T h e o ret i c a l B a c kg rou n d

Fundamental Analysis
The intrinsic value of an equity share depends on a multitude of factors. The
earnings of the company, the growth rate, and risk exposure of the company have a
direct bearing on the price of the share. These factors in turn rely on the host of other
factors like economic environment in which they function, the industry which they
belong to, and finally the companies own performance. The fundamental analysis
school of thought appraises the intrinsic value of shares through:
Economic Analysis
Industry Analysis
Company Analysis

Economic Analysis
The level of economic activity has an impact on investment in many ways. If
the economy grows rapidly, the industry can also be expected to show rapid growth
and vice-versa. When the level of economic activity is low, stock prices are low, and
when the level of economic activity is high, stock prices are high reflecting the
prosperous outlook for sales and profits of the firms. The analysis of macro economic
environment is essential to understand the behaviour of the stock prices. The
commonly analyzed macro economic factors are as follows:
Gross Domestic Product: GDP indicates the rate of growth of the economy.
GDP represents the aggregate value of the goods and services produced in the
economy. GDP consists of personal consumption expenditure, gross private
domestic investment and government expenditure on goods and services and
net export of goods and services. The growth rate of economy points out the
prospects for the industrial sector and return investors can expect from
investment in shares. The higher growth rate is more favourable to the stock
market.
Savings and investment: It is obvious that growth requires investment which
in turn requires substantial amount of domestic savings. Stock market is a
channel through which the savings of the investors are made available to

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 corporate bodies. Savings are distributed over various assets like equity shares,
deposits, mutual fund units, real estate and bullion. The saving and investment
patterns of the public affect the stock to a great extent.
Inflation: Along with the growth of GDP, if inflation also increases, then the
real rate of growth would be very little. The demand in the consumer product
industry is significantly affected. If there is a mid level of inflation, it is good
to the stock market but high rate of inflation is harmful to the stock market.
Interest rates: The interest rate affects the cost of financing to the firms. A
decrease in interest rate implies lower cost of finance for firms and more
profitability. More money is available at a lower interest rate for the brokers
who are doing business with borrowed money. Availability of cheap fund,
encourages speculation and rise in price of shares.
Budget: The budget draft provides an elaborate account of the government
revenues and expenditures. A deficit budget may lead to high rate of inflation
and adversely affect the cost of production. Surplus budget may result in
deflation. Hence, balanced budget is highly favorable to the stock market.
The tax structure: Concessions and incentives given to a certain industry
encourages investment in that particular industry. Tax reliefs given to savings
encourage savings. The type of tax exemption has an impact on the
profitability of the industries.
The Balance of payment: The balance of payment is the record of a countrys
money receipts from and payments abroad. The difference between receipts
and payments may be surplus or deficit. BOP is the measure of the strength of
rupee on external account. If the deficit increases, the rupee may depreciate
against other currencies, thereby, affecting the cost of imports. The volatility
of the foreign exchange rate affects the investment of the foreign institutional
investors in the Indian Stock Market. A favorable balance of payment renders
a positive effect on the stock market.
Infrastructure facilities: Infrastructure facilities are essential for the growth
of industrial and agricultural sector. A wide network of communication system
is a must for the growth of the economy. Regular supply of power without any

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 power cut would boost the production. Banking and financial sectors should
also be sound enough to provide adequate support to industry and agriculture.
Demographic factors: The demographic data provides details about the
population by age, occupation, literacy and geographic location. This is
needed to forecast the demand for the consumer goods. The population by age
indicates the availability of able work force. Population, by providing labour
and demand for products, affects the industry and stock market.

Industry analysis
Industry analysis is a type of business research that focuses on the status of an
industry or an industrial sector (a broad industry classification, like "manufacturing").
A complete industrial analysis usually includes a review of an industry's recent
performance, its current status, and the outlook for the future. Many analyses include
a combination of text and statistical data.
Five Forces Affecting Competitive Strategy
Porter identifies five forces that drive competition within an industry:
The threat of entry by new competitors.
The intensity of rivalry among existing competitors.
Pressure from substitute products.
The bargaining power of buyers.
The bargaining power of suppliers.
Industry Life Cycle Model
This model is a useful tool for analyzing the effects of an industry's evolution on
competitive forces. Using the industry life cycle model, we can identify five industry
environments, each linked to a distinct stage of an industry's evolution:
An embryonic industry environment
A growth industry environment
A shakeout industry environment
A mature industry environment
A declining industry environment

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Company Analysis
In the company analysis the investor assimilates the several bit of information
related to the company and evaluates the present and future value of stock. The risk
and return associated with the purchase of the stock is analyzed to take better
investment decision.
The present and future are affected by a number of factors. They are:-

Factors Share values

Competitive edge Historic price of stock

Earnings P/E ratio
Capital structure Economic condition
Management Stock market condition
Operating efficiency
Financial performance

Future price Present price

The competitive edge of the company:- The competitive edge of the company can
be studied with the help of:-
The market share
The growth of annual sales
The stability of annual sales
The market shares:- The market share of the annual sales helps to determine a
companys relative competitive position within the industry. If the market share is
high the company would be able to meet the competition successfully.

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Growth of sales:- The company would be the leading company, but if the growth of
sales is comparatively lower than another company, it indicates the possibility of
the company losing the leadership. The rapid growth in sales would keep the
shareholder in a better position than one with a stagnant rapid growth.
Stability of sales: - If a firm has stable sales revenue, other things being remaining constant
will have more stable earnings. Wide variation in sales leads to variation incapacity
utilization, financial planning and dividend.
Earnings of the company:- Sales alone do not increase the sales the earnings but the
costs and expenses of the company also influence the earnings of the company.
Further, earnings do not always increase with the increase in sales. The
companys sales might have increased but its per share may decline due to the
rise in costs.
Capital structure: - The equity holders return can be increased manifold with the
help of financial leverage, i.e. using debt financing along with equity financing. The
effect of financial leverage is measured by computing leverage ratios. The debt ratio
indicates the positions of long term and short terms debts in the company finance. The
debt may be in the form of debentures and term loans from financial institutions.
Management: - Good and capable management generates profit to the investors. The
management of the firm should efficiently plan, organize, actuate and control the
activities of the company. The basic objective of management is to attain the stated
objectives of the company for the good of the equity share holders, the public and the
employers. The good management depends on the quality of the manager.
The following are special traits of an able manager:-
Ability to get along with people
Leadership
Analytical competence
Industry
Judgment
Ability to get things done
Operating efficiency: - The operating efficiency of a company directly affects the
earnings of a company. An expanding company that maintains high operating

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efficiency with a low break-even point earns more than the company with high break-
even points. If a firm has stable operating ratio, the revenue will also be stable.
Efficient use of fixed assets with a raw materials, labour and management would lead
to more income from sales. This leads to internal fund generation for the expansion of
the firm. A growing company should have low operating ratio to meet the growing
demand for its product.
Financial analysis:- the best source of financial information about a company is its
own financial statements. This is a primary source of information for evaluating the
investments prospect in the particular companys stock. Financial statement analysis
is the study of a companys financial statement from various viewpoints. The
statement gives the historical and current information about the companys operations.
Historical financial statements help to predict the future. The current information aids
to analyse the present status of the company. The two main statements used in
analysis are:-
Balance sheet
Profit and loss account
Debt valuation techniques and concepts
In their simplest form bonds are pretty straightforward. After all, just about
anybody can comprehend the borrowing and lending of money. However, like many
securities, bonds involve some more complicated underlying concepts as they are
traded and analyzed in the market.
Bond Pricing
It is important for prospective bond buyers to know how to determine the price of a
bond because it will indicate the yield received should the bond be purchased. Bonds
can be priced at a premium, discount, or at par. If the bonds price is higher. Than its
par value, it would sell at a premium because its interest rate is higher than current
prevailing rates. If the bonds price is lower than its par value, the bond would sell at a
discount because its interest rate is lower than current prevailing.
Bondholder's Expected Rate of Return (Yield to Maturity)
The bondholder's expected rate of return is the rate the investor will earn if the bond is
held to maturity, provided, of course, that the company issuing the bond does not
default on the payments.

