NISM SERIES – XV: RESEARCH ANALYST CERTIFICATION BY- CA NITIN GURU

Chapter 7: Company Analysis

(Business and Governance)
 Role of Company analysis in fundamental research
Once an analyst understands how an economy is performing and how a particular industry likely to
prosper, they have to find answers to company specific questions, which includes the following:
1. What is company’s business?
2. What is the company’s business model?
3. Does the company enjoy any competitive advantage?
4. Does the company have the necessary capability to exploit opportunities?
5. Is the company management competent?
6. Does the management have a vision for the company’s future?

 Understand business and business models

It is important to understand the business or business model of the company before investing in it.
Accordingly, starting point of qualitative research on any business has to be questions such as:
1. What does company do and how does it do?
2. Who are the customers and why do customers buy those products and services?
3. How does the company serve these customers?
There are over 4000 companies listed and active on Indian Exchanges. It is not possible to track and
understand all of them. Each sector has its own unique parameters for evaluation. For the retail sector,
foot falls and same store sales (SSS) are important parameters. Each company will have its unique way of
doing business. The efficiency with which product and services are produced and delivered to the
customers may vary from one business to another and will significantly impact its earnings.
“Competition in the market place is not between products and services but between the Business
Models of the competing companies.”

 Pricing Power and sustainability of this Power

Pricing power refers to a company’s ability to independently determine and charge the price of its
products. Companies with strong pricing power would be able to pass on any escalation in input cost to
its customer. Most often pricing power is driven by industry factors that affect all companies in the
industry. These factors include the competition intensity in the industry, the price elasticity of the
product, and the level of commoditization of the product.

 Competitive Advantages/Points of differentiation over the Competitors

An analyst tries to understand how a particular company is likely to perform in future, they need to
understand how the company is likely to perform vis-a vis its competitors in the industry. The
differentiating factors for a company
1. Differentiation in product features
2. Competitive pricing driven by operational efficiency
3. Better execution

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 Strengths, Weaknesses, Opportunities and Threats (SWOT) Analysis

When a new opportunity is presented, companies that are well positioned to take advantage of that
utilize such opportunities and prosper while others miss out. On the other hand, companies that are
vulnerable may perish in the face of such a challenge. SWOT Analysis is one of the popular frameworks
that can help an analyst evaluate business fundamentals. SWOT is an acronym for strength, weakness,
opportunities and threats. Strengths and weakness are internal to the company while opportunities and
threats emanate from external conditions. Analysts can approach SWOT from two sides: (i) Identify the
strengths and weakness first and then identify what opportunities they can exploit and what are the
threats for which the company is vulnerable. (ii) Alternatively, the analyst can identify the opportunities
and threats first and then identify what strengths of the company will help them exploit the
opportunities and what weakness makes them vulnerable to external threats.
The four aspects are detailed below:

 Opportunity
Opportunities are created through external environment.
1. Certain events can create opportunity for faster growth.
2. New business opportunity may arise on account of technological advancement, change in
regulation of any such factor.
3. Companies may also get opportunities to expand geographical footprint.
4. Adverse market conditions can throw opportunities for consolidation.

 Threats
Threats are essentially risk that comes out from external environment. Some of the possible sources
of threats:
1. Economic Recession
2. Regulatory headwinds can also create threat.
3. Technological disruptions that favor one industry can be threat to others.
4. Deregulation of an industry can remove entry barriers and can create threat of increased
competition.

 Strengths
Strengths refer to internal capabilities of the company that allows it to exploit external opportunities
and withstand threats. Strengths of a company includes the following:
1. Strong financial position
2. Highly valuable intellectual properties
3. Low customer concentration
4. Low cost or high margins

 Weakness
Weakness refers to internal issues that make the company vulnerable to external events or prevents
it from exploiting an available opportunity.
1. Weak financial position

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2. High fixed cost

3. Low margins that can easily turn negative in case of a slow down
4. Higher customer concentration
5. Significant legal cases that can distract the company’s focus or that have potential to cause
losses
6. Lack of experiences in executing a particular strategy or in operating in a particular
environment.

 Quality of Management and Government Structure

The day to day management of the company is handled by a separate management team comprising of
the CEO/Managing Director. This separation in management and ownership creates an agency risk.
There is a risk that the management may pursue their personal interests at the cost of shareholders or
may not be capable enough to effectively run the organization. One of the critical areas that an analyst
needs to evaluate during a company analysis is the competency and integrity of the management and
board.

