UNIT III FUNDAMENTAL ANALYSIS

Economic Analysis – Economic forecasting and stock Investment Decisions – Forecasting

techniques. Industry Analysis : Industry classification, Industry life cycle – Company
Analysis Measuring Earnings – Forecasting Earnings – Applied Valuation Techniques –
Graham and Dodds investor ratios.

Table of Content

3.1 Financial Analysis……………………..……………………………………………. 1

3.2 Economic Analysis………………….………………………………………………. 2

3.2.1 Economic forecasting…………………………………………………….. 3

3.3 Industry or Sector Analysis…………………………………………………………. 7

3.3.1 Industry Classifications..……………………………………………………. 8

3.3.2 Industry Life Cycle………………………………………………………….. 9

3.4 Company Analysis………………………………………………………………….. 11

3.5 Applied Value Techniques………………………………………………………….. 15

3.6 Graham and Dodd Investing Ratios………………………………………………… 21

3.1 FUNDAMENTAL ANALYSIS:

Fundamental analysis is used to determine the intrinsic value of the share by examining
the underlying forces that affect the well being of the economy, Industry groups and companies.
Fundamental analysis is to first analyze the economy, then the Industry and finally individual
companies. This is called as top down approach.

The actual value of a security, as opposed to its market price or book value is called
intrinsic value. The intrinsic value includes other variables such as brand name,
trademarks, and copyrights that are often difficult to calculate and sometimes not accurately
reflected in the market price. One way to look at it is that the market capitalization is the price (i.e.
what investors are willing to pay for the company and intrinsic value is the value (i.e. what the
company is really worth).

The top down approach of fundamental analysis

• At the economy level, fundamental analysis focus on economic data (such as GDP,
Foreign exchange and Inflation etc.) to assess the present and future growth of
the economy.

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 • At the industry level, fundamental analysis examines the supply and demand forces for
the products offered.

• At the company level, fundamental analysis examines the financial data (such as
balance sheet, income statement and cash flow statement etc.), management, business
concept and competition.

ECONOMIC ANALYSIS:

Economic analysis occupies the first place in the financial analysis top down approach.
When the economy is having sustainable growth, then the industry group (Sectors) and companies
will get benefit and grow faster. The analysis of macroeconomic environment is essential to
understand the behavior of the stock prices. The commonly analysed macro economic factors are
as follows.

1. Gross domestic product (GDP): GDP indicates the rate of growth of the economy. GDP
represents the value of all the goods and services produced by a country in one year. The
higher the growth rate is more favourable to the share market.
2. Savings and investment: The economic growth results in substantial amount of domestic
savings. Stock market is a channel through which the savings of the investors are made
available to the industries. The savings and investment pattern of the public affect stock
market.
3. Inflation: Along with the growth of GDP, if the inflation rate also increases, then the real
rate of growth would be very little. The decreasing inflation is good for corporate sector.
4. 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.
5. Budget: Budget is the annual financial statement of the government, which deals with
expected 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 favourable to the stock market.
6. The tax structure: The tax structure which provides incentives for savings and
investments. The balance of payment: The balance of payment is the systematic record
of all money transfer between India and the rest of the world. The difference
between receipts and payments may be surplus or deficit. If the deficit increases, the
rupee may depreciate against other currencies. This would affect the industries, which are
dealing with foreign exchange.

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 7. Monsoon and agriculture: India is primarily an agricultural country. The importance of
agricultural in Indian economy is evident. Agriculture is directly and indirectly linked
with the industries. For example, Sugar, Textile and Food processing industries depend
upon agriculture for raw material. Fertilizer and Tractor industries are supplying input to
the agriculture. A good monsoon leads better harvesting; this in turn improves the
performance of Indian economy.
8. Infrastructure: Infrastructure facilities are essential for growth of Industrial and
agricultural sector. Infrastructure facilities include transport, energy, banking and
communication. In India even though Infrastructure facilities have been developed, still
they are not adequate.
9. 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.
10. Political stability: A stable political system would also be necessary for a good
performance of the economy. Political uncertainties and adverse change in government
policy affect the industrial growth.

3.2.1 ECONOMIC FORECASTING:

The common techniques used are analysis of key economic indicators, diffusion index,
surveys and econometric model building. These techniques help him to decide the right time to
incest and the type of security he has to purchase i.e. stocks or bonds or some combination of
stocks and bonds.

