EQUITY RESEARCH

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QUALITATIVE ANALYSIS

The qualitative analysis process must follow three basic steps:

1. Analysis of the Economy

2. Analysis of the Industry
3. Analysis of the Company

1. Analysis of the Economy

Economic Cycles

Economic cycles refer to the ‘rise and fall’ of economic health that most economies go through, every
few years.

In an economic downturn, valuations tend to be negatively impacted as the uncertainties get

magnified.

There are different ways in which an economic trough can affect the valuation of a company.

• When there is a decrease in demand of products

• When export markets dry up
• When prices of raw materials are volatile
• When capex plans become high-cost sinks.

Macroeconomic Factors

Macroeconomic factors play a very important role in the fortunes of any industry or company.

Each company operates within the realms of the broader economy.

Hence, it is very important to understand these factors and how they affect the performance of a
company, and its stock.

This is the first step in Equity Research.

Key Economic Factors

1. GDP: ‘Gross Domestic Product (GDP)’ is a measure of the country’s overall output in a given
year. The output that is produced by each industry, including agriculture and services, is
added together. That gives the GDP of the country.

2. Industrial Production: This measures the output of industries in the country and compares
it to the same period in the previous year.

3. Inflation: Inflation is defined as the general rise in prices over a given period. Analysts must
look at CPI, as that is what affects consumer demand. WPI and CPI are measured by the rise
in price of a defined basket of goods and services.

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4. Unemployment: An increasing unemployment rate implies lesser jobs, and thus lesser
output. If more people are unemployed, then the overall spending power of the consumers
goes down. This also reduces production.

5. Business & Consumer Confidence: Business and consumer confidence indicate what
businesses and the consumers feel about the present state of the economy.

6. Oil Prices: An increase in oil prices, affects the input costs of all the industries linked to oil,
and consequently the output prices.

7. FIIs: FIIs bring in large amounts of money into the stock market, propelling the market
upwards. On the other hand, when FIIs withdraw from these markets, they can also fall
dramatically. Hence, the role of FIIs, especially in emerging markets, is very significant.

Stock Indices

Given that global markets affect India as well, it is important to track the different benchmark stock
indices across the globe.

S&P 500 Dow Jones Industrial Average (US) NASDAQ (US)

Nikkei 225 (Japan) Hang Seng (Hong Kong) FTSE 100 (UK)
Sensex (India) Nifty India

How do share prices and stock indices move?

The price of a share at a given point in the market is determined by the price at which people are willing
to buy and sell the stock.

How are stock markets interlinked?

All stock indices are interlinked to each other, in differing degrees. When the Dow Jones moves, it is
moving to reflect some event in the US economy.

Most large cap companies in India have clients or business in the US. The U.S being the largest economy
in the world, it is bound to have a ripple affect on Indian companies as well, consequently affecting the
Sensex and the Nifty. Hence, a movement in Dow Jones affects the Sensex as well.

2. Analysis of the Industry

Broad questions one needs to ask about an industry are:

• What are the sub-sectors of a particular industry?

• What are the key revenue drivers in the industry?
• What are the key concerns affecting the industry?

Other Factors

• How many players are there in the industry?

• What are the prospects of the particular industry in the overall economy?

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• How dynamic and volatile is the industry?

How do we define the industry a company belongs to?

We need to understand, where a company’s revenues primarily come from. In case of Infosys, 95% of
revenue comes from IT services, then the company belongs to IT services sector.

What are the key revenue drivers in the industry?

Revenue drivers are important as any impact on them will have a direct impact on the revenue and hence
the valuation of the company. For example, day rate is one such element which affects the revenues of
companies in the oil exploration industry.

What are the key concerns affecting the industry?

This question addresses the biggest concerns that distort the profitability of an industry.

For example, the biggest concern in the oil and gas industry is that it is policy driven, and hence political
considerations could distort the profitability of this industry.

How many players are there in the industry?

This determines the:

• Competition and

• The nature of operating margins that the industry works with.

A classic example is the telecom industry. With new players coming in, the operating margins have been
decreasing year after year.

What are the prospects of the particular industry in the overall economy?
We need to know how a particular industry has developed over the years, and the future trends in the
industry.

How dynamic and volatile is the industry?

The nature of an industry is defined by how often developments take place in the industry that influences
movements in stocks of the companies. An industry where products change often, changing the dynamics
of the market tends to have volatile stock movements.

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3. Analysis of the Company

To begin, we need to ask ourselves the following:
• From where do we get all the information about the company?
• What are the questions that need to be answered, to understand a company well?

From where do we get all the information about the company?

The best resource for information about a company is its website.

Here, you can learn about:

• The business
• The financials
• The management team
• The clients, etc.

Also, one document that details everything about a public company is the ‘Annual Report’.

The annual report of a company talks about:

• The management team

• The company’s business, its performance in the previous year and expectations for the future
• Detailed financial statements of the previous year

Some of the important information we need for equity research is;

1. The Company’s Business and product range: For example Maruti Suzuki is in the business
of passenger car manufacturing. Its product range includes passenger cars, both at entry and
mid level. It also provides services for car financing and car leasing.

2. Revenue Drivers: For example Bajaj Hindusthan Ltd. which is one of the largest sugar
producers in the country, has its revenues impacted by government policies regarding pricing of
both sugar and sugarcane. Other factors like price elasticity also impacts the revenues, and
hence, valuation of the company.

3. Markets, Competitors, Entry Barriers:

o What is the nature of the market in which the company operates?
This will define: How much it can grow – are the entry barriers high or low? and how flexible is
the pricing – how competitive is the market?

o What are the dynamics of the market? Is it fast changing?

For example: If a company is operating in an oligopoly (few sellers, many buyers), it would have
different dynamics, than if it is operating in a perfect competition (many buyers, many sellers).

4. Clients and Suppliers:

• Clients:
ƒ Who are the major clients of the company?
ƒ What industries is the company exposed to, in terms of clients?

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ƒ How are these industries faring in the present economy?

ƒ Does the company have a dependency on a small number of customers?

• Suppliers:
ƒ A vendor or supplier can impact a company’s ability to quickly scale up its operations.

5. Management Team:
The competency of the management is one of the most important factors affecting the
company’s performance.

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