Fundamental Analysis Framework 353ox

Fundamental Analysis Framework Overall Economic Outlook 1. What country is the company based in? 2. How stable is the geo-political structure of the region? a. Is there danger of a war in the area? b. If a war were to break out, would the country be likely to be drawn into it? 3. How stable is the local government? a. Is there significant opposition to the government? b. Is there a significant probability of a coup? 4. What countries are the primary trading partners of the home country? a. What comparative advantages does the country have with its trading partners? b. What comparative disadvantages does the country have with its trading partners? 5. Does the company compete globally, regionally, or locally? 6. What are the current and expected GDP growth rates? a. How does they compare with past growth rates? b. How does they compare with rates for the country’s trading partners? 7. What are the current and expected inflation rates? a. How do they compare with past rates? b. How do they compare with rates for the country’s trading partners? 8. What are the current and expected employment levels? a. How do they compare with past levels? b. How do they compare with levels for the country’s trading partners? c. Is the employment rate so high that employers must bid up wages to obtain workers? 9. What are the current and expected inventory levels? a. How do they compare with past levels? b. How do they compare with levels for the country’s trading partners? 10. What is the strength of the local currency relative to the currency of major trading partners? a. How does this compare with past levels? b. Is currency strength impeding export sales? c. Is currency weakness impeding sales of imported goods?

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© 2002, Robert R. Penn

Industry Outlook 1. In what phase of the industry life cycle is the industry? 2. How does the industry respond to the business cycle? 3. How does each of Porter’s 5 forces affect the industry? a. Competitive rivalry i. Who are the major competitors in the industry? 1. What share of the market does each competitor have? 2. Is the competitor’s market share growing, shrinking, or staying the same? If it is changing, why is it changing? ii. How intensely do they compete? iii. What prevents existing competitors from leaving the industry? iv. What is the level of profit margins? b. Threat of substitution i. What products can be substituted for the industry’s products? ii. What are the costs of substitution? c. Barriers to new entrants i. What prevents new competitors from entering the industry? ii. What protections enable existing competitors to earn significant profits? d. Bargaining power of suppliers i. Are there many suppliers or few? ii. Are product inputs commodities or specialized to meet specific needs? iii. What costs are incurred in switching suppliers? e. Bargaining power of customers i. Are there many customers or few? ii. Are industry products commodities or specialized to meet customer needs? iii. What costs does a customer incur to switch from one product to another? 4. What is the total sales of the industry? 5. What are the major industry products? 6. What products complement the industry’s products? 7. What economic factors drive profitability? 8. What is the impact of changes in technology on the industry? 9. What impact does government regulation have on the industry? 10. What impact do social changes have on the industry? 11. What impact do demographic changes have on the industry? 12. What influence do changes in foreign economic conditions have on the industry? a. Does the industry compete globally, regionally, or locally? b. Are industry supplies affected by foreign conditions? c. Are industry customers affected by foreign economic conditions? 13. What projections can be made about demand? a. Are there different classes of s? b. What are the real and nominal growth rates in each class?

c. Are there trends in usage or demand? Is there cyclic variation in the trends? 14. What projections can be made about supply? a. What is the degree of supplier concentration? b. How easily can new suppliers enter the industry? c. What is the industry capacity of each type of supplier? 15. What is the industry’s profitability level and prospects? a. What is the balance between supply and demand? b. What factors drive costs? c. What pricing flexibility do industry participants have? 16. What impact do international competition and markets provide?

Company Analysis 1. What does the company do or what does it produce? a. Are there multiple product lines? b. How much does each product line contribute to sales? i. What is the trend in product line sales? ii. How much does each product line contribute to profits? iii. What is the trend in product line market share? iv. Where is each product/line in the product life cycle? 2. What competitive strategy does the company follow (cost leadership, differentiation, or focus)? a. How effectively does the company follow it? b. What specific factors does the company use to compete? 3. Who are the company’s closest competitors? 4. Common Size Analysis a. How do the company’s common size balance sheet and income statement compare to its closest competitors? b. How do the company’s common size balance sheet and income statement compare to the industry’s leaders? 5. Ratio Analysis a. Margins (Gross Margin, EBITDA Margin, Operating Margin, and Net Margin) i. What are the trends in each ratio? ii. Is the spread between margins changing? iii. How do the company’s margins compare to its closest competitors? iv. How do the company’s margins compare to the industry’s leaders? b. Turnover (Total Asset Turnover, Fixed Asset Turnover, Equity Turnover, Inventory Turnover) i. What are the trends in each ratio? ii. How do the company’s turnover ratios compare to its closest competitors? iii. How do the company’s turnover ratios compare to the industry’s leaders? c. Return on Investment (Return on Assets, Return on Equity) i. What are the trends in each ratio? ii. How do the company’s return on investment ratios compare to its closest competitors? iii. How do the company’s return on investment ratios compare to the industry’s leaders? d. Management of Fixed Assets (Average age of fixed assets, Degree of operating leverage) i. What are the trends in each ratio? ii. How do the company’s fixed asset management ratios compare to its closest competitors? iii. How do the company’s fixed asset management ratios compare to the industry’s leaders?