 Evaluating management competency

The top management of a competency typically include the CEO, CFO, COO, and other C level officers.
Assessing their competency is a challenging task for an analyst.
Analysts can try to find answers:
1. Do the members of the top management team possess the necessary educational
qualification in the relevant discipline?
2. How many years of experience do they have?
3. If any of the top management team has been in such a role for several years in any of the
companies, how did those companies perform during the years in which they were in senior
role?
4. How long has the top management team been associated with the company under study and
how has the company performed during the tenure?
5. Does the management have a vision on long term goals and strategic direction of the
company? Shareholder value is created over a long term?
6. Do the members of top management team have necessary experience in executing the
current strategy of the company?
7. Does the company give guidance on expected near term performance and whether they
typically achieve such guidance?
8. Has the management ensured timely regulatory compliance on a regular basis?
9. Is there sufficient delegation in the decision-making process?
10. Does the company have a succession plan for its top management?

 Evaluating Corporate Governance

Corporate governance refers to rules, processes, and procedures that are followed in the
management and operations of a firm. The objective of a good corporate governance standard is to
ensure that the company is run well to take care of all the stakeholders. A company following strong

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corporate government standards would be able to prevent agency risk or at the very least detect an
rectify them. An analyst can look at:

1. Board compositions
The directors of the company can include independent directors, non-executive directors and
executive directors. Currently SEBI regulation stipulates that independent directors should
constitute at least 50% of the board if the chairman is an executive director. In all other
cases, it requires 1/3rd of the board to be comprised of independent directors.

2. Separation of Board Chairman’s role and role of MD and CEO

3. Nomination Committee for independent directors

4. Auditors fees
Audit independence is one of the very critical aspects of corporate governance. For an
auditor to be able to be truly and completely independent, it is necessary that they should
not be over dependent on the fees earned from a given corporate entity or a business group.

5. Auditor rotation
It is necessary that auditors are rotated once in five years.

6. Audit committee composition

Ideally, the audit committee should comprise entirely of independent directors. SEBI
regulation requires at least 2/3rd of the members to be independent.

7. Related party transactions

Currently, the SEBI regulations does not mandate pre-approval but requires placement of all
related party transactions in front of the audit committee. If the transaction is not on an”
arms- length” basis, then the regulation also requires that the company should provide
justification for the same.

8. Remuneration Committee composition

SEBI regulation currently stipulates that all members should be non-executive directors and
the chairman of the committee should be independent director.

9. Remuneration of Independent directors

Income that an independent director earns from a company are disclosed so that
shareholders can evaluate the true degree of independence.

 Promoter Holdings
The law simply states that promoter is an investor who has been named or is identified as a
promoter. Practically, the promoter group of shareholders typically comprises of those who were
part of the initial founding of the company or are part of the group of controlling shareholders. A

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Promoter group of shareholders are likely to have a higher level of control on the management. This,
in turn, increases the likelihood of management acting in the best interest of shareholders. When
promoters need funds, many a times, they may choose to pledge their shareholdings rather than sell
them. High amount of pledged shares can aggravate the market risk in the event of fall in prices of
such shares.

 Risks in the Business

Entrepreneurs are by nature risk takers and have the psychological ability to bear shocks. The risk may
be apparent and known or they may be unknown. If promoters state that nothing could go wrong in the
business. These types of promoters need to be avoided.

 History of credit rating

Credit rating refers to the rating of the ability of a borrower to service its debt related obligations. These
ratings, which are provided by a credit rating agency, are issued at issuer level as well as at individual
debt levels. Credit rating provides an investor with the level of financial risk involved. Credit ratings
report specify what are the factors that have led to the rating agency conclude on a particular rating.

 ESG framework for company analysis

Over the last few years, the societal discussions about companies and businesses have also started
focusing on sustainable development, and corporate social responsibility. This has given transaction to
investment theme that is focused on Environment, Social and Corporate governance (ESG). Under this
framework investors evaluate companies based on these criteria
1. How does the company’s activity affect the environment?
2. What are the activities that the company performs in terms of social development?
3. The last criteria focus on corporate governance standard followed by the company.

ESG investors use the ESG filter to shortlist their potential investment. Several financial advantages that
can accrue to companies following ESG framework:
1. Companies focused on environment face minimum disruption on account of regulatory
intervention of environmental activism.
2. Companies working towards social cause generate positive recall value in the society which
can make it easy for them to recruit employees and attract customers.
3. Sustainable production process can lead to less cost on account of power consumption of
water usage.
4. Strong corporate governance practice reduces risk perception and in turn reduces the cost of
capital for that organization.

 Sources of Information for Analysis

1. Annual/Quarterly reports
2. Conference Call transcripts
3. Investor Relation (or Company) Presentations
4. Management interviews on internet
5. Company website

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6. Ministry of Corporate Affairs website

7. Research report from Credit Rating Companies
8. Research report from various other sources – media reports
9. Parent Company’s annual report and website
10. Competitors’ website including international competitors
11. Print media reports on companies
12. Discussion with suppliers, vendors, consumers and competitors