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Computing Yield-to-Maturity on a Bond (YTM)

1
1
MP C
1 r n
I 1
r 1 r n

Solving the equation for r gives the YTM.
1) If the investor's required return is greater than the YTM, the investor should not
buy the bond
2) If the investor's required return is less than the YTM, the investor should buy the
bond
Three Important Relationships
First relationship
A decrease in interest rates (required rates of return) will cause the value of a bond to
increase; an interest rate increase will cause a decrease in value. The change in value
caused by changing interest rates is called interest rate risk.
Second relationship
1. If the bondholder's required rate of return (current interest rate) equals the coupon
interest rate, the bond will sell at par, or maturity value.
2. If the current interest rate exceeds the bond's coupon rate, the bond will sell below
par value or at a "discount."
3. If the current interest rate is less than the bond's coupon rate, the bond will sell
above par value or at a "premium."
Third relationship
A bondholder owning a long-term bond is exposed to greater interest rate risk than
when owning a short-term bonds.
Relationships on the YTM
Since the bond's coupon rate, kc, is fixed for the life of bond, the following
YTM/bond price relationship is created:

If YTM is > r, the bond sells at Discount.

If YTM is < r, the bond sells at Premium

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 If YTM is = r, the bond sells at par.

The Term Structure of Interest Rates

The term structure of interest rates, also known as the yield curve, is a very common
bond valuation method. Constructed by graphing the yield to maturities and the
respective maturity dates of benchmark fixed-income securities, the yield curve is a
measure of the market's expectations of future interest rates given the current market
conditions. Treasuries, issued by the central government, are considered risk-free, and
as such, their yields are often used as the benchmarks for fixed-income securities with
the same maturities. The term structure of interest rates is graphed as though each
coupon payment of a non-callable fixed-income security were a zero-coupon bond
that matures on the coupon payment date. The exact shape of the curve can be
different at any point in time. So if the normal yield curve changes shape, it tells
investors that they may need to change their outlook on the economy.
Duration
The term duration, having a special meaning in the context of bonds, is a
measurement of how long in years it takes for the price of a bond to be repaid by its
internal cash flows. It is an important measure for investors to consider, as bonds with
higher durations are more risky and have higher price volatility than bonds with lower
durations.
Factors affecting Duration
Besides the movement of time and the payment of coupons, there are other factors
that affect a bond's duration: the coupon rate and its yield. Bonds with high coupon
rates and in turn high yields will tend to have lower durations than bonds that pay low
coupon rates, or offer a low yield. This makes empirical sense, since when a bond
pays a higher coupon rate, or has a high yield, the holder of the security receives
repayment for the security at a faster rate. The diagram below summarizes how
duration changes with coupon rate and yield.

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Types of Duration
There are four main types of duration calculations, each of which differ in the way
they account for factors such as interest rate changes and the bond's embedded options
or redemption features. The four types of durations are Macaulay duration, modified
duration, effective duration, and key-rate duration.
Macaulay Duration
Macaulay duration is calculated by adding the results of multiplying the present value
of each cash flow by the time it is received, and dividing by the total price of the
security. The formula for Macaulay duration is as follows:

n
t *c n*M
(1 i)
t 1
t

(1 i ) n
Mac Dur
P

n = number of cash flows

t = time to maturity
C = cash flow
i = required yield
M = maturity (par) value
P = bond price

1
1
MP C 1 r
n
I 1 .
r 1 r
n

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So the following is an expanded version of Macaulay duration:

n
t *c n*M
(1 i )
t 1
n

(1 i ) n
Mac Dur
1
1
(1 i ) n M
C*
i (1 i ) n

Modified Duration
Modified duration is a modified version of the Macaulay model that accounts for
changing interest rates. Because they affect yield, fluctuating interest rates will affect
duration, so this modified formula shows how much the duration changes for each
percentage change in yield. For bonds without any embedded features, bond price and
interest rate move in opposite directions, so there is an inverse relationship between
modified duration and an approximate one-percentage change in yield. Because the
modified duration formula shows how a bond's duration changes in relation to interest
rate movements, the formula is appropriate for investors wishing to measure the
volatility of a particular bond. Modified duration is calculated as the following:

macaulaydurartion
Modified Duraton
YTM
1
No of Cpn Periods

Valuation
The strategy of selecting stocks that trade for less than their intrinsic value. Value
investors actively seek stocks of companies with sound financial statements that they
believe the market has undervalued. They believe the market always overreacts to
good and bad news, causing stock price movements that do not correspond with their
long-term fundamentals. The result is an opportunity for value investors to profit by
taking a position on an inflated/deflated price and getting out when the price is later
corrected by the market.
Approaches to Valuation

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 Discounted cash flow valuation: This approach has its foundation in the
present value rule, where the value of any asset is the present value of
expected future cash flows on it. The discount rate will be a function of the
riskiness of the estimated cash flows, with higher rates for riskier assets and
lower rates for safer projects.
Relative valuation: estimates the value of an asset by looking at the pricing of
'comparable' assets relative to a common variable like earnings, cash flows,
book value or sales.
Contingent claim valuation: A contingent claim or option is an asset that
pays off only under certain contingencies, if the value of the underlying asset
exceeds a prescribed value for a call option or is less than the prescribed value
for a put option. Option pricing models are used to measure the value of assets
that share option characteristics.
Discounted Cash Flow Valuation
In discounted cash flow valuation, the value of an asset is the present value of the
expected cash flows on the asset. It is based on the philosophy that every asset has an
intrinsic value that can be estimated, based upon its characteristics in terms of cash
flows, growth and risk.
The 4 step DCF valuation Technique
Step 1Forecast Expected Cash Flow: the first order of business is to forecast the
expected cash flow for the company based on assumptions regarding the company's
revenue growth rate, net operating profit margin, income tax rate, fixed investment
requirement, and incremental working capital requirement.
Step 2Estimate the Discount Rate: the next order of business is to estimate the
company's weighted average cost of capital (WACC), which is the discount rate that's
used in the valuation process
Step 3Calculate the Value of the Corporation: the company's WACC is then used
to discount the expected cash flows during the Excess Return Period to get the
corporation's Cash Flow from Operations. We also use the WACC to calculate the
company's Residual Value. To that we add the value of Short-Term Assets on hand to
get the Corporate Value.

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Step 4Calculate Intrinsic Stock Value: we then subtract the values of the
company's liabilitiesdebt, preferred stock, and other short-term liabilities to get
Value to Common Equity, divide that amount by the amount of stock outstanding to
get the per share intrinsic stock value
Free Cash Flow to Firm (FCFF)
A Firm is composed of all its claimholders and includes, in addition to equity investors,
bondholders and preferred stockholders. The cash flows to the firm are therefore the
accumulated cash flows to all these claimholders.
Estimating Cash flows to the Firm
The cash flows to the firm are those cash flows left over after meeting operating expenses and
taxes but before making payments to any claimholders. There are two ways in which these
cash flows can be calculated. One way is to accumulate the cash flows to different
claimholders to the firm.
FCFF = Free cash flows to equity + interest expense (1- tax rate) + Principal
Repayments New Debt Issues + Proffered Dividends.
The other approach, which should yield an equivalent number, starts with the earnings before
interest and taxes.
FCFF = EBIT (1-tax rate) + Depreciation Capital Expenditures Working Capital
Needs

A firm with free cash flows to the firm growing at a stable growth rate can be valued
using the following model:

Value of firm = FCFF1 / (WACC - gn)

where,

FCFF1 = Expected FCFF next year

WACC = Weighted average cost of capital

gn = Growth rate in the FCFF (forever)

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Total Return Index
Nifty is a price index and hence reflects the returns one would earn if investment is made in the
index portfolio. However, a price index does not consider the returns arising from dividend
receipts. Only capital gains arising due to price movements of constituent stocks are indicated
in a price index. Therefore, to get a true picture of returns, the dividends received from the
constituent stocks also need to be factored in the index values. Such an index, which includes
the dividends received, is called the Total Returns Index.
Total Returns Index reflects the returns on the index arising from (a) constituent stock price
movements and (b) dividend receipts from constituent index stocks.
Methodology for Total Returns Index (TR) is as follows:
The following information is a prerequisite for calculation of TR Index:
1. Price Index close
2. Price Index returns
3. Dividend payouts in Rupees
4. Index Base capitalisation on ex-dividend date

Dividend payouts as they occur are indexed on ex-date.

