Part 1 — Fundamental Analysis Framework
Fundamental Analysis (FA) is the process of evaluating a security by examining its underlying business, financial statements, competitive position, and broader economic environment. Unlike technical analysis, FA targets intrinsic value — what a company is truly worth — and is the cornerstone of long-term investing.
01
Financial Statement Analysis
A company's financial health is captured in three core statements. Read all three together — no single statement tells the complete story.
1.1 Income Statement (P&L)
Reports financial performance over a period (quarterly or annual).
Revenue (Topline)
Total income from core business operations.
Gross Profit
Revenue minus COGS. Reflects production efficiency.
EBITDA
Earnings Before Interest, Taxes, Depreciation & Amortisation. Proxy for operating cash generation.
EBIT (Op. Profit)
Gross Profit minus Operating Expenses. Core business profitability before interest and taxes.
Net Income / PAT
Profit after all expenses, interest, and taxes. Belongs to shareholders. In India, PAT (Profit After Tax) is the standard term on BSE/NSE.
In India, PAT (Profit After Tax) is the standard term for Net Income on BSE/NSE.
1.2 Balance Sheet
A snapshot of assets, liabilities, and equity at a specific date.
Assets
Current Assets (cash, inventory, receivables) + Non-Current Assets (property, equipment, intangibles).
Liabilities
Current Liabilities (due within 1 year) + Long-Term Liabilities (bonds, loans).
Shareholders' Equity
Total Assets − Total Liabilities. Includes paid-up capital, reserves & surplus.
Key Identity
Assets = Liabilities + Shareholders' Equity
Any breach of this identity signals accounting errors.
1.3 Cash Flow Statement (CFS)
Tracks actual cash movements — the hardest metric to manipulate.
Operating CF (OCF)
Cash from core operations. Should be consistently positive and ideally greater than net income.
Investing CF (ICF)
Cash used for CapEx, acquisitions, or investments. Typically negative in growth companies due to capital expenditure.
Financing Activities CF
Cash from debt issuance, equity raising, or dividends paid. Can be positive (borrowing) or negative (repayment/dividends).
Free Cash Flow (FCF) = Operating CF − CapEx. It is a derived metric, not a section of the CFS. A profitable company can still go bankrupt if OCF is consistently negative — always cross-check PAT vs OCF.
02
Financial Ratios
Ratios convert raw numbers into comparable benchmarks. Always compare against: (a) the company's own historical trend, (b) industry peers, and (c) sector benchmarks.
2.1 Profitability Ratios
Gross Profit Margin
(Gross Profit ÷ Revenue) × 100 — Pricing power and production efficiency.
✓ > 40% — Strong pricing power
~ 20–40% — Industry dependent
✕ < 15% — Low margin / commodity
EBITDA Margin
(EBITDA ÷ Revenue) × 100 — Operating profitability before non-cash items.
✓ > 20% — Excellent operating leverage
~ 12–20% — Healthy
✕ < 8% — Thin / cost pressure
Net Profit Margin
(Net Income ÷ Revenue) × 100 — Overall profitability after all expenses.
✓ > 15% — Strong
~ 8–15% — Acceptable
✕ < 5% — Thin / at risk
ROE
(Net Income ÷ Shareholders' Equity) × 100 — Wealth generated for shareholders per unit of equity invested.
✓ > 20% — Best in class
~ 15–20% — Good
✕ < 10% — Poor capital efficiency
ROA
(Net Income ÷ Total Assets) × 100 — Efficiency of asset utilisation.
✓ > 8% — Highly efficient
~ 3–8% — Average
✕ < 2% — Asset-heavy / poor returns
ROCE
(EBIT ÷ Capital Employed) × 100 — Returns on all capital deployed (debt + equity). Widely used in India. Capital Employed = Total Assets − Current Liabilities.
✓ > 15% — Value creation
~ 10–15% — Neutral
✕ < Cost of Capital — Value destruction
ROIC
(NOPAT ÷ Invested Capital) × 100 — Measures capital allocation efficiency. NOPAT = EBIT × (1 − Tax Rate). Invested Capital = Equity + Debt − Cash. ROIC > WACC signals value creation.
✓ ROIC > WACC — Value being created
✕ ROIC < WACC — Value being destroyed
2.2 Liquidity Ratios
Current Ratio
Current Assets ÷ Current Liabilities — Short-term solvency. Target: 1.5–2.5. Below 1.0 = danger zone.
Quick Ratio (Acid Test)
(Current Assets − Inventory) ÷ Current Liabilities — Excludes illiquid inventory. Target: > 1.0.
