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Fundamental Analysis
A method of evaluating a security that measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and company-specific factors (like financial condition and management).
Analysis Framework:
These analysis include following 3 steps: Economy Analysis Industry Analysis Company Analysis
Economy Analysis
Industory Analysis
Company Analysis
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The rate of growth is an important variable for investment decision making. The important measure of National income is GDP (Gross domestic product), GNP (Gross national Product) and NNP (Net national product). All of these measures indicate the growth rate of an economy and the growth rate of Pakistan currently is 2.4% (2011) The Real GDP growth is estimated to remain at around 2.4 percent compared to the target of 4.5 percent. The set back was due to the agriculture sector which was badly affected by floods. However, the strong performance of services sector which grew at 4.1 percent has kept the overall growth in a reasonable range
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a) Depression
At the time of depression, demand is low and falling. Inflation is high and so are interest rates. Companies, crippled by high borrowing and falling sales, are forced to curtail production, close down plants built at times of higher demand, and let workers go.
b) Recovery
During this phase, the economy begins to recover. Investment begins anew and the demand grows. Companies begin to post profits. Conspicuous spending begins once again.
c) Boom
In the boom phase, demand reaches an all time high. Investment is also high. Interest rates are low. Gradually as time goes on, supply begins to exceed the demand. Prices that had been rising begin to stabilize and even fall. There is an increase in demand. Then as the boom period matures prices begin to rise again.
d) Recession
The economy slowly begins to downturn. Demand starts falling.. Interest rates and inflation are high. Companies start finding it difficult to sell their goods. The economy slowly begins to downturn.
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Inflation Rate
Inflation has reared its head in the first half of the year and posed a challenge for economic management. Two price indices like CPI and SPI witnessed a clear downtrend in recent months; however, WPI remained on upward trajectory. The inflation rate as measured by the changes in Consumer Price Index (CPI) after reaching peak at 25.3 percent in August 2008, showing easing since November 2008 with slight variations. The average CPI inflation for fiscal year 12, at 11 percent WPI inflation is primarily driven by inordinate spike in cotton prices because of its huge weight in the index. CPI inflation has moderated since January, 2011. The CPI inflation has escalated by 0.23 on month-on- month (M-o-M) basis and 13.2 percent on year- on-year (Y-o-Y) basis in May 2011. The cumulative increase in July-May 2010-11 is 14.0 percent as against 11.6 percent in the comparative period of last year. The recent slow-down in inflation has been due to better availability of food items, increased sugar production and a very good looking wheat crop that is exerting downward pressure on wheat and other products.
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Interest Rates:
The State Bank of Pakistan (SBP) has slashed discount rate by 150 bps to 10.5 percent for a
period of two months, a very surprising and welcome decision for industrialists and business community in the country. The decision was made in the light of controlled inflation that came down to 9.6% in July, while the incentive aimed at giving the private sector a chance to enhance investment for sustainable economic growth.
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Exchange Rate
Exchange rate is the price of one currency in relation to another. In a slightly different perspective, it expresses the national currencys quotation in respect to foreign ones. Thus, exchange rate is a conversion factor, a multiplier or a ratio, depending on the direction of conversion. It is believed that if exchange rates can freely move, it may turn out to be the fastest moving price in the economy, bringing together all the foreign goods with it.
Exchange Rates
Country U.S.A U.K EURO CANADA 5Selling 95.35 153.10 124.61 96.75 Buying 95.15 152.78 124.35 96.55
A stable political environment is necessary for steady, balanced growth. If a country is ruled by a stable government which takes decisions for the long-term development of the country, industry and companies will prosper.
Industry Analysis
Industry analysis is a market strategy tool used by investors to determine about the condition of a particular industry to for making investment decision to invest in that industry by ensuring about the risks and return from the investment in that industry . We will make a an analysis of following industry of Pakistan.
