefit from the economic trends. Research analysts should become familiar with the cash flow and risk attributes of the firms they are studying. In times of economic or industry growth, the most attractive candidates may be the firms in the industry with high levels of operating and financial leverage. A modest percentage increase in revenue can be magnified into a much larger percentage rise in earnings and cash flow for the highly leveraged firm. The point is, firms in an industry will have varying sensitivities to economic variables, such as economic growth, interest rates, input costs, and exchange rates. Because each firm is different, an investor must determine the best candidates for purchase under expected economic conditions.

2.2

Structural Influences

In addition to economic variables, other factors, such as social trends, technology, and political and regulatory influences, can have a major effect on some firms in an industry. Some firms in the industry can try to take advantage of demographic changes or shifts in consumer tastes and lifestyles, or invest in technology to lower costs and better serve their customers. Such firms may be able to grow and succeed despite unfavorable industry or economic conditions. For example, Wal-Mart became the nations leading retailer in the 1990s because it benefited from smart management.

The geographic location of many of its stores allowed it to benefit from rising regional population and lower labor costs. Its strategy, which emphasized everyday low prices, was appealing to consumers who had become concerned about the price and value of purchases. Wal- Marts technologically advanced inventory and ordering systems and the logistics of its distribution system gave the retailer a competitive advantage. During the initial stage of an industrys life cycle, the original firms in the industry can refine their technologies and move down the learning curve. Subsequent followers may benefit from these initial actions and can learn from the leaders mistakes and take the market lead away from them. Investors need to be aware of such strategies so they can evaluate companies and their stocks accordingly. Political and regulatory events can create opportunities in an industry even during weak economic periods.

3. Company Analysis
This section groups various analysis components for discussion. Firm Competitive Strategies continues the Porter discussion of an industrys competitive environment. The basic SWOT analysis, is intended to articulate a firms strengths, weaknesses, opportunities, and threats. These two analyses should provide a complete understanding of a firms overall strategic approach. Given this background, we review the fundamental valuation models. In the rest of this paper, we discuss estimating intrinsic value for Walgreens using the two valuation approaches: (1) the present value of cash flows, and (2) relative valuation ratio techniques. Following this, we discuss the significance of site visits to companies, how to prepare for an interview with management, and suggestions on when an investor should consider selling an asset. This is followed by a discussion of unique considerations regarding evaluation of international companies and their stocks. The final section of the chapter discusses the unique features of true growth companies and presents and demonstrates several models that can be used to value growth companies.

4. Firm Competitive Strategies

In describing competition within industries, we identified five competitive forces that could affect the competitive structure and profit potential of an industry. They are: (1) current rivalry, (2) threat of new entrants, (3) potential substitutes, (4) bargaining power of suppliers, and (5) bargaining power of buyers. After you have determined the competitive structure of an industry, you should attempt to identify the specific competitive strategy employed by each firm and evaluate these strategies in terms of the overall competitive structure of the industry. A companys competitive strategy can either be defensive or offensive.

4.1

Defensive competitive strategy:

A defensive competitive strategy involves positioning the firm so that its capabilities provide the best means to deflect the effect of the competitive forces in the industry. Examples may include investing in fixed assets and technology to lower production costs or creating a strong brand image with increased advertising expenditures.

4.2

Offensive competitive strategy:

An offensive competitive strategy is one in which the firm attempts to use its strengths to affect the competitive forces in the industry. For example, Microsoft dominated the personal computer software market by preempting, rivals and its early affiliation with IBM because it became the writer of operating system software for a large portion of the PC market. Similarly, Wal-Mart used its buying power to obtain price concessions from its suppliers. This cost advantage, coupled with a superior delivery system to its stores, allowed Wal-Mart to grow against larger competitors until it became the leading U.S. retailer. As an investor, you must understand the alternative competitive strategies available, determine each firms strategy, judge whether the firms strategy is reasonable for its industry, and, finally, evaluate how successful the firm is in implementing its strategy. In the following sections, we discuss analyzing a firms competitive position and strategy. The analyst must decide whether the firms management is correctly positioning the firm to take advantage of industry and economic conditions. The analysts opinion about managements decisions should ultimately be reflected in, and be the basis for the analysts estimates of the firms growth of cash flow and earnings. Porter suggests two major competitive strategies: low-cost leadership and differentiation. These two competitive strategies dictate how a firm has decided to cope with the five competitive conditions that define an industrys environment. The strategies available and the ways of implementing them differ within each industry.