DividendPayout (rs )
IndexedDividend 1000
BaseCapofindex(rs )

Indexed dividends are then reinvested in the index to give TR Index.

Total Return Index = [Prev. TR Index + (Prev. TR Index * Index returns)] +

[Indexed dividends + (Indexed dividends * Index returns)]

The base for both the Price index close and TR index close will be the same.

An investor in index stocks should benchmark his investments against the Total
Returns index instead of the price index to determine the actual returns vis--vis the
index.

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 D E S I G N O F TH E S T U D Y

Construction of balanced fund comprising of Debt and Equity

Statement of Problem:
To test the significance of excess return to beta, the researcher tries to find whether
one can construct a portfolio whose beta is equal to market beta (beta =1), with
returns greater than market returns.
Ho: Excess return to beta = 0.
H1: Excess return to beta > 0.
Objectives of the research:
To analyse the performance of the shares in the automobile and cement
sector in Indian stock market.
To study the factors influencing the share price of the company.
To find the intrinsic value of the shares based on fundamental analysis and
FCFF Model.
To construct a portfolio (Balanced Fund) of equities and debt. The
construction would be based on fundamental analysis and the single index
model.
To visualize the emerging trends and prospects in near future for mutual
funds in India
Scope of research: The study is restricted only to automobile and cement sector.
Sample selected is very small.

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 Research Methodology

Type of research
The study is a descriptive research, describing the construction of portfolios.
Tools for data collection:
The study involves collection of data from secondary sources and collected
from internet, magazines, news paper, and research reports.
Sampling:
Type of sampling: Non-probabilistic judgment sampling.
Sample size: Four stocks from the automobile sector and six stocks from the
cement sector; fifty companies Corporate debt; ten Government securities; and
364 day-T-bills.

Plan Of Analysis
After having collected the financial data related to the entities, i.e. the sample
selected from the selected sectors, the various valuation ratios and other financial
calculations which will help in the company valuation are calculated. This helps in
finding out the intrinsic value of the companys share. Based on the valuations, a
portfolio is constructed on the basis of fundamental analysis and on the basis of risk-
return analysis with different combinations of debt and equity to maximize the returns
and minimize the risk (beta).
Research process:
Explained in chapter 3.
Limitations of the Study
The study was confined only to the selected sectors.
The study was more confined with secondary data.
The study assumes no changes in the tax rates in the country.
As the scope is defined by the researcher it restricts the number of variables
which I influence the industry.
The researcher uses only FCFF model to value a stock.

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Operational Definitions

Bond: A debt instrument sold by a company or government to raise money. One who
buys a bond is a creditor of the company, but not an owner, as a stockholder would be.

Par: The value of a bond assigned by the issuer; also called face value.

Original issue discount: A bond with an offering price that is below par value.

Coupon: A bond's interest rate.

Premium: The amount by which a security sells above its par value.

Maturity: The length of time before the principal amount of a bond is due to the
bondholders. It is the time until a bond may be surrendered to its issuer. Also called
term-to-maturity.

Maturity date: The date on which a bond is to be redeemed and its principal and
interest returned to the owner.

Callability: The feature of some bonds whereby the issuer can redeem it before it
matures. Issuers often call their bonds when interest rates are falling and they want to
replace high-yielding bonds with lower-yielding bonds. Call provisions must be made
clear before a bond is sold. A bond with this feature is a callable bond.

Debenture: A bond backed by the issuer's general credit and ability to repay and not
by an asset or collateral.

Investment-grade: A classification of the ability of a bond issuer to repay a bond.

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Discount bond: A bond that sells at a discounted value of its face value. If a bond has
a Rs 1000 par value but sells for Rs 900, it is "sold at a discount" of Rs100. Adverse
market conditions and reductions in interest rates can convince sellers to discount the
bonds they sell.

Premium bond: A bond selling for more than its stated value. If a bond is Rs1000 par
but sells for Rs1100, it is "sold at a premium" of Rs100. Market conditions and
increases in interest rates can convince sellers to raise the prices of the bonds they
sell.

Yield: The rate of return on an investment, described as a percentage of the amount of

the investment. For example, a bond purchased for Rs1,000 with a 7% yield would
pay out 7% of Rs1,000, or Rs70.

Yield to maturity: The fully compounded annual rate of return paid out over a bond's
life, from purchase date to maturity, including appreciation/depreciation and earnings.
It is the most comprehensive measure of yield.

Accrued interest: The interest that has been accumulating on a bond since the last
time interest was paid on it.

Current yield: The expected rate of return calculated by dividing the most recent
annualized distribution by the selling price. For example, a Rs2,000 par bond that
pays Rs140 but is bought for Rs1600 has a current yield of 8 3/4 percent. The formula
for deriving current yield is annual income divided by current price.

Coupon rate: The interest as a percent of par paid by a bond. It is called a coupon
rate because historically bonds included attached coupons that were clipped and
surrendered for cash. Today, most bonds come without the attached coupons.

Duration: The change in value of a bond (expressed in years) caused by a change in

the prevailing interest rates.

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Floating-interest rate: A variable interest rate, one that changes periodically.

Floating-interest bond. A bond with an interest rate that changes each quarter to
reflect economic conditions.

Fixed-interest bond. A bond with an interest rate that stays the same over its life
span.
Corporate bond. A bond issued by a corporation and backed by the company's credit
and/or its assets.

Mortgage bond. A secured corporate bond that is backed by real estate. Because
mortgage bond collateral provides a clear claim on a company's assets, these bonds
are considered secure and high-grade.

Junk bond. Refers to the quality of bond that is a speculative, high yielding, and
issued by a company that typically finances its growth and operations with debt.
Ratings companies usually assign low grades to these bonds.

Revenue bond. A bond sold by a municipality to finance projects such as bridges,

hospitals, power plants and other local services. Also called limited obligation bonds,
revenue bonds are secured by the revenue generated by those projects.

Government bond. A bond sold by the. Government. Government bonds are rated
the highest of all bonds. They are used to finance federal projects.
Treasury bond (T-bond). A bond issued by the Treasury to meet the government's
financial needs. Treasury bonds are considered the safest bonds and are very popular
with investors. They have maturities lasting from ten to thirty years.

Treasury note (T-note). An intermediate-term federal government debt, similar to a

T-bond but maturing in one to ten years.

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Zero-coupon bond. A bond sold at discount and paying no interest, but instead
paying the holder the face value at maturity. A zero-coupon bond stated at 1000 but
sold for 600 would yield the holder a total of 1000 at maturity. The extra 400 the
investor makes would be treated as interest.

Fundamental Analysis: A method of evaluating a stock by attempting to measure its

intrinsic value. Fundamental analysts study everything from the overall economy and
industry conditions, to the financial condition and management of companies.

Intrinsic value: the economic value of a company or its common stock based on
internally-generated cash returns. Intrinsic value can be thought of as the discounted
stream of net cash flows attributable to an investment asset.

Terminal value: Terminal value refers to the value of the firm (or equity) at the end
of the high growth period. Terminal Value in year n= Cash Flow in year n+1/(r - g)
.This approach requires the assumption that growth is constant forever, and that the
cost of capital will not change over time.

Total Return Index: An index that calculates the performance of a group of stocks
assuming that all dividends and distributions are reinvested. This method is usually
considered a more accurate measure of actual performance than if dividends and
distributions were ignored.

Beta: Statistically, beta is the measure of systematic risk in the CAPM and is the ratio
of two co variances: the individual security divided by a proxy for the market as a
whole or the so-called market portfolio. The beta factor is the expected change in the
security's rate of return divided by the accompanying change in the rate of return to
the market portfolio.

Free cash flow to equity: free cash flow, an accounting concept that is equal to net
income plus non-cash charges (depreciation, depletion and amortization) minus debt
and other fixed obligations net of tax savings on interest expense minus preferred
dividends minus fixed capital expenditures needed to maintain the company's

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economic productive capacity at the same level minus the increase in working capital
needed to maintain the company's economic productive capacity at the same level.