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GAS
Average Daily employment in numbers=20854 Employment Cost (Million Rs.)=4142
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Barrier To Entry
New entrants increase the capacity in an industry and the inflow of funds. The question that arises is how easy is it to enter an industry? There are some barriers to entry:
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Economies of scale Product differentiation Capital requirement Switching costs Access to distribution channels
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It is imperative that one completes the politico economic analysis and the industry analysis before a company is analyzed because the company's performance at a period of time is to an extent a reflection of the economy, the political situation and the industry. What does one look at when analyzing a company? The different issues regarding a company that should be examined are:
PSO
2007 2008 Current Assets Current Assets 6251327 115878692 Current Liabilities
Current Liabilities
51385727 93736220
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Internal Comparison
Shells Current ratio increased significantly as compared to previous year although the volume of current liabilities increased as a whole due to increase in trade payables but current assets grew at a rapid rate. The reason behind this was the significant change in the value of stock in trade. This is due to higher prices of petroleum products during that time and the company is using FIFO method for its inventory. Also, the working capital requirements from the GOP was increased for MNCs.
External Comparison
Shell current ratio increased more rapidly as compared to PSO because PSO current liabilities grew at the same level as their current assets. PSO benefited from not being an MNC.
b. Quick Ratio
Shows a firms ability to meet its current liabilities with its most liquid assets. Formula=
Shell Current Liabilities Current Liabilities
2007 2008
20041859 30220209
19612115 23307811
Inventory Inventory
8244054 18095523
2007 2008
62513273 115878692
51385727 93736220
Inventory Inventory
29562055 62360067
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Internal Comparison
Shells Quick ratio decreased due to higher prices of petroleum products, as the volume allocated for inventories was higher.
External Comparison
There is no significant difference between the decreases of the ratio of both the companies as compared to their previous benchmarks.
2. Leverage Ratio
a. Total debt ratio
Shows the percentage of the firms assets that are supported by debt financing. Formula= Shell 19751156 26053221
2007 2008
29211927 39664859
PSO 2007 2008 Total Debts Total Debts 53798098 96144966 Total Assets Total Assets 74737315 127110020
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0.90
0.80 0.70 0.60 0.50 Shell Pso 0.68 0.66 0.72 0.76
Ratio
Internal Comparison
Shells total debt increased in absolute amount but not at a pace of changing total assets thats why a minor fall in debt ratio is seen.
External Comparison
Psos total debt increased at a higher pace than its total assets mainly due to the change in current liabilities. Overall PSO has become more leveraged than shell. The main reason behind this was the higher amount of GOPs receivables were not paid to PSO and to tackle with cashflow problems the company had to finance more than previous.
2007 2008
9460771 13611638
2007 2008
20929217 30965054
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Internal Comparison
Shells debt to equity ratio decreased due to increase in its retained earnings.
External Comparison
Shell has maintained its debt to equity ratio better than PSO whose ratio has fluctuated apparently than the previous year. This effect can be seen in the previous total debts ratio. The main reason behind that was to finance the excessive receivables not yet paid by GOP.
3. Coverage Ratio
a. Times interest earned
Shows a firms ability to cover its interest charges. Formula= Shell 1166405 8481359 PSO 7949786 22450992
2007 2008
EBIT EBIT
909919 970267
2007 2008
EBIT EBIT
1158112 1367898
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Internal Comparison
Shell has significantly improved its time interest earned ratio due to the massive increase in its operating income.
External Comparison
Although shell interest earned ratio increased significantly but it is still 50 percent as compared to Pso who is at good position.
4. Efficiency Ratios
a. Receivable Turnover
Indicates how successful the firm is in collection of receivable Formula= Shell 130129844 157626491
2007 2008
4905639.5 4578132.5
2007 2008
12657917 23752347
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Internal Comparison
Shell has managed to control its receivable volume with the growing sales level. Thats why a increase in the ratio has been seen which shows its efficiency in collecting receivables while at the same time increasing its sales volume.
External Comparison
Pso s ratio has been deteriorated as compared to previous year which shows its relative inefficiency in collecting receivables as compared to Shell. The main amount of receivables which had affected the figures is from Government of Pakistan and IPPs.
2007 2008
Days Days
26.53 34.43
PSO
2007 2008 Days Days 365 365 Receivable Turnover Receivable Turnover
32.47 24.55
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Internal Comparison
Shell has managed to control its receivable volume with the growing sales level. Thats why a increase in the ratio has been seen which shows its efficiency in collecting receivables while at the same time increasing its sales volume.
External Comparison
Pso s ratio has been deteriorated as compared to previous year which shows its relative inefficiency in collecting receivables as compared to Shell.
