Question

‘Financial forecasts are the basis for fundamental equity valuations. An effective forecast model must be based on a thorough understanding of a company’s business, management, strategy, external environment, and historical results.’

Explain how you would assess the fundamental drivers of a business in order to develop the inputs in an equity valuation forecast model.

Answer 1

ANSWER DOWN BELOW. FEEL FREE TO ASK ANY DOUBTS. THUMBS UP PLEASE.

The fundamental drivers to look into in order to develop an effective valuation models are:

1. Debt to equity should be less 1.
2. Interest coverage Ratio should be more than 3.
3. P.E ratio is less than twice of the last three years average EPS growth rate.(valuation purposes)
4. Last three years average Return on Equity (ROE) and Return on Capital Employed (ROCE) both are greater than 20%.
5. Promoters pledge less than 10% of their total shareholdings, or there is a clear indication that it will fall below 10% soon. (better if it is NIL).
6. Last three years CAGR sales growth rate is more than 10%.
7. Last three years CAGR profit growth rate is more than 12%. I.e EPS Growth.
8. There must be High ROE & low P/B value Ratio. P/B below 3 is acceptable. It's it sector specific. Like that of Auto sectors is different from IT sectors(intangible assets).
9. operational and free cash flow per share for past three years are positive.

Also consider the Current Assets/ Current liabilities ratio (Current Ratio) more than 1-2.

Management Analysis:
See the Share holding pattern. If promoters share holding & Institutional shareholding increases then it is a good sign.