Cash Ratio
Cash & Equivalents ÷ Current Liabilities — Strictest liquidity measure. Target: 0.2–0.5 for most businesses.
2.3 Leverage / Solvency Ratios
Debt-to-Equity (D/E)
Total Debt ÷ Shareholders' Equity — Financial risk indicator. < 0.5 is conservative; < 1 is generally safe; > 2 is risky.
Interest Coverage
EBIT ÷ Interest Expense — Ability to service debt. > 5x is very comfortable; > 3x is healthy; < 1.5x signals distress.
Debt-to-Asset
Total Debt ÷ Total Assets — Proportion of assets financed by debt. < 0.3 is equity-dominated; > 0.6 is debt-heavy.
Net Debt / EBITDA
Popular leverage metric used by analysts and rating agencies. < 1.5x is very low leverage; 1.5–3x is comfortable; > 5x is dangerous.
2.4 Efficiency Ratios
Asset Turnover
Revenue ÷ Total Assets — Sales generated per unit of assets. Higher and rising = improving efficiency. Retail: > 1.5×; Manufacturing: 0.5–1.0×.
Inventory Turnover
COGS ÷ Average Inventory — How fast inventory is sold. Higher is better. FMCG: > 6×; Manufacturing: 4–8×; Retail: > 10×.
Receivables Turnover
Revenue ÷ Average Accounts Receivable — Speed of collecting payments. Higher is better; declining ratio = worsening credit management.
DSO (Days Sales Outstanding)
365 ÷ Receivables Turnover — Average days to collect payment. < 30 days is ideal; > 90 days is a red flag in most sectors.
DIO (Days Inventory Outstanding)
365 ÷ Inventory Turnover — Days inventory is held before sale. Lower is generally better; rising DIO may signal slow-moving stock.
Cash Conversion Cycle
DIO + DSO − Days Payable Outstanding (DPO). Measures working capital efficiency. Negative CCC (e.g., Amazon, Walmart) is exceptional — cash collected before suppliers are paid.
2.5 Valuation Ratios
P/E Ratio
Market Price per Share ÷ EPS — Amount investors pay per unit of earnings. India general: < 15 = cheap; 15–25 = fair; > 25 = expensive.
Forward P/E
Market Price ÷ Expected Future EPS — Forward-looking valuation using analyst estimates. Forward < Trailing signals expected earnings growth.
P/B Ratio
Market Price per Share ÷ Book Value per Share — Market value vs net assets. < 1 = below book; 1–3 = normal; > 5 = highly premium.
P/S Ratio
Market Cap ÷ Annual Revenue — Useful for loss-making or early-stage companies. < 1 = cheap; 1–3 = acceptable; > 5 = expensive on revenue.
EV/EBITDA
Enterprise Value ÷ EBITDA — Capital-structure-neutral valuation. Widely used in M&A. India: < 8× = attractive; 8–15× = fair; > 20× = expensive.
PEG Ratio
P/E ÷ EPS Growth Rate (%) — Adjusts P/E for growth. < 0.5 = deeply undervalued; 0.5–1.0 = fairly valued for growth; > 1.0 = overvalued vs growth rate.
Earnings Yield
(EPS ÷ Market Price) × 100 — Inverse of P/E. > 7% better than bonds; 4–7% comparable; < 4% bonds may be preferred. Compare to 10-yr G-Sec (~7%).
Dividend Yield
(Annual DPS ÷ Stock Price) × 100 — Income return from dividends. > 3% = good income; 1–3% = moderate; < 1% = growth play.
ROIC
(NOPAT ÷ Invested Capital) × 100. ROIC > WACC = value creation; ROIC < WACC = value destruction. Key metric for capital allocation quality.
03
Business Performance Metrics
Revenue Growth
YoY / QoQ topline expansion.
✓ > 15% YoY — Strong compounding
~ 8–15% YoY — Moderate growth
✕ < 8% or declining — Stagnating
EPS
Net Income ÷ Total Shares Outstanding. Rising EPS over 5+ years = profitability compounding.
✓ > 15% CAGR (5 yr) — Compounding
~ 8–15% CAGR — Moderate
✕ Flat or declining — Earnings pressure
Diluted EPS
Accounts for options, warrants, and convertibles. More conservative than basic EPS.
✓ Diluted ≈ Basic EPS — Minimal dilution
✕ Diluted < Basic by > 5% — Significant dilution risk
Free Cash Flow (FCF)
Operating Cash Flow − CapEx. Cash available to shareholders after reinvestment needs.