2007 2008
COGS COGS
9111970 13169788.5
2007 2008
COGS COGS
28865344 45961061
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9.50
8.00 Shell Pso
Internal Comparison
Shells situation in that particular section has deteriorated significantly because of the large accumulation of inventory, may be not in physical quantities but in rupee amount due to higher oil prices. This can adversely affects the company earnings in the future.
External Comparison
In comparison with Shell Pso has maintained its inventory turnover ratio more efficiently although a decrease in ratio can be seen there also.
2007 2008
Days Days
11.93 9.47
2007 2008
Days Days
11.69 10.12
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38.55
36.06
30.00
28.00 Shell Pso
Internal Comparison
Shells situation in that particular section has deteriorated significantly because of the large accumulation of inventory, may be not in physical quantities but in rupee amount due to higher oil prices. This can adversely affects the company earnings in the future.
External Comparison
In comparison with Shell Pso has maintained its inventory turnover ratio more efficiently although a decrease in ratio can be seen there also.
2007 2008
28752163 34438393
2007 2008
72452919.5 100923667.5
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4.58
Internal Comparison
Shell Total asset turnover remained at the same level as the previous year.
External Comparison
Psos ratio also maintained at its previous level but Pso is more efficient in utilizing its assets overall.
5. Profitability ratios
a. Gross profit margin
Indicates the efficiency of the operations and the firms pricing policies. Formula= Shell 6380502 15150218
2007 2008
130129844 157626491
2007 2008
411057592 583213959
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10.00% Ratio 4.90% 2.98% 0.00% Shell Pso 2007 4.90% 2.98%
9.61% 5.15%
Internal Comparison
GPM of Shell has doubled from the previous year which is a good sign for companys operations. That might because of increasing oil prices.
External Comparison
GPM of Pso also doubled because of the same effect but the overall level of Shell is far higher than Pso.
2007 2008
130129844 157626491
2007 2008
411057592 583213959
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External Comparison
Psos NPM has also improved but not as significant as Shells. In fact the company was in better position as compared to shell previous year.
c. Return on investment
Indicates the profitability on the assets of the firm (after all expenses and taxes). Formula= Shell 706659 5137094
2007 2008
28752163 34438393
2007 2008
72452919.5 100923667.5
Ratio
13.93%
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External Comparison
Shell ROI has increased more massively as compared to Pso.
d. Return on equity
Indicates the profitability to the shareholders of the firm (after all expenses and taxes). Formula=
2007 2008
9808758.5 11536204.5
2007 2008
20876138 25952135.5
54.15%
44.53%
10%
0% Shell Pso
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External Comparison
Despite Shells massive increase in ROE, Pso is still ahead in this respect.
6. Equity ratios
a. Earnings Per Share
The portion of a company's profit allocated to each outstanding share of common stock. Formula= Shell 706659000 5137094000
2007 2008
After After
54790313 54790313
2007 2008
After After
171518901 171518901
Ratio
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External Comparison
EPS of both companies has almost no significant difference but improvement is seen in Shells performance which was far below from Psos level previous year.
2007 2008
12.90 93.76
2007 2008
Per Per
27.34 81.94
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External Comparison
Likewise Psos P/E ratio has also decreased almost to the same level as of Shells.
30286 8244054 4251325 42720 140239 5970763 219715 814530 19713632 29212427
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Current liabilities Current maturity of liabilities against assets subject to finance 56742 32203 lease Short-term running finances utilized under mark-up 4338339 725836 arrangements Short-term loans 1500000 6810000 Trade and other payables 16483008 11912496 Mark-up accrued 157268 131580 Taxation 772454 Total Current liabilities 23307811 19612115 Total Liabilities Total Equity and Liabilities 26053221 19751156 39664859 29211927
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Other operating income Other operating expenses Operating profit Finance cost
Share of profit of associate - net of tax Profit before taxation Taxation Profit after taxation
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337,886 3,264,599 1,160,741 1,119,137 47,689 3,352,969 9,283,021 313,860 22,450,992 1,367,898 21,083,094 294,318 21,377,412 7,323,617 14,053,795 Rupees 81.94
369,328 2,745,289 1,002,712 1,098,157 41,908 755,420 6,012,814 424,238 7,949,786 1,158,112 6,791,674 330,306 7,121,980 2,432,182 4,689,798 Rupees 27.34
Share of profit of associates Profit before taxation Taxation Profit for the year
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