Question

The Relative Importance of Factors of Fundamental Analysis

Fundamental analysis is the process that aims to develop an understanding of the determinants of a company’s value based on the performance of the economy, the company’s industry and the business performance of the company itself. Fundamental analysis considers factors such as: the level and growth rate of the GDP, the evolution of interest rates, the government’s fiscal and monetary policies, the industry’s lifecycle, the financial metrics of competitors’ performance, the company’s profitability and asset basis, and so on.

In this week’s Discussion you will evaluate many of the above factors and select which ones are the most important to consider in evaluating a fair price for a company’s stock through the choice of one of the basic equity valuation models.

To Prepare

• Review this week’s Learning Resources, as well as other resources you may access from the Internet.
• Consider the following:
  • How important is the performance of a company in relation to its competitors independently of the overall state of the economy?
  • To what degree does the particular industry a company is part of affect its own value?
  • Under what conditions do any of the fundamental equity valuation models seem more appropriate for the valuation of a company?

Post by Day 3 a 3- to 6-paragraph assessment of the most important macroeconomic, industry, and company performance factors to consider in the selection and use of one of the fundamental models for determining the company’s fair stock price. Please make sure to include responses to the following specific questions:

• #1What should be the three most important macroeconomic factors to consider for determining a company’s fair value and why?
• #2How does the importance of the selected macroeconomic factors compare to the importance of the company’s industry lifecycle?
• #3What might be a possible relationship between the macroeconomic factors, the industry’s lifecycle and the valuation model (such as the DDM, DCF, or P/E)? Is the choice of the valuation model affected at all by macroeconomic factors and characteristics of the industry? How?

Please address clearly each of the questions in 1-2 paragraphs. Make sure you use APA style for your response(s) and properly cite any resources you have used.

Answer 1

How important is the performance of a company in relation to its competitors independently of the overall state of the economy?

A company’s performance to its competitor is an important factor as:

• Each company in the same industry has a certain percentage of market share which is determined by how these competitors are performing in the market.
• A company’s performance to its competitors is a strong determinant in deciding what the position in terms of market share that the company will hold.
• If the company’s performance to its competitors is weaker or less efficient then it means losing the percentage in market share hence the competitors will gain the surplus market share.
• In a perfect competition market each company is working towards improving its market share as there are many competitors who have identical products to offer and it the company’s performance to its competitor’s deteriorate then it means that the competitors will gain market share and it will be a loss to the company.
• This is the prime reason that every company keeps tap of the competitor’s performance and tries to outperform it as to remain stable in the market.

To what degree does the particular industry a company is part of affect its own value?

The industry’s performance as a whole is an important determinant for determining the performance of the companies part of that industry. This can be better inferred as the individual performances of industries when summed up gives that performance figures of the industry these companies are part of.

If the industry is having a boom or is witnessing growth then it means that the companies functioning in that industry is having a bigger market opportunity to do business and gain more profit.

Suppose as an example ABC Inc. is a company in the real estate industry, now if the real estate industry is booming and people are buying more houses then ABC Inc. has a better opportunity to built and sell houses and make more profits. Suppose in this case instead of making profits the real estate sector is facing downfall then it means that the real estate sector is has less opportunities for ABC Inc. to make more houses and sell it.

If an industry is booming that means that there is more demand in that sector hence this demand is the opportunity for the industries in that sector to supply more and make more profits.

• Under what conditions do any of the fundamental equity valuation models seem more appropriate for the valuation of a company?

The fundamental equity valuation models may be broadly classified as balance sheet methods, discounted cash flow methods and relative valuation method.

Balance sheet valuation method:

Under the balance sheet valuation method the balance sheet entries in the respective heads are utilized to determine the company valuation.

Under the balance sheet valuation method there can be three determinants of company valuation:

• Book Value Method: Under the book value method company net worth is as follows:

Net Worth = Equity Share Capital + Preference Share Capital + Reserves and Surplus – Miscellaneous Expenditures – Accumulated Losses.

• Liquidation Value method: In this method the liquadition value is considered as the value of the entity:

Liquidation Value = Net Realizable Value of All Assets of the company – Amount to be paid to all creditors and preference Share Holders.

• Replacement Cost Method: In this method the value of replacement i.e. the value of equity, is the value of a company.

Equity value = Replacement cost of assets – Liabilities

Discounted cash flow method:

In the discounted cash flow method we find the present value of future cash flows of the company to determine the present value of equity.