✓ Positive & growing consistently
~ Positive but volatile — Capital cycle
✕ Persistently negative — Cash burn risk
FCF Yield
FCF ÷ Market Cap. Higher yield = more value returned relative to price paid.
✓ > 5% — Highly attractive
~ 3–5% — Reasonable
✕ < 2% — Low cash return on price paid
Dividend Payout Ratio
Dividends Paid ÷ Net Income. Reflects capital allocation philosophy.
✓ 30–50% — Balanced: income + reinvestment
~ > 70% — Mature / income stock
✕ > 100% — Unsustainable; paying from borrowings
Operating Leverage
How fixed costs amplify earnings relative to revenue changes. High fixed costs = high operating leverage.
✓ Margin expansion on revenue growth — Leverage working
✕ Margin compression on growth — Cost structure problem
Working Capital
Current Assets − Current Liabilities. Operational liquidity buffer.
✓ Positive — Operational continuity assured
~ Negative (retail/FMCG) — Structurally normal
✕ Negative (non-retail) — Liquidity stress signal
04
Industry & Market Analysis
Market Share
Company revenue as % of total industry revenue. Growing share = competitive edge.
Peer Benchmarking
Compare margins, ROE, and D/E against Nifty 50 / sector index constituents.
Industry Lifecycle
Introduction / Growth / Maturity / Decline — shapes appropriate valuation and growth expectations.
Porter's Five Forces
Competitive rivalry, buyer/supplier power, substitutes, and barriers to entry.
TAM / SAM / SOM
Total / Serviceable / Obtainable Addressable Market. Gauges growth runway.
Regulatory Environment
Sector-specific rules (SEBI, RBI, TRAI, etc.) that create or destroy value.
05
Economic Moats
An economic moat is a structural competitive advantage that protects long-term profitability.
Brand Strength
Commands premium pricing via loyalty (e.g., Asian Paints, Titan, Nestlé India).
Patents & IP
Legal monopoly on products/processes for a defined period. Common in pharma and specialty chemicals.
Cost Advantage
Lower unit costs through scale, proprietary technology, or process efficiency.
Network Effect
Value grows as more users adopt it (e.g., stock exchanges, payment networks like UPI/NPCI).
Switching Costs
High cost or inconvenience for customers to switch (e.g., ERP software, banking relationships).
Efficient Scale
Natural monopoly or duopoly markets (e.g., port infrastructure, pipelines, power grids).
Intangible Assets
Licences, government contracts, distribution networks, proprietary data.
06
Management Evaluation
Leadership Quality
Track record, domain expertise, and capital allocation history of promoters and CXOs.
Corporate Governance
Board independence, audit committee quality, related-party transaction disclosures.
Insider Activity
Promoter shareholding trends — consistent increase is bullish; pledging > 30–40% is a red flag.
Management Compensation
Excessive remuneration relative to profits can signal misaligned incentives. Watch for CXO pay > 5% of PAT.
Shareholder Communication
Quality of annual reports, investor presentations, and management commentary.
Capital Allocation
History of acquisitions, buybacks, dividends — measures value-creation discipline.
07
Macroeconomic Factors
Interest Rates
RBI Repo Rate and US Fed Funds Rate affect borrowing costs, valuations, and sector performance. Rising rates compress P/E multiples.
Inflation (CPI / WPI)
High inflation erodes purchasing power and compresses margins for cost-pass-through challenged companies. RBI targets CPI at 4% (±2%).
GDP Growth
Economic expansion drives corporate earnings. India's nominal GDP growth of 10–12% supports Nifty EPS growth of 12–15% historically.
Fiscal & Monetary Policy
Union Budget, GST, corporate tax rates, and RBI liquidity measures.
Currency (INR/USD)
INR depreciation benefits IT/exporters; hurts importers (oil, electronics). A 1% INR depreciation typically adds ~0.5% to IT sector margins.
Crude Oil Prices
Critical macro variable for India given heavy import dependency (~85% of oil is imported). Impacts inflation, trade deficit, and sector margins.
FII / DII Flows
Foreign and domestic institutional flows significantly influence market direction and NSE/BSE liquidity.
Global Macro Cues
US markets (S&P 500, Nasdaq), US treasury yields, China growth data, and geopolitical events affect Indian equity sentiment.
08
Risk Assessment
Business Risk
Operational challenges, competition, technology disruption, and demand cyclicality.
Financial Risk
High debt, liquidity constraints, and refinancing risk. D/E > 2 combined with falling EBITDA is a warning sign.
Regulatory Risk
Adverse regulatory changes, legal proceedings, or environmental liabilities.
Geopolitical Risk
Trade wars, sanctions, border conflicts, and political instability.