e. Liquidity Ratios (Current Ratio, Quick Ratio, Cash Ratio, Receivables Turnover Ratio, Receivables Collection Period, Payables Turnover Ratio, Payment Period, Cash Conversion Cycle) i. What are the trends in each ratio? ii. How do the company’s liquidity ratios compare to its closest competitors? iii. How do the company’s liquidity ratios compare to the industry’s leaders? f. Financial Risk Ratios (Debt/Equity, LT Debt to LT Capital, Interest Coverage, Fixed Charge Coverage, Cash Flow/Interest Expense, Cash Flow Coverage, Cash Flow/LT Debt, Cash Flow from Operations (CFO) to Total Debt, Free Cash Flow to Total Debt, Dividend Payout Ratio, Sustainable Growth Rate) i. What are the trends in each ratio? ii. How do the company’s financial risk ratios compare to its closest competitors? iii. How do the company’s financial risk ratios compare to the industry’s leaders? 6. Analysis of Growth a. At what rate are company sales growing (Current quarter, 1-year, 3-year, and 5-year)? b. At what rate is the company’s operating income growing (Current quarter, 1-year, 3-year, and 5-year)? c. At what rate is the company’s net income growing (Current quarter, 1year, 3-year, and 5-year)? d. What is the company’s potential growth rate? e. What is the company’s sustainable growth rate? f. What factors drive growth? i. Which unit, division, or product contributes most to earnings and revenue growth? ii. Is there reason to believe the current growth rate will be sustained or accelerated in the future? 1. Will demand for the current product or products accelerate? 2. Is there a new product that will keep the growth level up? g. How do growth rates compare to the company’s closest competitors? h. How do growth rates compare to the industry’s leaders? i. How long can the current growth rates be sustained? j. What growth rate can be expected after the end of the current growth period? 7. Business Risk a. What is the variability of net earnings? i. How does net earnings variability compare to the closest competitors? ii. How does net earnings variability compare to the industry’s leaders? b. What is the variability of operating earnings?

i. How does net earnings variability compare to the closest competitors? ii. How does net earnings variability compare to the industry’s leaders? c. What is the variability of sales? i. How does net earnings variability compare to the closest competitors? ii. How does net earnings variability compare to the industry’s leaders? 8. What is the makeup of the management team? a. How long have they been in place, especially the CEO and CFO? b. What is their track record?

Valuation 1. Relative Valuation a. What is the company’s estimated P/E ratio? i. How does it compare to historical values? ii. How does it compare to the company’s closest competitors? iii. How does it compare to the industry’s leaders? b. What is the company’s price to book value ratio? i. How does it compare to historical values? ii. How does it compare to the company’s closest competitors? iii. How does it compare to the industry’s leaders? c. What is the company’s price to cash flow ratio? i. How does it compare to historical values? ii. How does it compare to the company’s closest competitors? iii. How does it compare to the industry’s leaders? d. What is the company’s price to sales ratio? i. How does it compare to historical values? ii. How does it compare to the company’s closest competitors? iii. How does it compare to the industry’s leaders? e. Based on industry chrematistics, which of these are appropriate measures of company performance? 2. Discounted Cash Flow Valuation a. What is the beta for this company? i. What benchmark was used for calculating beta? Why? b. What is the required/expected return for this company’s stock? i. What is the expected market risk ? c. What is the estimated return for the company? i. How does the estimated return compare to the expected return? d. Is the company in a supernormal growth period? i. What is the supernormal growth rate? ii. How long is the supernormal growth expected to last? iii. Will the transition from supernormal growth to normal growth occur quickly or over a transition period? 1. How long is the transition period expected to last? e. Does the company pay dividends? i. What is the dividend payout ratio? ii. How is the payout ratio expected to change in the future? iii. What is the value of the stock using the dividend discount model? f. What is the company’s free cash flow to equity (FCFE)? i. How is FCFE expected to change in the future? ii. What is the value of the stock using the FCFE model? g. Is the company a takeover target? i. Is the company using its cash effectively? 1. Is it a net generator or net of cash? 2. Is it growing above, at, or below its sustainable growth rate?

ii. Does the company have underutilized assets? iii. Does the company have a unique technology that industry leaders need? iv. Is the company a marginal player in a high-growth industry? A declining industry? v. What is the company’s free cash flow to the firm (FCFF)? 1. How is FCFF expected to change in the future? 2. What is the value of the company using the FCFF model?

Portfolio Considerations 1. Company risk and return a. What is the expected return from the company stock? b. What is the expected standard deviation of returns from the company stock? 2. Existing portfolio risk and return a. What is the expected return from the portfolio prior to purchasing the stock? b. What is the expected standard deviation of returns from the portfolio? 3. Combined risk and return a. What is the correlation between the portfolio and the historical returns of the company stock? b. What is the covariance between portfolio returns and the returns from the company stock? c. What proportion of the combined portfolio will be made up of the company’s stock? d. What is the expected return of the combined portfolio? e. What is the expected standard deviation of returns from the combined portfolio?