Macro Factors for Stock Investing
Lastly, we need to perform the stock analysis i.e., comparing firms on the basis of financial ratios and cash flow analysis.
A bottom-up approach assumes that an individual company might perform well in an industry that is not performing very well. A Bottom-up approach is just the vice versa of the Top-down approach. Making sound decisions based on a bottom-up investing strategy entails a thorough review of the company in question. This includes becoming familiar with the company's products and services, its financial stability and its research reports.
Before discussing the steps of making a company analysis, let us discuss-
What is company analysis?
Company analysis is a process of evaluating a company's value by digging deep into its fundamentals to get a fair view of it.
What are the factors affecting company analysis?
- Qualitative factors take into consideration the business model, competitive advantage, management & corporate governance.
- Quantitative factors deal with the industry growth & the company's growth along with its peers.
Pros & Cons of Company analysis:
- Company analysis helps in understanding & getting the details about a company which further guides our investing decision.
- But on the other hand, too much analysis leads to nowhere, but a lot of questions, doubts & fear which might affect our decision of investing.
How to evaluate company fundamentals?
- Understanding the business model is the primary & essential part of the process of company analysis.
- Analyzing the profit & loss statement along with the balance sheet and the cash flow statement is the next important part of the company analysis process.
- Finally, peer comparison should be made with the available data to get a comparative view of the company.
Let us discuss the steps in the company analysis process: -
1. Identify company and industry’s economic characteristic:
We need to start off by knowing about the company and the industry it operates in. This step will help us in getting an idea as to which part of the value chain does the company fits in as well as its closest peers.
Source – StockEdge
2. Identify and know about the products and/or services:
After getting to know the overview of the company, we need to know the specific products & services offered by the company.
We have to also look at the nature of the product being offered by the firm, uniqueness of the product, demand and supply dynamics, market share, brand awareness in the geographical area it is present in.
For example: IRCTC is the only company which offers the platform to book online railway tickets for travellers. There is no competitor for this type of service in India which is a big positive for the company.
3. Understanding the risks and concerns about the company:
Every business and industry has its own set of specific risks and concerns which might impact the performance and profitability of the company.
So, as an investor it is very important to get an idea as to the risks the company is exposed to in case of any eventualities.
For example, crude oil is an important component in the manufacturing of paints which constitutes around 55% of the raw materials, so the fluctuations in the crude prices will likely impact the EBITDA and the margins of the company manufacturing paints.
So, we need to check and analyse, to which extent will that particular risk affect the business and can the company overcome it.
For example: Currency volatility is an important risk for the IT industry as it generates the majority of the revenues from other countries. Here we need to check how and to what extent will currency appreciation or depreciation impact the company’s performance.
The Company’s Annual Report also contains the risks and concerns that the company is exposed to.
The 'Management Discussion and Analysis' section lists the risks which the company might face in its operations along with the steps it is taking to overcome those situations.
4. Analysing the Financial Statements:
This is one of the most important steps in the process to analyse a company.
The financial statement gives us the actual quantitative picture of any company which is an important part.
Income statement is the financial document that measures a company's financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business earns and incurs its revenues and expenses through both operating and non-operating activities.
From the Balance Sheet we get an idea as to how strong the company financially is. It offers a snapshot of the company's health. It tells us how much a company owns (assets) and how much it owes (liabilities) at a particular point in time. The difference between what it owns and what it owes is its equity, also commonly called "net assets" or "shareholders equity".
The balance sheet is named by the fact that it represents a business' financial structure balances in the following manner:
Assets = Liabilities + Shareholders' Equity
Cash Flow Statements gives us a detailed account of the company’s cash transactions from operating, investing and financing activities. It helps in understanding the firm’s liquidity position. Cash Flow statement is a document which provides aggregate data regarding all cash inflows of a company from both its ongoing operations and external investment sources and all cash outflows on account of business activities and investments during a given quarter or year.
Finally, it is also important to go through the ratios in a comparative manner, in relation to the past periods or relative to the other players in the industry.
As we have come to the end of this module, it is clear that analyzing the macro factors of the economy is vital before investing in stocks. This module has established a basic understanding of why macro elements of the economy are essential and how to apply them when conducting stock analysis for investments. Similarly, we have designed other modules on ELM School that help you get more knowledge on stock investing. So, be sure to check them out as well.