4.3

Low-Cost Strategy:

The firm that pursues the low-cost strategy is determined to become the low-cost producer and, hence, the cost leader in its industry. Cost advantages vary by industry and might include economies of scale, proprietary technology, or preferential access to raw materials. In order to benefit from cost leadership, the firm must command prices near the industry average, which means that it must differentiate itself about as well as other firms. If the firm discounts price too much, it could erode the superior rates of return available because of its low cost. During the past decade, Wal-Mart was considered a low-cost source. The firm achieved this by volume purchasing of merchandise and lower-cost operations. As a result, the firm charged less but still enjoyed higher profit margins and returns on capital than many of its competitors

4.4

Differentiation Strategy

With the differentiation strategy, a firm seeks to identify itself as unique in its industry in an area that is important to buyers. Again, the possibilities for differentiation vary widely by industry. A company can attempt to differentiate itself based on its distribution system (selling in stores, by mail order, or door-to-door) or some unique marketing approach. A firm employing the differentiation strategy will enjoy above-average rates of return only if the price premium attributable to its differentiation exceeds the extra cost of being unique. Therefore, when you analyze a firm using this strategy, you must determine whether the differentiating factories truly unique, whether it is sustainable, its cost, and if the price premium derived from the uniqueness is greater than its cost

4.5

Focusing a Strategy

Whichever strategy it selects, a firm must determine where it will focus this strategy. Specifically, a firm must select segments in the industry and tailor its strategy to serve these

specific groups. For example, a low-cost strategy would typically exploit cost advantages for certain segments of the industry, such as being the low-cost producer for the expensive segment of the market. Similarly, a differentiation focus would target the special needs of buyers in specific segments. For example, in the athletic shoe market, companies have attempted to develop shoes for unique sport segments, such as tennis, basketball, aerobics, or walkers and hikers, rather than offering only shoes for runners. Firms thought that participants in these activities needed shoes with characteristics different from those desired by joggers. Equally important, they believed that these athletes would be willing to pay a premium for these special shoes. Again, you must ascertain if special possibilities exist, if they are being served by another firm, and if they can be priced to generate abnormal returns to the firm. Exhibit 15.2 details some of Porters ideas for the skills, resources, and company organizational requirements needed to successfully develop a cost leadership or differentiation strategy. Next, you must determine which strategy the firm is pursuing and its success. Also, can the strategy be sustained? Further, you should evaluate a firms competitive strategy over time, because strategies need to change as an industry evolves; different strategies work during different phases of an industrys life cycle. For example, differentiation strategies may work for firms in an industry during the growth stages. When the industry is in the mature stage, firms may try to lower their costs. Through the analysis process, the analyst identifies what the company does well, what it doesnt do well, and where the firm is vulnerable to the five competitive forces. Some call this process developing a companys story. This evaluation enables the analyst to determine the outlook and risks facing the firm. In summary, understanding the industrys competitive forces and the firms strategy for dealing with them is the key to deriving an accurate estimate of the firms longrun cash flows and risks of doing business. Another framework for examining and understanding a firms competitive position and its strategy is the following SWOT analysis.

5. How to Find Company Information

SWOT Analysis
SWOT analysis involves an examination of a firms strengths, weaknesses, opportunities, and threats. It should help you evaluate a firms strategies to exploit its competitive advantages or defend against its weaknesses. Strengths and weaknesses involve identifying the firms internal abilities or lack thereof. Opportunities and threats include external situations, such as competitive forces, discovery and development of new technologies, government regulations, and domestic and international economic trends. The strengths of a company give the firm a comparative advantage in the marketplace. Perceived strengths can include good customer service, high-quality products, strong brand image, customer loyalty, innovative R&D, market leadership, or strong financial resources. To remain strengths, they must continue to be developed, maintained, and defended through prudent capital investment policies. Weaknesses result when competitors have potentially exploitable advantages over the firm. Once weaknesses are identified, the firm can select strategies to mitigate or correct the weaknesses. For example, a firm that is only a domestic producer in a global market can make investments that will allow it to export or produce its product overseas. Another example would be a firm with poor financial resources that would form joint ventures with financially stronger firms.

Opportunities, or environmental factors that favor the firm, can include a growing market for the firms products (domestic and international), shrinking competition, favorable exchange rate shifts, a financial community that has confidence in the outlook for the industry or firm, or identification of a new market or product segment. Threats are environmental factors that can hinder the firm in achieving its goals. Examples would include a slowing domestic economy (or sluggish overseas economies for exporters), additional government regulation, an increase in industry competition, threats of entry, buyers or suppliers seeking to increase their bargaining power, or new technology that can obsolete the industrys product. By recognizing and understanding opportunities and threats, an investor can make informed decisions about how the firm can exploit opportunities and mitigate threats.