Weighted Average Cost Of Capital: A calculation of a firm's cost of capital that

weights each category of capital proportionately. WACC is calculated by multiplying
the cost of each capital component by its proportional weighting and then summing:

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 CHAPTER SCHEME

Chapter: 1 THEORETICAL BACKGROUND OF THE STUDY

This chapter mainly contains the theoretical part which is required to carry out
the study. The major tools and models which are used in the study are contained in
this chapter.

Chapter: 2 RESEARCH DESIGN

A research design serves as a bridge between what has been done in the
conduct of study to realize the specified objectives. It is an outline of the projects
working.

Chapter: 3 PROFILES
This chapter includes the profile of the industry on which the study is
conducted. This also includes the trends and prospects in the industries.

Chapter: 4 ANALYSIS AND INTERPRETATION

In this chapter, the researcher constructs the portfolio with the concepts
discussed in the chapter 1. and analyses using hypothesis tests to find whether there
exists a significance difference between various portfolio mean returns constructed
through different approaches.

Chapter: 5 Summary of Findings, conclusions and Suggestions

In this chapter we will actually include all that we have analyzed and what has
been found. Finally conclude checking whether the objective of the study has been
achieved or not.

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 I n d u s t r y P rof i l e

Indian Money Market

Whenever a bear market comes along, investors realize that the stock market is a risky
place for their savings, a fact we tend to forget while enjoying the returns of a bull
market! This, unfortunately, is part of the risk/return tradeoff. That is, to get higher
returns, you have to take on a higher level of risk. But for many investors, a volatile
market is too much to stomach - an alternative is the money market. The money
market is better known as a place for large institutions and government to manage
their short-term cash needs. However, individual investors have access to the market
through a variety of different securities.
The money market is a subsection of the fixed income market. Many people
think of the term "fixed income" as synonymous with bonds, but technically, a bond is
just one type of fixed income security. The difference between the money market and
the bond market is that the money market specializes in very short term debt securities
(debt that matures in less than one year). Money market investments are also called
cash investments because of their short maturities. Money market securities are
essentially bonds issued by governments, financial institutions, and large
corporations. These instruments are very liquid, and considered very safe. Because
they are so conservative, money market securities offer a lower return than most other
securities. One of the main differences between the money market and the stock
market is that most money market securities trade in very high denominations and so
individual investors have limited access to them. Also, the money market is a dealer
market, which means that firms buy and sell securities in their own accounts, at their
own risk. Compare this to the stock market where brokers usually act as agents,
making money on commissions, while investors takes the risk of holding the stock.
One other characteristic of a dealer market is there is no central trading floor or
exchange. Deals are transacted over the phone or through electronic systems .
The easiest way for us to gain access to the money market is with a money market
mutual funds, or sometimes a money market bank account. Although, some money
market instruments like treasury bills may be purchased directly or through other
large financial institutions with direct access to these markets. There are several

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different instruments in the money market, offering different returns and different
risks. Let's take a look at the major ones.
Treasury Bills
Treasury Bills (T-bills) are the most marketable money market security. Their
popularity is mainly due to their simplicity. T-bills are basically a way for the
government uses to raise money from the public. T-bills are short-term securities that
mature in one year or less from their issue date. T-bills are issued with 3 month, 6
month, and 1 year maturities.
Certificate of Deposit (CD)
A certificate of deposit (CD) is a time deposit with a bank. Time deposits may not be
withdrawn on demand like a check account. CDs are generally issued by commercial
banks but they can be bought through brokerages. They bear a specific maturity date
(from 3 months to 5 years), a specified interest rate, and can be issued in any
denomination, very similar to bonds.
Commercial Paper
For many corporations, borrowing short-term money from banks is often a labored
and annoying task. Their desire to avoid banks as much as possible has led to the
Commercial paper is an unsecured, short-term loan issued by a corporation, typically
for financing accounts receivable and inventories.
Debentures
These are the normal types of bonds. It is unsecured debt, backed only by the name
and goodwill of the corporation. In the event of the liquidation of the corporation,
holders of debentures are repaid before stockholders, but after holders of mortgage
bonds.

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Indian Cement Industry

Background

The Indian cement industry (120 million tons per annum) is the fourth largest
in he world after China, Japan and USA. However, per capita consumption in the
country is only around 80-90 kg compared to the world average of approximately 250
kg.

Historically, the Indian cement sector has been highly fragmented comprising 54
players that operate 124 plants. The majority of the plants are small-sized and well
spread through out the country. The cement industry is cyclical and capital intensive.
A new plant typically has a gestation period of 3-4 years.

Overview of The Indian cement industry

The Indian cement industry with a total capacity of 144 m tonnes (including mini plants)
in FY04, has surpassed developed nations like USA and Japan and has emerged as the second
largest market after China. Although consolidation has taken place in the Indian cement
industry with the top six players controlling almost 60% of the capacity, the remaining 40%
of the capacity remains pretty fragmented with around 40 players in the fray.

Despite the fact that Indian cement industry has clocked a production of more than
100 m tonnes for the second year in succession, the per capita consumption of 110 kgs
compares poorly with the world average of 260 kgs. This, more than anything
underlines the tremendous scope for growth in the Indian cement industry in the long
term.

Cement, being a bulk commodity, is a freight intensive industry and transporting

cement over long distances can prove to be uneconomical. This has resulted in cement
being largely a regional play with the industry divided into five main regions viz.
north, south, west, east and the central region. While the southern region is excess is
capacity owing to the availability of limestone, the western and northern region are
the most lucrative markets. Therefore, players like Grasim, L&T and Gujarat Ambuja
enjoy high price realisations compared to the all India average.

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 Although the government has reduced the import duty on cement, imports do not pose
a threat since prices of cement in India are lower than those prevailing in the
international markets. Moreover, the storage facilities on the Indian ports are
inadequate for large-scale imports.

Key points about the cement industry

Supply : There is an oversupply situation in the industry due to capacity
additions by the major players in the industry. The situation is likely to
improve, as there is no major Greenfield expansion in sight.
Demand : Housing sector acts as the principal growth driver for cement.
However, in recent times, industrial and infrastructure sector have also
emerged as demand drivers for cement.
Barriers to entry: High capital costs and long gestation periods. Access to
limestone reserves (principal raw material for the manufacture of cement) also
acts as a significant entry barrier.
Bargaining power of suppliers:Licensing of coal and limestone reserves,
supply of power from the state grid and availability of railways for transport
are all controlled by a single entity, which is the government.
Bargaining power of customers: Cement is a commodity business and sales
volumes mostly depend upon the distribution reach of the company. However,
things are changing and few brands such as Gujarat Ambuja and L&T have
started commanding a premium on account of better quality perception.
Competition:Due to large number of players in the industry and very little
brand differentiation to speak of, the competition is intense with players
resorting to frequent price cuts in order to gain market share.

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Key Stages In Cement Production

Cement production is one of the worlds most energy intensive industries. Key
production stages can be summarized as:

1.Raw materials

These are generally combinations of limestone, shells or chalk, and shale, clay, sand
or iron ore, usually mined from a quarry close to the plant where they undergo
reduction using primary and secondary crushers. When the reduced materials reach
the cement plant they are proportioned to create a cement of specific chemical
composition. Much work is being done on the use of alternative raw materials often
the by-products of other industrial processes. These can minimize the effects of
quarrying, reduce the impact of the cement plant on the local environment and enable
the cement industry to become a major player in materials recycling. There are two
basic methods used in Portland cement production wet and dry. In the dry process
dry materials are proportioned, ground to a powder, blended and fed into the kiln dry.
The wet process involves adding water to the proportioned raw materials and
completing the grinding and blending operations in slurry form.

2. Pre-heater

To conserve energy, most modern cement plants pre-heat raw materials before they
enter the kiln, using the hot exhaust gases from the kiln itself.
3. Kiln

The mixture of raw materials is fed into the upper end of a rotating, cylindrical kiln,
which achieves temperatures in excess of 1000C. It passes through at a rate
controlled by the slope and rotational speed of the kiln. Chemical reaction inside the
kiln leads to the fusion of the raw materials to produce clinker. Traditionally kiln fuels
have been powdered coal or natural gas, but increasingly alternative fuels are being
used. These include materials such as scrap tyres, processed sewage sludge and
packaging waste.

