[Music] friends welcome to the fifth video in the learn stock market from scratch series by the wall street school now we have understood financial statements we have understood annual reports in the previous videos in case you have not watched them please pause this video watch them and come back again to watch this video because everything is in continuation now from the financial statements and from the annual reports let's move ahead let's try to gauge the financial health of the company using fundamental analysis fundamental analysis is done through various ratios and in this video we're going to cover some of those ratios here along with that we're also going to cover the industry and the competition so that we can take an informed decision about a company so please do not skip any part of the video as we're going to take up lot of practical examples in real time so that you understand in a more lucid manner so let's get started [Music] how to do fundamental analysis of companies let's try to understand from this video in the words of the great warren buffet he says price is what you pay and value is what you get we have to understand the difference between price and what value a particular stock is or could be now there are two reasons we put money in the stock markets one of course is the price appreciation that we expect from any company second is the dividends that we earn from that stock now with respect to that just pause this video and think of all the different companies when which give good dividends you you know a lot of government companies so let's let's talk of some companies which pay huge amount of dividend suppose nhpc is there ntpc indian oil hindustan zinc bharat petroleum vedanta ptc most of these are government companies rec ongc hpcl coal india those are the companies which pay really really good dividends when they pay and one one of the points of uh you know people putting money in the stock markets is that we let's let's put in the company let's enjoy the dividends at least we'll earn at least more than what the fixed deposits pay us and at the same time let's hope for a price appreciation also for the stock which is fair which is fair expectation to have for any particular company but the game begins now in 1984 berkshire hathaway's letter to the shareholders mr warren buffet has discussed about retained earnings and he says for a number of reasons restricted earnings need not concern us further in this dividend discussions let us turn let us turn to the much more valued unrestricted variety these earnings may with equal feasibility be retained or distributed in our opinion management should choose whichever course makes greater sense for the owners of the business now because if you have earned the net profits there are two treatments possible one you pay it as a dividend second you retain it as an earnings for yourself now this principle is not universally accepted for a number of reasons managers like to withhold unrestricted readily distributable earnings from the shareholders to expand from corporate empire over which the managers ruled to operate from a position of exceptional financial comfort etc but we believe there is only one valid reason for retention unrestricted earnings should be retained only when there is a reasonable prospect that preferably by historical evidences or when appropriate by a thoughtful analysis of the future that for every dollar retained by the corporation at least one dollar of market value will be created for the owners let's read this again for every dollar retained by the corporation at least one dollar of market value will be created for the owners now this means what we just saw all the companies which pay big dividends and this must be in your consideration set also in case you this is how you plan to pay the dividends uh you know to invest in the companies because they paid good dividends let's talk of this company a company called nhpc uh it's a government owned company uh with a dividend yield of almost almost 7.41 percent fantastic much more than a fixed deposit these days and dividend yield with the probability of price appreciation also and you see the stock price performance of nhpc it has varied from 35 to the last 10 years to this and to this so it has remained almost even statements not much change in the price appreciation except for that it is one of the highest dividend paying stocks in terms of the yield so let's try to understand the financials of the company i have their profit and loss account i have their cash flows and i have the balance sheet of the company here for the last 10 years from 2011 till 2020. now if you see this the sales have grown from 5000 to almost 10 000 crores so sales have doubled in last 10 years the net profits of the company they have almost remained flat three to twenty three hundred three thousand two thousand three thousand and almost three thousand crores now you talk of their borrowings sixteen thousand were their borrowings and this last year twenty three thousand two twenty two twenty six crores of their overall borrowings the fixed assets are almost flat not my change now if i were to analyze just the latest year from 20 2019 till 2020 the borrowings grew by four thousand crores almost the boiling is grew by 4000 crores and companies sitting on 10 000 crores of sales and has borrowings of almost 23 000 crores so four thousand of additional borrowings the company has a dividend yield of seven percent all right however it pays nearly fifteen hundred crores as dividends out of the total profits of two eight seven four crores and and the company sits on on 23 000 crores of debt on a sales of 10 000 crores my sales have doubled my profits have almost remained flat but i'm i'm big enough or big hearty enough to keep on paying this much of dividends every year when my net profits have almost almost remained flat throughout my debt is not going down my debt has remained almost same and i keep on paying dividends 1500 crores of dividend this year and this is consistent and now go back to the letter produced uh you know 1984 letters to the shareholders by warren buffet says what that for every dollar retained by the corporation at least one dollar of market value has to be created for the owners so whatever money you are retaining what value you have created for the owners so for nhpc and for that matter the other companies which we just saw in the video the government companies uh there was a bit of analysis so we made this template you know we we structured this template uh you know in the of course the detailed stock market wizard program will teach you how to make this template but what we learned here was you talk of coal india the value created per rupee