Concentration Risk
Dependence on a single customer, product, geography, or supplier. A single customer > 25% of revenue is a risk flag.
ESG Risk
Environmental, Social, and Governance risks increasingly priced by institutional investors under BRSR/SEBI frameworks.
Management Risk
Promoter fraud, governance failures, or key-person dependency.
Market Risk
Macro-driven systematic risks that cannot be diversified away — interest rate changes, currency movements, market beta.
09
Qualitative Factors
Vision & Mission
Long-term strategic direction and clarity of business purpose.
CSR / ESG Practices
Companies investing in ESG attract long-term institutional capital. SEBI mandates BRSR reporting for top 1,000 listed companies.
Customer Satisfaction
Net Promoter Score (NPS) and repeat purchase rates as proxies for product quality and brand stickiness.
Innovation Pipeline
R&D expenditure as % of revenue, new product launches, and patent filings.
Employee Culture
Attrition rates, Glassdoor ratings, and talent acquisition as indicators of organisational health.
Sectoral Tailwinds
Megatrends (digital transformation, PLI schemes, green energy, China+1) that structurally favour certain businesses.
10
Historical Performance
Stock Price CAGR
5-year and 10-year CAGR vs Nifty / Sensex benchmark. Outperformance > 3–5% CAGR over benchmark is quality signal.
Dividend History
Consistency and growth in dividends. Uninterrupted 10-year dividend track record signals financial discipline.
Earnings Track Record
Multi-year trend in Revenue, EBITDA, PAT, and EPS. Look for 5–10 year consistent expansion without major earnings misses.
Book Value Growth
BVPS trend over years reflects retained earnings accumulation. BVPS CAGR > 12% over 5 years = strong value building.
11
Book Value per Share (BVPS)
Formula
BVPS = (Total Assets − Total Liabilities) ÷ Total Shares Outstanding
Represents the net asset value per share — the theoretical liquidation value if the company were wound up today.
Market Price < BVPS
Potentially undervalued — stock trading below net asset value. Common during broad market corrections or sector distress.
Market Price > BVPS
Market expects superior returns or growth; justified by consistently high ROE (> 20%) and strong brand/moat.
For asset-heavy sectors (banking, insurance, NBFCs), P/B is the primary valuation metric. For capital-light businesses (IT, FMCG), use P/E or EV/EBITDA instead.
12
Face Value (Par Value)
The nominal value assigned at incorporation — typically ₹1, ₹2, ₹5, or ₹10 per share in India. It is the base for:
Dividend Calculation
Dividends sometimes declared as a percentage of face value (e.g., "200% dividend on ₹2 FV" = ₹4 per share).
Bonus Shares
Issued at face value; does not change the total value of holding but increases share count.
Stock Splits
Face value divided proportionally (e.g., ₹10 → ₹1 in a 10:1 split), shares outstanding multiply by 10.
Face value has no direct relationship to market price or intrinsic value. Never use face value for investment decisions.
13
Intrinsic Value & Valuation Models
Intrinsic value is the present value of all future cash flows a business will generate. Comparing it to market price reveals whether a stock is undervalued, fairly valued, or overvalued.
13.1 Discounted Cash Flow (DCF)
Projects future Free Cash Flows and discounts them to present value using WACC.
DCF Formula
Intrinsic Value = Σ [FCFt ÷ (1 + WACC)^t] + Terminal Value ÷ (1 + WACC)^n
WACC
Weighted Average Cost of Capital — blended cost of equity (Ke) and after-tax cost of debt (Kd × (1−T)), weighted by capital structure.
Terminal Value
Present value of all cash flows beyond the explicit forecast period. Often calculated as FCFn × (1+g) ÷ (WACC − g) using the Gordon Growth Model.
Margin of Safety
Buy at a 20–40% discount to intrinsic value to protect against assumption errors and unforeseen risks.
DCF is highly sensitive to WACC and terminal growth rate inputs. A 1% change in WACC can move intrinsic value by 20–30%. Always run sensitivity scenarios.
13.2 Comparable Company Analysis (Comps)
Values a company by benchmarking its multiples against similar publicly listed peers. Metrics used: P/E, EV/EBITDA, P/B, P/S. Market-based and reflects current investor sentiment, but the entire peer set can be overvalued simultaneously, skewing the analysis — a limitation known as "relative valuation bias."
13.3 Dividend Discount Model (DDM)
DDM Formula (Gordon Growth Model)
P = D1 ÷ (Ke − g)
Where P = Intrinsic value per share, D1 = Expected next annual dividend, Ke = Cost of Equity (required return by equity shareholders), g = Sustainable dividend growth rate. Requires Ke > g. Best suited for stable dividend-paying companies (e.g., mature PSUs, utilities, private sector banks).