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4. Cooling/finish grinding

Clinker is discharged from the lower end of the kiln and transferred to various types
of coolers.

Total production

The cement industry comprises of 125 large cement plants with an installed capacity
of 148.28 million tonnes and more than 300 mini cement plants with an estimated
capacity of 11.10 million tonnes per annum. The Cement Corporation of India, which
is a Central Public Sector Undertaking, has 10 units. There are 10 large cement plants
owned by various State Governments. The total installed capacity in the country as a
whole is 159.38 million tonnes. Actual cement production in 2002-03 was 116.35
million tonnes as against a production of 106.90 million tonnes in 2001-02,
registering a growth rate of 8.84%. Major players in cement production are Ambuja
cement, Aditya Cement, J K Cement and L & T cement.
Apart from meeting the entire domestic demand, the industry is also exporting
cement and clinker. The export of cement during 2001-02 and 2003-04 was 5.14
million tonnes and 6.92 million tonnes respectively. Export during April-May, 2003
was 1.35 million tonnes. Major exporters were Gujarat Ambuja Cements Ltd. and
L&T Ltd.
The Planning Commission for the formulation of X Five Year Plan constituted
a 'Working Group on Cement Industry' for the development of cement industry. The
Working Group has identified following thrust areas for improving demand for
cement;

i. Further push to housing development programmes;

ii. Promotion of concrete Highways and roads; and
iii. Use of ready-mix concrete in large infrastructure projects.

Further, in order to improve global competitiveness of the Indian Cement Industry, the
Department of Industrial Policy & Promotion commissioned a study on the global
competitiveness of the Indian Industry through an organization of international repute,

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viz. KPMG Consultancy Pvt. Ltd. The report submitted by the organization has made
several recommendations for making the Indian Cement Industry more competitive in
the international market. The recommendations are under consideration.
Cement industry has been decontrolled from price and distribution on 1st March 1989
and de-licensed on 25th July 1991. However, the performance of the industry and
prices of cement are monitored regularly. Being a key infrastructure industry, the
constraints faced by the industry are reviewed in the Infrastructure Coordination
Committee meetings held in the Cabinet Secretariat under the Chairmanship of
Secretary (Coordination). The Committee on Infrastructure also reviews its
performance.

Technological change

Continuous technological upgrading and assimilation of latest technology has

been going on in the cement industry. Presently 93 per cent of the total capacity in the
industry is based on modern and environment-friendly dry process technology and
only 7 per cent of the capacity is based on old wet and semi-dry process technology.
There is tremendous scope for waste heat recovery in cement plants and thereby
reduction in emission level. One project for co-generation of power utilizing waste
heat in an Indian cement plant is being implemented with Japanese assistance under
Green Aid Plan. The induction of advanced technology has helped the industry
immensely to conserve energy and fuel and to save materials substantially. India is
also producing different varieties of cement like Ordinary Portland Cement (OPC),
Portland Pozzolana Cement (PPC), Portland Blast Furnace Slag Cement (PBFS), Oil
Well Cement, Rapid Hardening Portland Cement, Sulphate Resisting Portland
Cement, White Cement etc. Production of these varieties of cement conform to the
BIS Specifications. Also, some cement plants have set up dedicated jetties for
promoting bulk transportation and export.

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Future Prospects about the Cement industry
The industry is likely to maintain its growth momentum and continue growing
at around 8% in the medium to long term. Government initiatives in the infrastructure
sector (such as the commencement of second phase of NHDP, rural roads, 10,000 kms
of additional highways as announced in Finance Budget) and the housing sector are
likely to be the main drivers of growth for the industry.

The acquisition of L&T's cement division by Grasim has changed the

landscape of the entire cement industry and in one fell swoop has catapulted
Grasim to the leadership position. This is a healthy sign for the industry, as
this would result in consolidation and would give significant pricing power to
the bigger players. With consolidation taking place at the lower end also, the
unviable units will be forced to shut down thus benefiting the long-term
interests of the industry.

With no major capacity expansion in the pipeline, the demand supply level is
expected to achieve parity on a macro level by FY07 and this will help in the
improvement of prices. However, since the level of demand supply mismatch
is higher in the southern region, it will take longer to achieve demand supply
parity. We expect cement price to increase by around 6% in FY05 owing to
fundamental reasons.

The industry worked at estimated 84% capacity in FY04 and given the current
growth rates and also assuming no major capacity expansion in the near
future, the capacity utilisation is likely to go up significantly in the future. This
will help in improving the margins of all the major players and will lead to
higher profitability.

Despite these positives, the possibility of interest rates heading north and the
consequent impact on housing demand remains to be seen. While infrastructure
spending was a boon, there was a strong cushion from the steady growth of the
construction sector. If this support wanes, it could take even longer for demand-supply
balance to reach parity. Also, the hike in prices of coal and petroleum products could

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impact cement companies margins (account for around 40% of sales). Though the
pricing cushion exists, the margin rise will be mitigated to this extent.

Automobile Industry

The Indian automobile industry has come a long way since in the first car ran
on the streets of Bombay (now Mumbai) in 1898. The initial years of the industry
were characterized by unfavorable government policies. The real big change as we see
in the industry today, started to take place with the liberalization policies that the
government initiated in the 1991. The liberalization policies had a salutary impact on
the Indian economy and the automobile industry in particular.
The automobile industry in the country is one of the key sectors of the
economy in terms of the employment opportunities that it offers. The industry directly
employs close to around 0.2 million people and indirectly employs around 10 million
people. The prospects of the industry also has a bearing on the auto-component
industry which is also a major sector in the Indian economy directly employing 0.25
million people.
All is not well with the automobile industry the world over currently with the
slowdown that has gripped most of the major economies of the world. The incidents
of 9/11 have also contributed to an already ailing global economy. The gap between
the manufacturing capacity volume and the assembly volume is growing by the day
and has the worried the manufacturers. This state of affairs has triggered a lot of
cutthroat competition and consolidation in the industry. Cost reduction initiatives have
come to be the in thing in the global industry today. Towards this direction, many
automobile factories are being closed down.
The Indian automobile industry is a stark contrast to the global industry due to
many of the characteristics, which are peculiar to India. The Indian automobile
industry is very small in comparison to the global industry. Except for two wheelers
and tractors segments, the Indian industry cannot boast of big volumes vis-a-vis
global numbers.

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Highlights

The Indian automobile segment can be divided into several segments viz. two-
wheelers (motorcycles, geared and ungeared scooters and mopeds), three
wheelers, commercial vehicles (light, medium and heavy), passenger cars,
utility vehicles (UVs) and tractors. The Indian automobile sector can be
divided into several segments: 2 & 3 wheelers, passenger cars, commercial
vehicles (Heavy CVs/ Medium CVs/Light CVs), utility vehicles (UVs) and
tractors.

Demand is linked to economic growth and rise in income levels. To highlight

the co-relation, while GNP per capita (gross national product) grew at a
CAGR of 11% between FY71-FY01, passenger car production increased by
9%. Per capita penetration across all categories is among the lowest in the
world (including other developing economies like Pakistan in segments like
cars).
The industry is highly capital intensive in nature. Though three-wheelers and
tractors have low barriers to entry in terms of technology, other segments are
capital and technology intensive. Costs involved in branding, distribution
network and spare parts availability increase entry barriers. With the Indian
market moving towards complying with global standards, capital expenditure
will rise to attune to future safety regulations.

The industry is highly fragmented in nature. In the last ten years, supply has
outstripped demand, as multinationals and domestic players have set up large-
scale manufacturing facilities to meet future needs. As a result, there is an
absence of pricing power with manufacturers. Competition is expected to
increase further, as global majors are planning to enter India either through
direct investment or imports.

Automobile majors increase profitability by selling more units. As number of

units sold increases, average cost of selling incremental unit comes down
when demand recovers. This is because the industry has a high fixed cost

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 component. This is the key reason why operating efficiency through increased
localization of omponents and maximizing output per employee is of
significance.