of retained earnings is negative 4.55 negative my sales have not even doubled growing at a cager of six percent my operating profit have not even doubled growing at a cagr of six percent my net profits have been this much growing at a cheer of five percent so in total ten years company earned a net profit of 1 lakh 36 000 crores out of which it retained just 32 000 crores and it doled out one lakh 4000 crore as dividends in the last 10 years consolidatedly so dividend is fine but what has been the value created for rupee of retained earnings go back to this letter here that for every dollar retained by the corporation at least one dollar of market value has to be created for the owners for every rupee retained by coal india 4.55 negative value has been created for the owners so dividend is not the core thing why you should put money in any company just see the value created per rupee of retained earnings for that company over here you see the market cap of the company was to like 18 000 crores it in september 20 it was 72 000 crores she equity shareholders have not made money dividend just because you have earned some dividends doesn't mean that you've earned money you're in the stock markets for creating wealth for creating money for yourself the companies have to create money and which will they will reward the shareholders so it's a question of your and my money we got to be savvy in terms of where we want to put our money for the value created per rupee of retained earnings now sample this another company hindustan unilever now you see this here it also gives a phenomenal dividend you see the sales have doubled in last 10 years the operating profits have grown phenomenally at 15 percent their net profits have tripled in the last 10 years operating profit has become more than 3.5 x more than 3.5 x less than 4 x in in last 10 years their net profits have traveled in the last 10 years and out of a total profits earned of 43 867 crores of the company they have retained 9000 crores they have given dividends of almost 34 000 crores so they've also given a great amount of dividend most of the money has gone in dividends but but you see the value created per rupee of retained earnings 46 rupees per rupee of retained earnings see the difference see the difference in coal india they are also giving a major portion as as dividends you talk of hindustan unilever call india negative four point five five negative the market cap was two like eighteen thousand the market cap is seventy two thousand the market cap was sixty one thousand the market cap is four like eighty five thousand it is also giving a major dividend this is also giving a major dividend but you see the sales growth doubled you operating profit fifteen percent you talk of uh coal india just six percent six percent and five percent when it's a question of your and my money we decide the value the price will by default be there that's what warren buffet says price is what we pay value is what we get that's what we need to focus on now if i you know did a bit of analysis at our end and we will teach you in detail about how to come up with analysis for different sectors per se in terms of return on average equity for the different companies and return on average capital employed now what is return on equity it is your net profits divided by your total shareholders equity that how much in money the shareholders have put in and how much did how much profits they have earned from whatever they put in what is your return on average capital employed it is your ebit your operating profit divided by your debt plus equity how much of capital capital constitutes your debt and equity from putting money in terms of debt and equity how much of operating profit you have earned from it so you talk of uh different companies here you talk of coal india ongc bpcl and and and stuff like that uh let's talk about india for example we just saw the example phenomenal 56 percent return on average capital employed 56 percent returns on average capital employed phenomenal 40 percent 39 percent 38 percent 75 percent return on the equity and phenomenal dividends payout almost 121 percent 133 percent 44 percent the dividends paid as a percentage of the net profits of of these companies however the value created per rupee of retained earnings barring bpcl and this is basis the template that i just shared with you which we will learn in the detailed stock market webinar uh that we have in the stock market wizard program it's all negative last 10 years barring bpcn focus on value price will follow go back here for every dollar retained by the corporation at least one dollar of market value will be created for the owners focus on that now in terms of understanding and analyzing any company's financial health what all ratios that we need to consider three broad level parameters profitability solvency efficiency profit margins your gross profit gp margin is your gross profit by sales operating profit is operating profit by sales state margins is your net profits by sales so everything dependent upon your sales will give you the profitability margins liquidity ratios coverage ratios capital structure this will help us understand the liquidity position and capital structure whether the liquid assets are sufficient to meet these short-term obligations for example i want to find out my interest coverage ratio interest coverage ratio the formula is a bit upon my interest that my operating profit is how much times sufficient that i can pay off my interest cost because i have an under an obligation to pay interest once uh once once i have taken debt similarly another important ratio that i need to understand is my debt service coverage ratio it is ebit upon my interest plus short-term data now what is the short-term debt debt which is payable within 12 months so my operating profit is how much time sufficient that i can pay off my interest and my short-term debt which is supposed to be paid within 12 months a higher icr and a higher dscr shows the financial health of a particular company then in terms of seeing the efficiency of a particular company i have the turnover ratios let's talk of asset turnover ratio the formula is my sales upon my assets if it is fixed assets so it is fixed as a turnover ratio so for every one rupee of fixed asset on my assets how much times the sales i have been able to generate so we have return on equity return on capital employed we just saw the formulas in the previous slides this will help us understand how effectively the management is using the assets to generate returns and how efficiently are the assets being utilized and how efficiently is the company managing its working capital i'll take you through uh you know