ECONOMIC INDICATORS

The economic indicators are statistics about the economy that indicate the present status,
progress or slow down of the economy. They are capital investment, business profits, money
supply, GNP, interest rate, unemployment rate, etc. The economic indicators are grouped into
leading, coincidental and lagging indicators.

The indicators are selected on the following criteria

• Economic significance
• Statistical adequacy
• Timing
• Conformity

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The leading indicators:

The leading indicators indicate what is going to happen in the economy. It helps the investor
to predict the path of the economy. The popular leading indicators are the fiscal policy, monetary
policy, productivity, rainfall, capital investment and the stock indices. The fiscal policy shows
what the government aims at and the fiscal deficit or surplus has an effect on the economy.

The coincidental indicators:

The coincidental indicators indicate what the economy is. The coincidental indicators are
gross national product, industrial production, interest rates and reserve funds. GDP is the
aggregate amount of goods and services produced in the national economy. The gap between the
budgeted GDP and the actual GDP attained indicates the present situation. If there is a large gap
between the actual growth and potential growth, the economy is slowing down. Low corporate
profits and industrial production show that the economy is hit by recession.

The lagging indicators:

The changes that are occurring in the leading and coincidental indicators are reflected in the
lagging indicators. Lagging indicators are identified as unemployment rate, consumer price index
and flow of foreign funds. These leading, coincidental and lagging indicators provide an insight
into the economy s current and future position.

DIFFUSION INDEX

Diffusion index is a composite or consensus index. The diffusion index consists of leading,
coincidental and lagging indicators. This type of index has been constructed by the National
Bureau of Economic Research in USA. But the diffusion index is complex in nature to calculate
and the irregular movements that occur in individual indicators cannot be completely eliminated.

ECONOMETRIC MODEL BUILDING

For model building several economic variables are taken into consideration. The
assumptions underlying the analysis are specified. The relationship between the independent and
dependent variables is given mathematically. While using the model, the analyst has to think
clearly all the inter-relationship between the variables. When these inter-relationships are
specified, he can forecast not only the direction but also the magnitude. But his prediction depends
on his understanding of economic theory and the assumptions on which the model had been built.
The models mostly use simultaneous equations.

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 Factors affecting Economic Forecasting

• GDP ( Gross Domestic Product)

• Inflation

• Interest rates

• Government revenue, expenditure and deficits

• Exchange rates

• Infrastructure

• Monsoon

• Economic and political stability

STOCK INVESTMENT DECISION

✓ Look for a stable company : financially strong
✓ Look for a company that can grow and prosper: Profit and success
✓ Look for a company that has good management and corporate structure: Right people
in right direction

FORECASTING TECHNIQUES

1. Anticipatory surveys:
a. Expert Opinion
b. Delphi Technique:
A systematic forecasting method that involves structured interaction among a
group of experts on a subject

c. Cross-Impact Analysis:
Analysis of high importance and high probability

d. Multiple scenario: building of pictures of alternative futures.

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2. Trend Analysis method: based on time series

a. Trend Extrapolation: analyze and fit time series data( Linear quadratic or s shaped
growth curves)

b. Trend correlation: It also know as barometric or indicator approach.

Leading Indicators: To know the economic direction in advance eg., rainfall

Coincidental Indicators: Economic factors reaching approximately at the same time as the
economy

eg., GNP, Interest rates

Lagging Indicators: Economic factors reaching their peaks or troughs after the economy
has already reached its own.

eg., Unemployment and inventory debtors.

3. Diffusion Indexes : It is an indicator of spread of an expansion.

a. Composite or consensus Index: It combines several indictors into one single measure .

Eg: Diffusion Index:

No of members in the set in the same direction/Total no of members in the set

b. Component Evaluation Index: It measures the breadth of the movement within a

particular series.

4. Monetary Indicators: Deals with money supply, corporate profits, interest rates and stock
prices sprinkle observed.

5. Econometric Model: It explains past economic activity by deriving mathematical equation.

Eg., Disposable Income Inventories.

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6. Opportunistic model:

a. Hypothesis of total demand: Deals with environmental decisions as war or peace

b. Test of consistency and comparison: Measure the internal consistency and comparing
with other projections.