Key Points about the Automobile Industry

Supply : The Indian automobile market is plagued with excess capacity.
Demand: Is largely cyclical in nature and dependent upon economic growth
and per capita income. Seasonality is also a vital factor.
Barriers to entry: High capital costs, technology, distribution network, and
availability of auto components.
Bargaining power of suppliers:Low, due to stiff competition and its
fragmented nature.
Bargaining power of customers: Very high due to availability of options
Competition: Except for heavy CV segment, competition is stiff. Expected to
increase even further.
Future Prospects

The government spending on infrastructure in roads and airports and higher

GDP growth in the future could benefit the auto sector in general. This
combined with a softer interest rate environment will play a vital role in
providing a fillip to demand. We expect a slew of launches in the Segment 'B'
of passenger cars. Utility vehicle segment is expected to grow at around 8% in
FY05.

In the two-wheeler sector, motorcycle segment is expected to witness a flurry

of new model launches that will result in fragmentation of market share.
Though the market size is expected to grow by 12% -15%, competitive
pressure could keep prices and margins under control. While geared scooter
and moped segments could see a fall in volumes, TVS, Honda and Kinetic are
poised to benefit from higher demand for ungeared scooters in the urban
market.

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 After three years in the wilderness, tractor industry seems to have finally come
out of the trough as it grew by 10% during FY04. While good monsoon is a
positive for the sector, given the fact that the country has had erratic rainfall in
the past, volumes may not recover sharply. But the longer-term picture is
impressive in light of poor mechanisation levels in the country.

With an estimated 39% of CVs plying on the roads 10 years old, demand for
HCVs is expected to grow by 8% in FY05. Also adding the positives are
higher crop output, industrial sector growth and favorable interest rate
environment. While the industry is cyclical in nature, we expect this factor to
weaken in the medium term arising out of structural changes in the industry.
The privatization of select state transport undertakings and hiking of bus fares
bodes well for the bus segment as well.

The reduction in peak customs duty from 30% to 25% in the budget will result
in savings on the raw material front as well. Since raw material costs account
for almost 50% of revenues of auto companies in general, this is a positive.
Also, steel prices have shown some signs of softening and this is likely to have
a positive impact on the margins of the players.

We expect Indian auto majors to increase capital expenditure budget at an

average of 4%-5% of revenues in FY05 as against around 2%-3% historically.
This would be towards product development and complying with new
environmental regulations. With MNCs willing to sacrifice profitability for
growth in the short-term, it has become imperative for domestic players to
spruce up R&D efforts. At the same time, cash flow position is much stronger
now given that most manufacturers have reduced working capital and debt.
This would mean financing bulk of incremental capex from internal accruals.

Domestic manufacturers acting as a global hub for exports of certain products

is also gaining acceptance. Passenger car exports have grown at a healthy
CAGR of 38% in the last five years. Tata Motors, Bajaj Auto and Maruti have
met with success in the past. Though exports are not necessarily lucrative, it

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 will enable domestic players to increase exposure and maintain capacity
utilisation at a healthy level.

Hero Honda Motors Ltd

Company background
Hero Honda Motors Ltd (HHML), established in 1984, is a joint venture between
Hero Group, the worlds largest bicycle manufacturers and the Honda Motor
Company
of Japan. Today it is the worlds largest two-wheeler manufacturer. Hero Group
belongs to the Munjal family and came into existence in 1956. It manufactured
bicycle
components in the early 1940s and later became the worlds largest bicycle
manufacturer.
HHML manufactures a range of motorcycles with brands like CD Dawn, Splendor,
Passion, CBZ, Karizma and Ambition. It is the market leader in two-wheelers and its
Splendor range of bikes is the largest selling motorcycle in the country.
Industry scenario
The two-wheeler industry thrives in developing countries especially in densely
populated
countries like India. With income levels rising, customers are opting for entry-level
motorcycles than scooters. The two-wheeler industry grew 11.6% yoy to 5.64mn
units in FY04 from 5.05mn units in FY03. The share of motorcycles in total
twowheeler
sales continues to improve (76.6% from 74.4% in 2002-03) while that of
geared scooters continues to be on the decline.
In terms of volumes, two-wheelers constitute nearly 80% of the vehicles produced in
India. However, in value terms, they account for 25% approximately of the total
vehicle production. HHML is the market leader followed by Bajaj Auto and TVS
Motors, in that order.

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Table 1: Market share in motorcycles

In two-wheelers, HHMLs market share stood at 37% during FY04. In the premium
segment, the company enjoyed a 14% market share for the same period.
Higher volumes, lower realizations
HHML registered a 14.4% yoy growth in net sales to Rs58.3bn in FY04, similar to
the growth rate achieved in FY03. The key difference however, was the significant
fall in realizations in FY04 compared to FY03. While volumes increased by 23.4%
yoy in FY04, net realizations declined by 7.4% yoy during the same period.

The company launched 5 new models in FY04 to increase its share in the motorcycle
market. CD Dawn in April 2003, Karizma in May, Passion Plus in September 2003,
Splendor+ in October 2003 and Ambition 135 in January 2004. The company sold
over a million units of its Splendor range and 0.5mn units of CD Dawn in FY04. The
company enjoys a customer base of nearly 10mn.
FY04 witnessed export growth of 72% yoy mainly led by success of new models.
CD Dawn, Splendor+ and Passion Plus led to increase in exports by 87%. Besides
providing support services to Sri Lanka, Bangladesh and Columbia, the company
established its presence in new markets like Sierra Leone and Philippines for
motorcycles and components respectively.

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Operating profit growth 14.9%, OPM at 16.6%
The company was able to marginally improve its operating margins by 7bps to 16.6%
in FY04 in spite of increase in steel prices and other input costs. The 104bps increase
in raw material cost was offset by a 108bps decline in other expenditure. The lower
other expenditure was due to reduction in advertising and revenue spends by the
company in FY04, which declined by 12.3% yoy. In contrast, raw material cost
increase was a result of a 7.3% yoy rise in cost of steel sheets and 15.3% yoy rise in
cost of components in FY04. Change in sales mix too contributed to higher raw
material cost.
Outlook
During the year, HHML renewed its technical collaboration with Honda Motor
Corporation of Japan for another 10 years up to 2014. This will give HHML access to
Hondas technology for another 10 years for developing new products. HHML plans
to launch two motorcycles in FY05 and a scooter with the technology provided by
Honda.
Growing competition, price undercutting, rising steel prices and other input costs
continue to pose a threat. Reduction in import duties for imports could also pose a
threat for the higher end bikes. The company mentions in the annual report that the
next three years for the twowheeler industry are positive but volatile. The company is
planning to further increase its capacity to meet the growing demand for motorcycles.
It is considering setting up a third plant for its products.

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Step 1 : Calculation of the Total Return Index (TRI) :

Table 2 : Calculation of TRI

Total Return Index = [Prev. TR Index + Return

(Prev. TR Index * Index returns)] +
[Indexed dividends +
(Indexed dividends * Index returns)]
Year

1999 67.22

2000 -14.42

2001 -15.83

2002 3.91

2003 76.42

2004 10.77

Average Annualised Return 21.35

Absolute returns over a period of 6 years 1.353841

Annualised Market Returns (Rm) 15.34

Step 2: Calculation of beta

Beta: Statistically, beta is the measure of systematic risk in the CAPM and is the ratio of two
covariances: the individual security divided by a proxy for the market as a whole or the so-
called market portfolio. The beta factor is the expected change in the security's rate of return
divided by the accompanying change in the rate of return to the market portfolio.
Co var(market , stock )
Beta
Var Market

Table 3 : Calculation of Beta

Particulars Value
Variance 0.03%
Covariance 0.02%

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 Beta 0.89636

Step 3: Calculation of Weighted Average Cost of Capital

Weighted Average Cost Of Capital : A calculation of a firm's cost of
capital that weights each category of capital proportionately. A firm's WACC is the
overall required return on the firm as a whole. It is the appropriate discount rate to use
for cash flows similar in risk to the overall firm.WACC is calculated by multiplying
the cost of each capital component by its proportional weighting and then summing:

