Fundamental analysis is the evaluation of a company's financial health and performance through the analysis of its financial statements. The various values and figures depicted in the statements give an insight into where the company is headed, its current performance, and its past performance. These values are the basic parameters to understand a company, by just taking one glance at them.
In order to make a well-informed investment decision, an investor must know how to read and interpret the financial statements. In the previous blog, we learned about the basic values such as market cap, enterprise value, P/B ratio, and a cash component. However, just knowing these values will not be enough to get a basic idea just yet.
This article talks about the various other important factors and figures that are required for analyzing a company and its future prospects in terms of investments. We will discuss concepts like dividend, promoter holding, and how they influence the choice of a potential investment.
The concept of dividend seems simple in the beginning but has a lot of different aspects attached to it, thus making its analysis all the more crucial.
Promoter holding is a figure that can often be deceiving in terms of its face value and can often make an investor make the wrong decision.
However, if an investor knows the basics of these topics and understands how they work, he/she can make a more informed decision.
The major objective of any company is to create returns and generate profits. When you buy the shares of a company, you gain some share in the company's ownership, no matter how small or large it might be. When the company earns profit, it might choose any or both of the following things:
One, it may choose to use this profit for further expansion like advertisements or buying assets; or second, it may choose to give this profit back to its shareholders. It means each shareholder will get their share of profit in proportion to the shares they hold. A company can also choose to do both. For example, out of their ₹100 profit, a company may keep ₹60 for its expansion and give back ₹40 to all its shareholders.
Hence, this portion of the profit that is given back to the shareholders is called a 'dividend.' In our example, it is ₹40.
A dividend is the distribution of some portion of a company's earnings to its shareholders. They are rewards that a company gives as payments to its investors or shareholders for investing in the company. Dividends can be paid off as cash or as additional stock.
Dividend = Net Income * Dividend Payout Ratio
Here, the dividend payout ratio suggests the portion of a company's net income that it wishes to distribute among its shareholders. It can be assessed by studying the company's dividend payout trends in the past.
Most investors prefer companies that give high dividends. For such investors, other factors don't really matter as long as the company is providing high dividends to its shareholders. Investors who want to generate regular income, generally look for high dividend-yielding stocks.
Have you read our previous Master Class: Parameters of Fundamental Analysis of Stocks ?
Do all companies give dividends?
Not at all. The dividend policy depends on the company's planning for the future. If the company has a lot of idle cash and is not looking forward to the expansion, it may choose to distribute its profits as dividends. Sometimes, when a company might feel that there is a lack of demand for its services or products, it can think to defer its plans for a new strategy rather than investing for a loss.
Some other companies may keep using this money for further expansion. Warren Buffet's Berkshire Hathaway has given just one dividend in its entire run. Hence, we may conclude that despite the company earning good profits, it might not give it away as dividends, but instead use it to expand further.
This aspect is reflected in the 'dividend yield.' Dividend Yield is defined as the dividend amount per share against its share market price. Since the lower dividend is not a reflection of the profit or loss of the company, hence low dividend yield also does not mean that the company is performing poorly. On the other hand, if a company is handing out much of its profits as dividends, it is quite possible that the company is not looking for growth in the near future. This means that your invested capital might not appreciate much. Yet, if you happen to find a growing company with high dividends, it is a potential buy.
Face Value is a simple term and is much less relevant since the Demat era. There are still a few uses of this term, and hence it has not yet been eliminated. Face value shows how many shares the company has issued. If a company values ₹10000 and issued shares of face value ₹10, it means that it has issued 1000 shares. The market value or book value are entirely different concepts and should not be mixed up.
Face Value is also used as a reference while issuing dividends. Suppose the face value of a share is ₹10. If a company issues a dividend at 50% of the face value, it means it will give you ₹5 per share owned.
Promoters or promoter groups are entities that hold a significant influence on the company. Promoters are usually the owners of the company. They often have a major stake in the company and hold the top management positions. The stake in the company or the total percentage of shares that the promoters of a company holds is known as the promoter holding.
So, if the company has as much as 35-40% shareholding with promoters, it shows the stability as well as the promoters' confidence in their own business. A high promoter holding shows that the promoters have faith in the company's future and wish to benefit from that.
Nonetheless, the promoter holding value is not an absolute factor in making a decision.
Some companies like ITC are professionally managed and have less promoter ownership or promoter holdings. Instead, a cluster of companies owns its shares. Recently, several organizations came to rescue Yes Bank, which will now be a professionally managed company with its shareholding under SBI, LIC, HDFC, and others.
Banks are an exception because RBI keeps a cap on the limit to which the promoters can have ownership of the bank. This is done so that banks remain professionally managed and depositors are safe, rather than run the bank to the whims of promoters.
Is a high promoter-holding a guarantee?
There might be cases where the promoters are not a part of the organization, and their holding is limited. Yet they can work well as a professionally managed company.
Sometimes, institutional investors like mutual funds, banks, insurance companies, investment banks also invest in the company and own a major chunk. Such companies invest after detailed research; hence their ownership can also be considered safe.
One factor that must be attended is that despite the high promoter holdings, how much have the promoters pledged to the banks? Pledging is like keeping collateral against a loan. So if promoters have taken huge loans and pledged a good share of their holdings in the company, it is generally not a good sign.
The other factor one should see is that the trend of promoter holding. If the promoter holding is reducing with time, it might be a bad sign. Either, the promoters want to exit from the firm, or they might have to dilute their equity to pay for the loans. Yet, this depends on the reason the ownership is being diluted. If ownership dilution is happening due to a recent Follow on Public Offer (FPO), it might not be a problem.
The bottom line is that dividends and promoter holdings are good signs to analyze how the company has been performing so far. To get a more informed idea about how these values are to be interpreted, watch this video tutorial YouTube.
However, just like other important financial figures, dividends, face value, or promoter holdings should not be the sole decision affecting parameters. They have to be combined with other important financial values in order to make a well-informed investment decision.
Hop on to the next blog series: Understanding Return on Equity and Net Profit Margin
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