6. Steps to Complete a Company Analysis

1. To begin with Macro (big picture) environmental scan. Drill down to Micro (specific industry/company) scan. To look at the financial statements of a company (at least the past 5 years). 2. To find competitors. Compare and contrast. 3. To use Market Share Reporter to identify the size of the market for a company and how it compares to the rest of the industry. Market share information can also be found in business articles that appear in magazines or newspapers. 4. To look at Mergent Investor Edge and Standard & Poor's Net Advantage for (3rd party-objective) updated analyses of current status as well as 3-5 years projection of your interested company. 5. SWOT Analysis (Strengths, weaknesses, opportunities, & threats). 6. The steps above are a recursive process that to repeat many times

7. How to Analyze a Company's Financial Position

To understand and value a company, investor have to look at its financial position. Fortunately, this is not as difficult as it sounds. Evaluating the financial position of a listed company is quite similar, except investors need to take another step and consider financial position in relation to market value. Let's take a look.

7.1

Start with the Balance Sheet

A company's financial position is defined by its assets and liabilities. A company's financial position also includes shareholder equity. All this information is presented to shareholders in the balance sheet. Let's suppose that we are examining the financial statements of fictitious publicly listed retailer, The Outlet, to evaluate its financial position. To do this, we examine the company's annual report, which can often be downloaded from a company's website. The standard format for the balance sheet is assets, followed by liabilities, then shareholder equity.

7.2

Current Assets and Liabilities

Assets and liabilities are broken into current and non-current items. Current assets or liabilities are those with an expected life of less than 12 months. For example, suppose that the inventories that The Outlet reported as of January 31, 2010, are expected to be sold within the following year, whereupon the level of inventory will fall and the amount of cash will rise. Like most other retailers, The Outlet's inventory represents a big proportion of its current assets, and so should be carefully examined. Since inventory requires a real investment of precious capital, companies will try to minimize the value of inventory for a given level of sales, or maximize the level of sales for a given level of inventory. So, if The Outlet sees a 20% fall in inventory value together with a 23% jump in sales over the prior year, this is a sign they are managing their inventory relatively well. This reduction makes a positive contribution to the company's operating cash flows. Learn how to use penny stocks & beat the stock market! Current liabilities are the obligations the company has to pay within the coming year, and include existing (or accrued) obligations to suppliers, employees, the tax office and providers of short-term finance. Companies try to manage cash flow to ensure that funds are available to meet these short-term liabilities as they come due.

7.3

The Current Ratio

The current ratio - which is total current assets divided by total current liabilities - is commonly used by analysts to assess the ability of a company to meet its short-term obligations. An acceptable current ratio varies across industries, but should not be so low that it suggests impending insolvency, or so high that it indicates an unnecessary build-up in cash, receivables or inventory. Like any form of ratio analysis, the evaluation of a company's current ratio should take place in relation to the past.

7.4

Non-Current Assets and Liabilities

Non-current assets or liabilities are those with lives expected to extend beyond the next year. For a company like The Outlet, its biggest non-current asset is likely to be the property, plant and equipment the company needs to run its business. Long-term liabilities might be related to obligations under property, plant and equipment leasing contracts, along with other borrowings.

7.5

Financial Position: Book Value

If we subtract total liabilities from assets, we are left with shareholder equity. Essentially, this is the book value, or accounting value, of the shareholders' stake in the company. It is principally made up of the capital contributed by shareholders over time and profits earned and retained by the company, including that portion of the any profit not paid to shareholders as a dividend.

7.8

Market-to-Book Multiple

By comparing the company's market value to its book value, investors can in part determine whether a stock is under- or over-priced. The market-to-book multiple, while it does have shortcomings, remains a key tool for value investors. (You can read more about the marketto-book multiple in the article Value by the Book.) Extensive academic evidence shows that companies with low market-to-book stocks perform better than those with high multiples. This makes sense since a low market-to-book multiple shows that the company has a strong financial position in relation to its price tag. Determining what can be defined as a high or low market-to-book ratio also depends on comparisons. To get a sense of whether The Outlet's book-to-market multiple is high or low, you need to compare it to the multiples of other publicly listed retailers.

7.9

The Bottom Line

A company's financial position tells investors about its general well-being. A study of it (and the footnotes in the annual report) is essential for any serious investor wanting to understand and value a company properly.