14
DuPont Analysis
Decomposes ROE into three components to pinpoint the true source of profitability or capital efficiency.
DuPont Formula (3-Factor)
ROE = Net Profit Margin × Asset Turnover × Equity Multiplier
Net Profit Margin
Profitability — Profit extracted from each unit of sales. (Net Income ÷ Revenue)
Asset Turnover
Efficiency — How effectively assets generate sales. (Revenue ÷ Total Assets)
Equity Multiplier
Financial Leverage — (Total Assets ÷ Shareholders' Equity). Higher leverage magnifies both gains and losses. A high ROE driven primarily by a high Equity Multiplier (leverage) is less desirable than one driven by margin or efficiency.
DuPont is especially useful for comparing companies with similar ROEs but different drivers — e.g., an FMCG company achieves ROE via high margin; a bank achieves it via high leverage. Same number, very different risk profiles.
15
Working Capital Management
Formula
Working Capital = Current Assets − Current Liabilities
Positive Working Capital
Company can meet short-term obligations. Essential for operational continuity in most industries.
Negative Working Capital
Potential liquidity crisis unless structurally normal for the model (e.g., supermarkets, e-commerce with fast inventory turnover and deferred supplier payments).
Cash Conversion Cycle
DIO + DSO − DPO. Shorter or negative CCC = more capital-efficient business model. A negative CCC means the business collects cash from customers before paying its suppliers.
Poor working capital management often precedes financial distress — even in profitable companies. Rising DSO and falling inventory turnover together are early warning signals.
Part 2 — Quick Reference Ratio Tables
General benchmarks — always validate against sector norms. Numbers below reflect India (NSE/BSE) market conventions unless stated.
A
Valuation Ratios
| Ratio | Numbered Thresholds | Interpretation |
|---|---|---|
| P/E Ratio (India General) |
✓ < 15 — Undervalued / Cheap
~ 15–25 — Fairly Valued
✕ > 25 — Expensive / Growth-priced
|
Compare to sector avg. Low P/E alone is not a buy signal — check earnings quality and growth outlook. |
| Forward P/E |
✓ Lower than trailing P/E — Earnings growth expected
✕ Higher than trailing P/E — Earnings expected to decline
|
Forward < Trailing means earnings expected to grow. Market is pricing in improvement. |
| PEG Ratio |
✓ < 0.5 — Deeply undervalued
~ 0.5–1.0 — Fairly valued for growth
✕ > 1.0 — Overvalued vs growth
|
More accurate than raw P/E for growth stocks. PEG < 1 is the classic sweet spot per Peter Lynch. |
| P/B Ratio |
✓ < 1 — Below book value
~ 1–3 — Normal range
✕ > 5 — Highly premium / speculative
|
Critical for banks & NBFCs. P/B < 1 may signal distress or deep value opportunity. |
| P/S Ratio |
✓ < 1 — Cheap on revenue basis
~ 1–3 — Acceptable
✕ > 5 — Very expensive on revenue
|
Useful for loss-making or early-stage companies where P/E is meaningless. |
| EV/EBITDA |
✓ < 8× — Attractive (India)
~ 8–15× — Fair value range
✕ > 20× — Expensive / high growth priced in
|
Capital-structure neutral. Preferred in M&A. EV = Market Cap + Net Debt. < 8–10× is attractive in Indian markets. |
| Earnings Yield |
✓ > 7% — Better than G-Sec bonds
~ 4–7% — Comparable to bonds
✕ < 4% — Bonds may be preferred
|
Inverse of P/E. Compare to 10-yr G-Sec yield (~7%). Equity premium is the reward for additional risk. |
| Dividend Yield |
✓ > 3% — Good income return
~ 1–3% — Moderate yield
✕ < 1% — Growth play, not income
|
Higher yield is attractive for income investors. Verify payout is sustainable — check payout ratio < 80% and positive FCF. |
B
Profitability Ratios
| Ratio | Numbered Thresholds | Interpretation |
|---|---|---|
| Net Profit Margin |
✓ > 15% — Strong
~ 8–15% — Acceptable
✕ < 5% — Thin / at risk
|
Sector-dependent: IT companies often 20%+; FMCG 10–15%; manufacturing 5–10%; retail 2–5%. |
| Gross Profit Margin |
✓ > 40% — Strong pricing power
~ 20–40% — Industry dependent
✕ < 15% — Low margin / commodity
|