3.3 INDUSTRY OR SECTOR ANALYSIS

The second step in the fundamental analysis of securities is Industry analysis. An industry
or sector is a group of firms that have similar technological structure of production and produce
similar products. These industries are classified according to their reactions to the different phases
of the business cycle. They are classified into growth, cyclical, defensive and cyclical growth
industry. A market assessment tool designed to provide a business with an idea of the
complexity of a particular industry. Industry analysis involves reviewing the economic, political
and market factors that influence the way the industry develops. Major factors can include the
power wielded by suppliers and buyers, the condition of competitors and the likelihood of new
market entrants.

The industry analysis should take into account the following factors.

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 ✓ Characteristics of the industry: When the demand for industrial products is seasonal, their
problems may spoil the growth prospects. If it is consumer product, the scale of production
and width of the market will determine the selling and advertisement cost. The nature of
industry is also an important factor for determining the scale of operation and profitability.
✓ Demand and market: If the industry is to have good prospects of profitability, the demand
for the product should not be controlled by the government.
✓ Government policy: The government policy is announced in the Industrial policy
resolution and subsequent announcements by the government from time to time. The
government policy with regard to granting of clearances, installed capacity, price,
distribution of the product and reservation of the products for small industry etc are also
factors to be considered for industrial analysis.
✓ Labour and other industrial problems: The industry has to use labour of different
categories and expertise. The productivity of labour as much as the capital efficiency would
determine the progress of the industry. If there is a labour problem that industry should be
neglected by the investor. Similarly when the industries have the problems of marketing,
investors have to be careful when investing in such companies.
✓ Management: In case of new industries, investors have to carefully assess the project
reports and the assessment of financial institutions in this regard. The capabilities of
management will depend upon tax planning, innovation of technology, modernisation etc. A
good management will also insure that their shares are well distributed and liquidity of
shares is assured.
✓ Future prospects: It is essential to have an overall picture of the industry and to study their
problems and prospects. After a study of the past, the future prospects of the industry are to
be assessed. When the economy expands, the performance of the industries will be better.
Similarly when the economy contracts reverse will happen in the Industry. Each Industry is
different from the other. Cement Industry is entirely different from Software Industry or
Textile Industry in its products and process.

3.3.1 INDUSTRY CLASSIFICATION

1. Classification by reporting Agencies

✓ Under Reserve bank of India-industries- 32 groups
✓ Under SEBI- 10 groups
✓ Under Economic times-10 groups
✓ Under financial express- 19 groups

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2.Classification by Business cycle

a. Cyclic industries : Related to business cycle and changes

b. Defensive industries: Products of having relatively inelastic demand eg., food processing
industry

c. Cyclical growth industries: Based on technical and economical changes eg., Airlines
industry

3. Industry groups:

a. Small size units: Small scale industries with a capital of 30 Lac will be listed in OTCEI

b. Medium size units: Industry with a capital of 5 crores will be listed in the regional stock
exchanges like cochin, Coimbatore etc.,

c. Large scale units: Industry with a capital of 10 crores will be listed in BSE & NSE.

4. Input based Classification

▪ Chemical based products

▪ Agro based products

▪ Forest based products

▪ Metal based products

▪ Marine based products.

3.3.2 INDUSTRY LIFE CYCLE

1. Pioneering/ Introduction stage: Introduction of new product

2. Expansion/ Growth stage: overcoming the problem to improve financially and

competitively

3. Stagnation/ Maturity stage: stagnation to have a new life cycle

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 4. Decay/ Decline stage: decline death signals and implement proactively

Industry forecasting Methods

1. Market profile: no of establishments, geographical locations, value if sales etc.,

2. Cumulative methods: based on statistical measurements.

a. Surveys: Carried by researchers, consultants

b. Correlation and regression analysis: Demand measurements

3. Time series:

a. Trend(T): Result of basic development in population, capital formation and technology

b. Cycle(C ): Helps in intermediate range forecasting( wave like movement of sales)

c. Seasons( S): Sales movement within a year

d. Erratic Events: Unpredictable events as strikes, riots, floods etc.,

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3.4 COMPANY OR CORPORATE ANALYSIS

Company analysis is a study of variables that influence the future of a firm both
qualitatively and quantitatively. It is a method of assessing the competitive position of a firm, its
earning and profitability, the efficiency with which it operates its financial position and its future
with respect to earning of its shareholders.