understanding of roc e and roe with practical example uh two different companies we have grasim we have crompton greaves it has an equity share capital of 131 it has a capital of 125 it has reserves of this it has reserves of this it has net worth of 41929 it has net worth of this much the sum of sum of both of these it has total debt of 292903 it has total debt of this much and if so this is done this is done this is done and i have a net profit of 509 crores here and i have net profits of almost four zero two crores here okay now if at all i want to calculate my return on capital employed for this company this will be nothing but my ebit upon the total capital employed which comes out to be just three point four percent and with whereas with respect to crompton grieves it is almost 42.9 percent now see profits the net profits of both the companies are almost same i mean 400 500 crores all the same but the return on capital employed for grasim is just three point four percent the return on capital employed for crop technologies is almost 42 percent because the total net worth is much lesser than that of uh net of grasim compton greaves is able to generate almost as much profit as grass ms but it is doing it with 96 percent less capital as compared to what grasim is that is why there is a difference in terms of the return on capital employed here hence crompton green's return on equity and return on capital employed numbers are much higher as compared to grasim so how much of money we have invested in terms of our capital be it equity be debt and basis that how much of profitability a company has been able to generate so to two different companies but earning almost a similar sort of net profits the return on capital employed for a particular company is lesser and for a particular company is much much much higher because the base is small now in 2007 letters to the shareholder by berkshire hathaway they've defined great business they've defined good business and they've defined gruesome business so as per one buffet he says that charlie and i look for companies that have business we understand a favorable long-term economics and able and trustworthy management and a sensible price tag we'd like to buy the whole business or if management is a partner at least 80 percent but if a business requires a superstar to produce great results the business itself cannot be deemed great a medical partnership led by your areas premier brain surgeon may enjoy outsized and over growing earnings but that tells little about its future the partnership mode will understand more in the next video we'll go when the surgeon goes so you know he has defined great business as the business which has an enduring mode and what is the mode we will discuss this in detail in the next video so as for him the great businesses are the business with with in enduring mode now what is a good business a good business is a company that needs large increases in capital to engender its growth may well prove to be a satisfactory investment and what is a gruesome business a gruesome business is the worst sort of business that grows rapidly requires significant capital to engender the growth and then earns little or no money that is a gruesome business now let's take some practical examples here this is amara raja batteries i have their annual report of 2013 and 14 with me and i've taken a dated annual report there's a reason behind it and the chairman says logic says we should be content nationality guides us to make incremental investments and prudence advises cautious aggression at this juncture we can either be satisfied by the bountiful returns or undertake the challenge of doing the extraordinary that transforms the perception of the brand and the corporate in the minds of the stakeholders and the sector as a whole so here at amara raja we have opted for the later option case in point we initiated our largest capacity augmentation exercise at a time when most corporates chose to put their capex investments on the back burner because we are focused on outperforming the prevailing growth averages and has inevitably made it happen through a combination of superior products distinctly positioning a deeper distribution network great so the efficacy of this approach is reflected in superior numbers which amar raja has posted so from this annual report of 2013-14 i get to know that the company has you know gone for a major capital expansion when many of its competitors have put it on the back burner now let's try to read the numbers of the company now here you go so i have the financials of the company so my sales growth is there and the year i was talking about was 2014 and the operating profit margins of the company are 19 14 15 and so on and as a turnover ratio we just saw what is an asset ratio that is for every one rupee of asset which i have how much sales i have been able to generate now we will learn this how to calculate this through the templates you know in the detailed sessions that we have the asset turnover ratio for this company was 8.25 that means for every one rupee of a set i was able to generate sales of 8.25 times now their net block was 3 58 crores and next year when we saw it you know it increased it it almost doubled so from 358 it became 623 crores here right because we we saw in the last slide that the company has gone for a major expansion and we can see that it was flat and it has gone up here and you see for till 2019 the company's net block has increased from 358 crores to almost 30 1800 crores so my fixed assets have grown at more than almost 5x however my sales if you see from 2014 onwards my sales have just about doubled my fixed assets have grown at more than 5x and you see your asset turnover ratio here it is growing at it has not reached the level at it which was before the capacity expansion here so over here i have reasons to believe that my assets are not being effectively utilized as the they should have been and this is happening over a period of time five six years is a reasonable time for for the assets to augment the sales which has not happened over here for the company as such and it's not a surprise for me you see the margins of the company are almost intact margins of the company are almost intact the way they were these have increased 5x you see the stock price movement of amara raja 2013-14 when it went for a major capacity expansion the stock right zoomed up but it has just been just around flat if you see the stock price in 2021 by the time this goes to shoot it is around 900 rupees also but it has not you know given the returns that was anticipated when the stock was zoomed over here now let's talk of snowman logistics another company now on the face of it you see the