High gross margin = pricing power or efficient production. Compare only within same sector. |
| EBITDA Margin |
✓ > 20% — Excellent operating leverage
~ 12–20% — Healthy
✕ < 8% — Thin / cost pressure
|
Stable or expanding EBITDA margin signals operating leverage working in company's favour. |
| ROE (Return on Equity) |
✓ > 20% — Best in class
~ 15–20% — Good
✕ < 10% — Poor capital efficiency
|
Use DuPont to understand if ROE is driven by margins, efficiency, or leverage. > 15% sustained over 5 years is the quality bar. |
| ROCE (Return on Capital Employed) |
✓ > 15% — Value creation
~ 10–15% — Neutral
✕ < Cost of Capital — Value destruction
|
ROCE > WACC means the business earns more than it costs to run. Widely used in Indian fundamental analysis. |
| ROA (Return on Assets) |
✓ > 8% — Highly efficient
~ 3–8% — Average
✕ < 2% — Asset-heavy / poor returns
|
Banks typically show lower ROA (~1–2%) due to leverage structure. Compare strictly within sector. |
| EPS Growth |
✓ > 15% YoY — Strong growth
~ 8–15% YoY — Moderate
✕ Declining — Earnings pressure
|
Rising EPS over 5+ years is the single most reliable indicator of a compounding business. |
C
Leverage & Solvency Ratios
| Ratio | Numbered Thresholds | Interpretation |
|---|---|---|
| D/E Ratio (Debt-to-Equity) |
✓ 0 – 0.5 — Debt-free / conservative
~ 0.5–1.5 — Acceptable
✕ > 2.0 — High leverage / risky
|
D/E < 1 is generally safe. Capital-intensive sectors (infra, utilities) can tolerate higher. Debt-free = 0. |
| Interest Coverage |
✓ > 5× — Very comfortable
~ 3–5× — Adequate
✕ < 1.5× — Debt stress / default risk
|
EBIT ÷ Interest Expense. Below 1× means earnings cannot cover interest — distress territory. |
| Net Debt / EBITDA |
✓ < 1.5× — Very low leverage
~ 1.5–3× — Comfortable
✕ > 5× — Dangerous leverage
|
Popular with analysts and rating agencies. Shows how many years of EBITDA are needed to fully repay net debt. |
| Debt-to-Asset |
✓ < 0.3 — Equity-dominated
~ 0.3–0.5 — Moderate
✕ > 0.6 — Debt-dominated balance sheet
|
Below 0.5 means more than half of assets are equity-funded. Lower is safer for cyclical sectors. |
D
Liquidity Ratios
| Ratio | Numbered Thresholds | Interpretation |
|---|---|---|
| Current Ratio |
✓ 1.5–2.5 — Healthy liquidity
~ 1.0–1.5 — Tight but manageable
✕ < 1.0 — Liquidity crisis risk
⚠ > 3.0 — Excess idle assets
|
Current Assets ÷ Current Liabilities. Below 1 means current liabilities exceed current assets — danger zone. |
| Quick Ratio (Acid Test) |
✓ > 1.0 — Strong quick liquidity
~ 0.7–1.0 — Acceptable
✕ < 0.5 — High inventory dependency
|
Excludes inventory (illiquid). More conservative than current ratio. Tech/service companies often > 1.5. |
| Cash Ratio |
✓ > 0.5 — Strong cash buffer
~ 0.2–0.5 — Adequate
✕ < 0.2 — Very low cash reserves
|
Strictest liquidity test — only cash & equivalents vs current liabilities. Most healthy firms sit at 0.3–0.5. |
E
Efficiency Ratios
| Ratio / Metric | Numbered Thresholds | Interpretation |
|---|---|---|
| Asset Turnover |
✓ > 1.5× (retail / IT) — High efficiency
~ 0.5–1.5× (manufacturing) — Normal range
✕ < 0.3× — Very asset-heavy / poor utilisation
|
Revenue ÷ Total Assets. Higher and rising signals improving efficiency. Compare within sector only — heavy industries naturally run lower. |
| Inventory Turnover |
✓ > 8× (FMCG/retail) — Fast-moving
~ 4–8× (manufacturing) — Healthy
✕ < 3× — Slow inventory; obsolescence risk
|
COGS ÷ Average Inventory. Fast-moving inventory reduces holding costs and write-off risk. Falling ratio YoY = warning sign. |
| Receivables Turnover |
✓ > 12× — Collections within 30 days
~ 6–12× — Acceptable (30–60 day terms)
✕ < 4× — Slow collections (> 90 days)
|
Revenue ÷ Average Accounts Receivable. Declining ratio suggests worsening credit management or channel stuffing. |
| Cash Conversion Cycle (DIO + DSO − DPO) |
✓ Negative CCC — Cash before supplier payment
✓ 0–30 days — Highly efficient
~ 30–90 days — Normal for manufacturing
✕ > 120 days — Capital-intensive / working capital strain
|