E D
WACC * Re * Rd * (1 Tc )
V V

Where:
Re = cost of equity
Rd = cost of debt
E = the market value of the firm's equity
D = the market value of the firm's debt
V=E+D
Tc = the corporate tax rate
Table 4 : Calculation of WACC
Particulars Value
Cost of equity 14.87%
market value of eq 109428750000.00
Proportion of Equity 0.999999998
Cost of debt 0.006202633
Book value of debt 174.7
Proportion of Debt 0.00
WACC 14.87%

Step 4: Capital Expenditure

Capital Expenditure for the current year is calculated using the following formula
CAPEX= (Increase in Fixed Assets) + (Increase in Capital Work-in-progress) (increase
in Investments) (increase in depreciation)

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 Table 5 : Calculation Of CAPEX
Particulars 2003 2004 Increase
CAP WIP 9.19 17.69 8.5
Fixed Assets 786.29 916.91 130.62
Investment 1193 1565.1 372.1
Depreciation 63.39 73.33 9.94
Capex -242.92

Hero Hondas Future CAPEX Plans

Hero Hondas capex plans are calculated with respect to its average fixed assets
turnover ratio
Step 1: We find the fixed assets turn over ratio for the previous years as follows :
Fixed assets turnover ratio (FATR) = Sales / (net block + depreciation + capital wip)
Step 2: We find the weighted average of FATR

Capital expenditure = Difference between CY sales and PY sales / Avg FATR

Table 6: FATR
YEAR 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
FATR of company 6.85 6.84 6.77 5.68 5.14 4.46 4.15 3.83 4.58 3.82
Weights 10 9 8 7 6 5 4 3 2 1
68.5 61.56 54.16 39.8 30.8 22.3 16.6 11.5 9.16 3.82
Weighted Avg 5.785

Table 7 : Sales growth

Current year 2005 2006 2007 2008 2009

Difference in sales
2066.51 2798.89 3790.81 5134.27 6953.86 -26575.37
AvgFATR 5.785 5.785 5.785 5.785 5.785 5.785
Capital expenditure -242.92 357.20 483.79 655.25 887.47 1201.99

Valuation using Stable Growth FCFF Model

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Table 8: FCFF Valuation

HERO HONDA CY 2005 2006 2007 2008 2009

Net Sales 5831.02
Sales growth rate 35.44% 35.44% 35.44% 35.44% 35.44%
Operating Profit Margin (ebit) 20% 11.00% 11.25% 11.35% 11.45% 10.50%
Tax Rate NA 22% 22% 22% 22% 22%
ASSUMING THE RATE REMAINING TO BE
Depreciation as % capex 12% SAME
26575.3
Capital expenditures -242.92 357.20 483.79 655.25 887.47 7
Working capital inv. as % of
increased sales -11%
Gross Assets 916.91 1200.78 1535.45 2000.01 2639.09 2790.41
Weighted average cost of capital 14.87% 436.33
19968750
Number of shares outstanding 0 517.90
Market value of obligations 174.70 1836.18
Market value of non operating assets 436.33

Terminal Free cash flow growth 13.00% 2272.52

1 2 3 4 1201.99 TV
Net Sales 5831.02 7897.53 10696.42 14487.23 19621.50 -764.92
1835.45
Operating profits 1147.51 868.73 1203.35 1644.30 2246.66 0.50
(Less) Depreciation 73.33 149.13 190.69 248.39 327.76 917.64
(Less) Cash taxes 344.14 158.31 222.78 307.10 422.16
NOPLAT 730.04 561.29 789.87 1088.81 1496.75
(Add) Depreciation 73.33 149.13 190.69 248.39 327.76
Gross cash flow 803.37 710.42 980.56 1337.20 1824.50
(Less) capital expenditures -242.92 357.20 483.79 655.25 887.47
(Less) working capital investments -124.95 -227.32 -307.88 -416.99 -564.77
110792. 110792.
Free cash flow at time t 1171.24 580.53 804.65 1098.94 1501.80 53 53
Discount factor, t 0.87 0.76 0.66 0.57 0.50 0.50
55391.0 55391.0
PV FCF, time 0 505.37 609.78 724.99 862.49 1 1
59011.278
63
less DEBT 174.7
58836.578
FCFF 63
19968750
NO OF SHARES 0
0.0002946
value of share 43 622.00

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PORTFOLIO CONSTRUCTION BASED ON FUNDAMENTAL ANALYSIS

The FCFF model is used to value companies to be included in the portfolio. The
proportion of each stoch to be included is determined by assigning weights to the
expected future growth rates of the companies. These weights are used to calulate the
Portfolio return and beta.
Table 9 : Exp returns on portfolio
Exp
Sl Growth Prop
No Co Names rate Weights returns

1 Bajaj Auto 15% 10.03% 1.50%

2 Hero Honda 35.44% 23.69% 8.40%
3 Kin Motors 8.57% 5.73% 0.49%
4 Tvs Motors 15.08% 10.08% 1.52%
5 ACC 11.06% 7.39% 0.82%
6 Ambuja Cement 10.60% 7.09% 0.75%
7 Birla 14.35% 9.59% 1.38%
8 Madras cement 9% 6.02% 0.54%
9 Mysore cements 13.50% 9.02% 1.22%
10 Prism Cement 17% 11.36% 1.93%

150% 100.00% 18.55%

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BETA OF THE PORTFOLIO

Table 10 : Beta of the Portfolio

Sl No Co Names Weights Beta Port Beta

1 Bajaj Auto 10.03% 0.603 0.06048279

2 Hero Honda 23.69% 0.896 0.212346609
3 Kin Motors 5.73% 0.930 0.053261096
4 Tvs Motors 10.08% 0.907 0.091413099
5 ACC 7.39% 0.928 0.068575331
Ambuja
6 Cement 7.09% 0.624 0.044244232
7 Birla 9.59% 1.169 0.11214297
Madras
8 cement 6.02% 0.814 0.048998349
Mysore
9 cements 9.02% 1.392 0.125623459
10 Prism Cement 11.36% 1.436 0.163224045

Port
Beta 0.980311981

A n a l y s i s an d I n t e r p ret a t i o n

Debt Valuation

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 The study includes research of different kinds of fixed income securities, like
corporate debt, government securities and treasury Bills.

Corporate Debt :
Step 1: The sample of 50 corporate debt is taken from the market on random basis
Step 2: All the securities are given weights according to ratings given by the agencies
on the basis of below mentioned scale.
RATING Weight
AAA 5
AA+ 4
AA 3
AA- 2

Step 3: All the 50 securities YTMs, Durations, and Modified Durations are
calculated and assigned weights for YTM assuming higher the YTM higher the
returns.
YTM YTM Weight
1.17 3.42 1
3.42 5.67 2
5.67 7.92 3
7.92 10.17 4
10.17 12.42 5

Step 4: As the modified duration tells the sensitivity of the bond ( Beta of the bonds )
to the changes in the interest rates. We can say that higher he modified duration higher
the risk. On this basis modified duration is taken as percentage and reduced in the sum
of all the weights.
(Rating + YTM (% MOD DUR))
Step 5: The weighted average of the parameters is calculated and those securities are
selected whose total is above average.
Step 6: Proportion to be invested is calculated by keeping the returns as the base. And
expected returns are then calculated by multiplying the proportions with the returns.
Table 11: Corporate Debt Portfolio
Issue Description Weights Weights Weights
Rating AYTM Mod Dur Proportion Exp

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 Invested Returns
HDFC 6.30% 2007(S-33) 5 5 3.94% 9.70% 1.19%
HDFC 7.15% 2010 (SER-
67(B-018) 5 4 4.11% 7.71% 0.75%
GUJ AMBUJA 8.10%
2007(SR-27) 5 5 3.28% 8.29% 0.87%
GRASIM
IND.LTD8.85%2008(S-
XXX) 5 5 3.30% 8.08% 0.83%
HDFC 6.10% 2008 (S-35) 5 4 3.41% 8.05% 0.82%
ELECTROSTL CASTINGS
6.10% 2008 4 4 3.44% 7.99% 0.81%
HDFC 5.85% 2009 5 4 3.48% 7.53% 0.72%
HDFC 5.82% 2008 (S-37) 5 5 2.65% 8.55% 0.92%
HDFC 6.67% 2007 (S-31) 5 4 2.67% 7.44% 0.70%
CITF 5.90% 2007 (SER-
198) 5 5 1.79% 9.80% 1.21%
CITF 5.90% 2007 (SER-
197) 5 5 1.81% 8.52% 0.92%
CITF 5.90% 2007 (SER-
201) 5 5 1.82% 8.34% 0.88%
Portfolio exp returns 100.00% 10.60%