sales were 34 crores it became through 223 232 crores growing at a ca of 24 percent the operating profit growing at a change of 22 percent which is fantastic numbers but if you see the sales on a comparative basis of 100 percent for example my sales was 100 you know if it was 34 rupees it is 100 here and rest everything is as a percentage of the sales here so my depreciation was 10 9 10 of my overall sales but if you see along the depreciation has become 20 21 and 18 almost such a big jump here and when the depreciation increases that means you have made lot of investments in your fixed assets and if you go to the balance sheet of the company here now you see your net block the fixed assets was this much which is 25 of your overall assets which has now become almost 74 of your overall assets this means that the fixed assets contribute a major portion of the assets indicating the company's need to keep on making adjustments and fix assets to grow and the borrowings this was a debt-free company here because the company has to con continuously make investments in fixed assets the borrowing is also going up and up and up and up which is impacting the margins and i go back to the to the profit and loss account here a cert turnover ratio one point one six zero point seven nine zero point eight three zero point eight two zero point five six assets you know my sales upon my assets for every one rupee of asset which i have i am able to generate sales just of 0.56 times at that set so despite the fact that my sales have grown at a phenomenal growth rate of 24 percent my net profits have just about doubled growing at a c age of 10 percent because because asset turnover ratio is very low in this case means my assets are not being effectively utilized i have to keep on making investments in my fixes a lot to ensure that my to my that my sales generate and this is not a number 1.16 it was 10 years back it is 0.56 now almost half go back to what uh the the great and the good and the gruesome businesses were defined it's said that the worst sort of business that grows rapidly requires significant capital to engineer the growth and then earn little or no money so despite the fact that the company's sales was growing at such a rate see the stock moment of snowman logistics in the last five years it has been just one way trajectory and there's so many examples so many more examples of great good and the gruesome businesses which we'll discuss in the detailed stock market visit workshop but i want to discuss with you a very important thing the cumulative profit after taxes what versus the cumulative cash flows we have understood the cash flows the balance sheet and the uh the income statement in the previous videos now over here understand friends that a company that makes a sale of any product today might not receive its payments from debtors and debtors might show now because as the accounting norms allow the sales to be shown even if they have they have actually not been received so this year sales can be you know can be shown even if they have still not been received it can be shown as debtors and money received from the buyers will reflect be reflected in the cash flows only when the money is actually received from the buyers and if we compare the profit after tax and cash flows for only one year they would be different but over a period of time especially for the fmcg players or the business which is more into b2c sort of a segment over a period of time the cumulative profit after tax and cumulative cash flows should be similar you know and you know direction they should be in a similar lines because if it is it means that the company is able to collect its profit in actual cash from its buyers if cash flow from operation is lower it would mean that either the company is though legitimately eligible to receive money from buyer is not able to collect it or the profits are fictitious and fictitiousness of the financials can be gauged to this very simple trick here in either case the investors should avoid such a company now what i mean by this is let's see some examples from the templates that that that we created for itc this company called itc now if i see its overall profits in 10 years it is 962 242 and cash flow from operations is 96 922 it's an fmcg player b2c segment without even going into any further granularity i know as a matter of fact that i am comfortable with the books because over a period of time net net profit is matching my overall cash flow firm operations similarly if i talk of and hindustan you deliver i know as a matter of fact that their overall net profits in the last 10 years is 43 867 and the cash flow from operations is almost forty four thousand four forty four zero eight so i'm you know without even getting into any further granularity of understanding it at a broad level i know that at least the books of the account books of the companies are clean and then i'll do my own research gradually let me take another example of one person beverages another another you know fmcg player now you see this here the profit of the company minus 480 the cash flow from operations minus seven here minus seven success sales shown some which which might be to fictitious debtors and then issue over a period of time cash is the real thing right not sales cash whatever that actual money the company has earned let's let me give you another example and then i'll wind up this video uh pc dwellers uh now you see this the total net profits earned by the company 2695 cash flow from operations minus 958 here and this is overall consolidated but if you do not want to be wiser after the event let's go back to 2011 to 2016 here when everything was okay about the company and you know it was going as a normal entity the net profits was 165 from 2011 until 2016 that overall net profits for five years was one six five five and their cash from operations at that time and it's into b2c segment which sells jewelry to the end users minus 254 the trouble was brewing at this time only so as investors we need to have that hawkeye trying to understand the financials fundamentally the numbers don't lie you can lie for one year you can lie for two years over a period of time you will be caught so that that is uh it with respect to this video uh i hope you have understood at a broad level uh what uh you know how to do a fundamental analysis of of any particular company so in the detailed video we're going to teach you at a much more granular level with much more examples and much more case studies but i hope this has set as a good ground for you to gorge the companies the good the great and the gruesome companies we'll see you again in the next video so that's it from my side for this video thank you