Shorter or negative CCC = superior business model. Amazon and Walmart famously run negative CCCs, funding operations with supplier credit. |
| Days Sales Outstanding (DSO) |
✓ < 30 days — Excellent collections
~ 30–60 days — Industry standard
✕ > 90 days — Collection risk / bad debts likely
|
365 ÷ Receivables Turnover. Rising DSO is a red flag — may signal revenue recognition issues or weak credit control. |
F
Cash Flow Metrics
| Ratio / Metric | Numbered Thresholds | Interpretation |
|---|---|---|
| Free Cash Flow (OCF − CapEx) |
✓ Positive & growing — Self-funding, surplus capital
~ Positive but flat — Stable, limited reinvestment headroom
✕ Persistently negative — Cash burn; monitor debt levels
|
Self-funding businesses can pay dividends, buy back shares, or grow organically without external capital. |
| FCF Yield (FCF ÷ Market Cap) |
✓ > 5% — Highly attractive
~ 3–5% — Reasonable value
✕ < 2% — Low cash return on price paid
|
The cash-based equivalent of earnings yield. More reliable than P/E as cash flow is harder to manipulate. |
| OCF / Net Income (Cash Quality Ratio) |
✓ > 1.0 — Cash earnings exceed accounting earnings
~ 0.8–1.0 — Broadly aligned
✕ < 0.5 — Earnings quality concern; possible accrual manipulation
|
OCF consistently below Net Income suggests revenue recognition gaming or accounts receivable inflation. Classic manipulation warning. |
| CapEx Intensity (CapEx ÷ Revenue) |
✓ < 5% — Capital-light (IT, FMCG)
~ 5–15% — Moderate (manufacturing)
✕ > 20% — Capital-heavy (infra, telecom, metals)
|
Capital-light businesses generate more FCF per rupee of revenue. High CapEx is not inherently bad if ROIC > WACC on new investments. |
| OCF Growth (YoY %) |
✓ > 15% YoY — Strong cash generation
~ 5–15% YoY — Moderate
✕ Declining — Cash flow deteriorating
|
Sustained OCF growth alongside PAT growth = highest quality earnings signal. Divergence between the two warrants investigation. |
G
Book Value & Per Share Metrics
| Ratio / Metric | Numbered Thresholds | Interpretation |
|---|---|---|
| P/B Ratio (Market Price ÷ BVPS) |
✓ < 1.0 — Trading below book; potential deep value
~ 1.0–3.0 — Normal; growth premium
✕ > 5.0 — Highly premium; requires very high ROE
|
P/B < 1 during market corrections is often an opportunity for banking and NBFC stocks. High P/B is justified only if sustained ROE > 20%. |
| BVPS Growth (5-yr CAGR) |
✓ > 15% CAGR — Strong wealth compounding
~ 8–15% CAGR — Healthy retained earnings
✕ < 5% or declining — Poor value creation
|
Consistent BVPS growth reflects disciplined retained earnings. If BVPS declines, the company may be destroying equity value through losses or excessive payouts. |
| Diluted vs Basic EPS Gap |
✓ Gap < 2% — Minimal dilution
~ 2–5% gap — Moderate ESOP dilution
✕ Gap > 10% — Significant dilution; shareholder value at risk
|
A large gap between basic and diluted EPS signals heavy ESOP grants or convertible instruments. Reduces the real earnings per share for existing shareholders. |
| Dividend per Share (DPS) Growth |
✓ Growing DPS 5+ years — Confidence signal
~ Flat DPS — Stable but no income growth
✕ Cut or omitted dividend — Financial stress likely
|
Companies that consistently grow DPS over 5+ years demonstrate financial strength and shareholder-friendly management. Dividend cuts are among the strongest bearish signals. |
Part 3 — Step-by-Step Analysis Process
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Analysis Workflow
Use this structured workflow when analysing any listed company on NSE / BSE or US markets.
1
Screen for quality businesses — Use screeners (Screener.in, Tickertape, NSE website). Filter by ROE > 15%, D/E < 1, revenue growth > 10%, positive FCF.
2
Read the Annual Report — Focus on MD&A, Chairman's letter, and Notes to Accounts. Look for management candour, disclosed risks, and related-party transactions.
3
Analyse all three financial statements — Minimum 5-year trend for Income Statement, Balance Sheet, and Cash Flow Statement. Cross-check PAT vs OCF every year.