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Government Securities:
Step 1: The sample of ten government securities are taken from the market on random
basis.
Step 2: The data available was on daily price changes in the market of the underlying
security. Based on the available data we calculate variance and the average returns of
the security.
Step 3: Assuming the risk free rate to be 6.5% we calculate excess return to standard
deviation, which gives the premium for the extra risk.
Step 4: Rank all the securities according to the Excess return to the standard
deviation.
Step 5: Portfolio is constructed with those securities whose excess return to the
standard deviation is greater then the average of the excess return to the standard of
sample.
Step 6: Proportion to be invested is calculated by keeping the returns as the base.
Table 12: G-Sec portfolio
Cpn Avg Exp
Symbol rate Std Dev Returns Proportation Returns
0740E12 7.4 0.69% 10.32% 23.41% 2.42%
0939G11 9.39 0.69% 8.72% 19.79% 1.73%
1305D07 13.05 0.69% 8.55% 19.38% 1.66%
1200E08 12 0.65% 8.31% 18.85% 1.57%
1210F08 12.1 0.65% 8.19% 18.57% 1.52%
Expected
Returns 8.89%

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Construction of portfolio of Debt and Equity

A portfolio that buys a combination of common stock, bonds, and short-term bonds,
to provide both income and capital appreciation while avoiding excessive risk. The
purpose of balanced portfolio (also sometimes called hybrid funds) is to provide
investors with a single portfolio that combines both growth and income objectives, by
investing in both stocks (for growth) and bonds (for income). Such diversified
holdings ensure that these portfolios will manage downturns in the stock market
without too much of a loss; the flip side, of course, is that balanced funds will usually
increase less than an all-stock fund during a bull market.

Equity Portfolio:
Table 13 : Equity Portfolio
Exp
Growth prop Port
Co Names rate weights returns Beta Beta

Bajaj Auto 15% 10.03% 1.50% 0.950 0.095

Hero Honda 35.44% 23.69% 8.40% 0.900 0.213
Kin Motors 8.57% 5.73% 0.49% 0.950 0.054
Tvs Motors 15.08% 10.08% 1.52% 0.990 0.100
ACC 11.06% 7.39% 0.82% 0.928 0.069
Ambuja Cement 10.60% 7.09% 0.75% 1.818 0.129
Birla 14.35% 9.59% 1.38% 1.169 0.112
Madras cement 9% 6.02% 0.54% 0.814 0.049
Mysore cements 13.50% 9.02% 1.22% 1.392 0.126
Prism Cement 17% 11.36% 1.93% 1.436 0.163

Returns 18.55% Beta 1.11

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Debt portfolio:
Table 14: Debt Portfolio
Avg Prop Prop Returns
Composition of Funds Returns Invested

corporate debt 10.60% 50.00% 5.30%

G Sec 8.89% 30.00% 2.67%
364 T-bill and cash 6.50% 20.00% 1.30%

Annual Returns 100.00% 9.27%

Now based on the above tables we construct a balanced portfolio with different
combinations of debt and equity where we try to trace the one combination which
gives the optimum returns with least risk (beta).
Table showing different combinations of debt and equity

Table 15: Different combinations of debt and equity.

Equities total
Equity Debt Returns Debt returns Beta returns
1 0 18.55% 0.00% 1.11 18.55%
0.9 0.1 16.70% 0.99% 1.00 17.68%
0.8 0.2 14.84% 1.97% 0.89 16.81%
0.7 0.3 12.99% 2.96% 0.78 15.94%
0.6 0.4 11.13% 3.94% 0.67 15.07%
0.5 0.5 9.28% 4.93% 0.56 14.20%
0.4 0.6 7.42% 5.91% 0.44 13.33%
0.3 0.7 5.57% 6.90% 0.33 12.46%
0.2 0.8 3.71% 7.88% 0.22 11.59%
0.1 0.9 1.86% 8.87% 0.11 10.72%
0 1 0.00% 9.85% 0 9.85%

By analyzing the table above, one with basic finance knowledge can easily identify
the optimum combination. The selected portfolio gives the returns of 17.68% with
beta of 1.
The most interesting part here is the beta = 1. As we know that the market portfolio
Nifty, the optimum portfolio with zero unsystematic risk has the beta of 1. So we can
easily claim that the constructed portfolio is almost equal to Nifty and it moves
according to the market.

Portfolio Nifty

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Annual Returns 17.68% 15.84%
Beta 1 1

The objective of any fund manager for any portfolio created by him/her is
Returns maximization at a fixed level of risk.
Risk minimization at a fixed level of returns.

This is the case where the researcher has achieved one of the stated objectives.

Hypothesis Testing:
Z = {Rm Rf } {sqrt(Var(p))/n}

Variance 0.680%
N 381
Rp 17.68%
Rf 6.50%

Calculated Z = 26.4709.
Table value Z = 1.645
As the calculated value is greater then the table value we reject null hypothesis.

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 Findings and Suggestions

Cement Industry

With increasing demand due to increased infrastructure activities and limited

growth in capacity the demand supply gap would reduce. In the Apr- June 05
quarter we expect cement demand to be robust on account of summer season and
prices to remain firm. However, cut down on coal supplies to cement companies by
about 25% would put cost pressure on the companies. Cement demand would slow
down in the late June with the beginning of the monsoon. With demand expected to
grow at the rate of 8% p.a. we expect the capacity utilization in the coming years to be
above 85%. We are positive on the sector in the medium and long term.

Demand Drivers for Cement Industry

Indias per capita consumption is about 90 kg compared to the world average of 250
kg. This implies great growth potential for the domestic industry. With 60% of the
demand coming from the housing sector, the fortunes of cement industry are closely
linked to it. The soft interest rates prevailing in the country and ever increasing need
for housing and easy availability of finance have enabled strong growth in the housing
construction sector, thereby leading to improved demand for cement. Further, the
huge investment flows into the roadways and highway projects have stimulated
demand growth for the cement industry. The roadways and highways project in
general .Greater thrust on continued investments in new infrastructure projects like
ports, roads and highways will power the demand growth for cement for next few
years. With nearly Rs. 8,00,000 crore worth of investments likely in electricity
generation in the coming decade, the overall prospects of the growth in demand
appears bright.

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Automobile Industry

Competition within the industry is set to become fierce with the entry of new
players. Also most manufacturers are increasingly flooding the market with new
products and launches in order to grab the customers attention. Further the rising
aspiration of individuals is showing a growing demand for entry level cars. While
Bajaj Auto (BAL) has increased prices by 1-2%, Hero Honda Motors (HHML) has
upped prices by 2-3% given the uptrend in input costs. Chennai- based, TVS Motor
too, is considering a 2-3% price hike, across all models. Fierce competition had
prevented the companies from hiking prices of motorcycles in the past year. The costs
of items such as steel, plastic and metal have been going up for the past few months.

Beside there are various concerns such as rise in international fuel prices, free trade
agreements (FTA) with other countries, inflationary pressures, etc. are likely to have
an adverse impact on demand and profit margins as well. Moreover the growth rate
are expected to decelerate in coming months due to higher base generated earlier.

However going by positive broad indicators such as higher GDP growth, increased
thrust on agriculture & infrastructure, poor public transport systems, higher disposable
incomes in the hands of consumers as a result of the changes in the tax structure and
low interest rates would continue to drive growth in two-wheeler sales. Also two-
wheeler companies who were prevented from increasing the prices due to competition
are expected to increase the same now following a rise in input costs; this would ease
the pressure on profit margins.

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Portfolio evaluation

As the objective of the study was to construction of a portfolio based on

fundamental analysis and include debt to the portfolio so as to reduce the risk and
make the portfolio yield regular returns with stable capital appreciation.

The research also tries to test the significance of excess return to beta, and find
weather one can construct a portfolio which beta is equal to market beta ( beta =1 )
and returns greater then market returns and proves by creating the portfolio which
give excess return of 2.5% with the beta equal to 1.

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