4
Compute and benchmark ratios — Apply the framework from Parts 1 & 2. Compare to historical data and sector peers. Use Screener.in for 10-year financials.
5
Evaluate management quality & governance — Promoter holding, pledging, related-party transactions, and capital allocation history.
6
Assess competitive moat — Identify sustainable advantages using Porter's Five Forces and moat categories. Ask: why can't a well-capitalised competitor displace this business?
7
Build a valuation estimate — Use DCF, Comps (EV/EBITDA, P/E), and DDM. Triangulate across methods to find a reasonable intrinsic value range.
8
Factor in macro & sector backdrop — Interest rates, inflation, regulatory changes, FII/DII flows, global macro cues.
9
Determine risk-reward & investment thesis — Define what must be true for your thesis to play out — and what would break it (write it down).
10
Apply a Margin of Safety — Only invest when the price offers a sufficient discount (20–40%) to your calculated intrinsic value. The margin of safety is your protection against being wrong.
Part 4 — Summary at a Glance
✦
Green Flags & Red Flags
✅ Green Flags — Quality Business
- Revenue + PAT growth: consistent 15%+ CAGR over 5–10 years.
- OCF > PAT every year: earnings quality is real, not accounting-driven.
- ROE > 15% & ROCE > Cost of Capital, sustained over multiple cycles.
- Low leverage: Debt-free or D/E < 0.5 with interest coverage > 5×.
- Promoter holding > 50% & rising. Zero or minimal share pledging (< 5%).
- Expanding margins with operating leverage as revenue scales.
- Identifiable economic moat: brand, network effect, switching costs, or patents.
- Positive FCF consistently. FCF Yield > 3–5%.
- Valuation at or below intrinsic value with an adequate margin of safety (20–40%).
- Disciplined capital allocation: proven track record on acquisitions, buybacks, and dividends.
🚩 Red Flags — Warning Signs
- PAT growing but OCF declining: possible revenue recognition manipulation.
- Rapidly rising receivables / DSO > 90 days: revenue may not be converting to real cash.
- Frequent equity dilution: large ESOP issuances dilute EPS and shareholder value.
- High promoter pledging > 30–40%: forced selling risk in a downturn.
- Promoter holding declining consistently: insiders reducing stake — bearish signal.
- Auditor changes or qualified opinions: major governance concern; investigate immediately.
- Significant related-party transactions without clear business rationale: may indicate fund diversion.
- Debt rising faster than revenue: leverage increasing without commensurate growth.
- Shrinking margins on growing revenue: cost structure deteriorating.
- Negative working capital (non-retail): operational stress signal.
⊞
Formula Cheatsheet
EPS
Net Income ÷ Total Shares Outstanding
P/E Ratio
Market Price per Share ÷ EPS
PEG Ratio
P/E ÷ EPS Growth Rate (%)
P/B Ratio
Market Price per Share ÷ Book Value per Share
EV/EBITDA
(Market Cap + Net Debt) ÷ EBITDA
ROE
(Net Income ÷ Shareholders' Equity) × 100
ROCE
(EBIT ÷ Capital Employed) × 100
ROIC
(NOPAT ÷ Invested Capital) × 100
Net Profit Margin
(Net Income ÷ Revenue) × 100
D/E Ratio
Total Debt ÷ Shareholders' Equity
Interest Coverage
EBIT ÷ Interest Expense
Current Ratio
Current Assets ÷ Current Liabilities
Quick Ratio
(Current Assets − Inventory) ÷ Current Liabilities
Free Cash Flow
Operating Cash Flow − CapEx
FCF Yield
FCF ÷ Market Cap × 100
Dividend Yield
(Annual DPS ÷ Stock Price) × 100
Cash Conversion Cycle
DIO + DSO − Days Payable Outstanding
DuPont ROE
Net Profit Margin × Asset Turnover × Equity Multiplier
BVPS
(Total Assets − Total Liabilities) ÷ Shares Outstanding
DCF Intrinsic Value
Σ [FCFt ÷ (1 + WACC)^t] + TV ÷ (1 + WACC)^n
DDM (Gordon Growth)
P = D1 ÷ (Ke − g)
NOPAT (for ROIC)
EBIT × (1 − Effective Tax Rate)
"Price is what you pay. Value is what you get."— Warren Buffett
Fundamental analysis is not a one-time exercise. Re-evaluate your thesis every quarter after results, and annually with the full annual report. Markets are dynamic — businesses evolve, moats erode, and macro conditions shift. Combine FA with Technical Analysis for entry/exit timing and position sizing.