The fundamental nature of the analysis is that each share of a company has an intrinsic value
which is dependent on the company's financial performance. If the market value of a share is
lower than intrinsic value as evaluated by fundamental analysis, then the share is supposed to be
undervalued. The basic approach is analysed through the financial statements of an organisation.
The company or corporate analysis is to be carried out to get answer for the following two
questions.

1 How has the company performed in comparison with the similar company in the same
Industry?
2 How has the company performed in comparison to the early years?
Before making investment decision, the business plan of the company, management, annual report,
financial statements, cash flow and ratios are to be examined for better returns.

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Measuring Earnings:

a. Internal Information: Relating to enterprise

b. External Information: Out side the company

Financial Indicators:-

Analyze the financial position of the company.

Tools:

a. Income statement

It gives past records of the firm that forms a base for making predictions of the firm.

b. Balance sheet

It shows the assets and liabilities of a firm along with shareholder s equity

c. Statement of Cash flows

It shows how a company's cash balance changed from one year to the next

d. Ratio Analysis

It makes intra firm and inter firm comparisons.

1. Profitability Ratios:

Earning before interest and taxes

a. Return on Investment:
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

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b. Leverage Ratios:

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
Debt Equity Ratio = 𝐸𝑞𝑢𝑖𝑡𝑦

c. ROE Analysis
ROE= PBT * PAT* NS* TA
NS PBT TA NW

Non Financial Indicators:

1. Business of the company

2. Top Management

3. Product range

4. Diversification

5. Foreign collaboration

6. Availability of cost of inputs

7. Research and development

8. Governmental regulations

9. Pattern of shareholding and listing

Forecasting Earnings

1. Identification of variables:

a. Operations and Earnings

Operating cycle of a firm starts with cash converted into inventory

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 𝑬𝑩𝑰𝑻
ROI= 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭

b. Financing& Earnings
Debt financing: Provide leverage to common share holders
Equity financing: Equal shares

2. Selecting a Forecasting method:

a. Traditional method

▪ Earnings model: Analysis EAt & EBT

▪ Market share: Consists of tracking historical record and net income
▪ Projected Financial statements: Projection of earnings

b. Modern methods:

1. Regression analysis

It s the measure of the average relationship between two or more variable in terms of
the original units of the data

2. Correlation analysis
Its to reduce the range of uncertainty of our prediction

3. Trend analysis
It refers to collecting information and attempting to spot a pattern

4. Decision trees
It used to forecast earnings as security values.

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3.5 APPLIED VALUATION TECHNIQUES:

Although the raw data of the Financial Statement has some useful information, much more
can be understood about the value of a stock by applying a variety of tools to the financial data.

1. Earnings per Share EPS

2. Price to Earnings Ratio P/E
3. Projected Earnings Growth PEG
4. Price to Sales P/S
5. Price to Book P/B
6. Dividend Payout Ratio
7. Dividend Yield
8. Book Value per share
9. Return on Equity

1. Earnings per Share

The overall earnings of a company is not in itself a useful indicator of a stock's worth. Low
earnings coupled with low outstanding shares can be more valuable than high earnings with a
high number of outstanding shares. Earnings per share is much more useful information than
earnings by itself. Earnings per share (EPS) is calculated by dividing the net earnings by the
number of outstanding shares.

EPS = Net Earnings / Outstanding Shares

For example: ABC company had net earnings of $1 million and 100,000 outstanding shares for
an EPS of 10 (1,000,000 / 100,000 = 10). This information is useful for comparing two companies
in a certain industry but should not be the deciding factor when choosing stocks.

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2. Price to Earnings Ratio

The Price to Earnings Ratio (P/E) shows the relationship between stock price and
company earnings. It is calculated by dividing the share price by the Earnings per Share.

P/E = Stock Price / EPS

In our example above of ABC company the EPS is 10 so if it has a price per share of $50
the P/E is 5 (50 / 10 = 5). The P/E tells you how many investors are willing to pay for that
particular company's earnings. P/E's can be read in a variety of ways. A high P/E could mean that
the company is overpriced or it could mean that investors expect the company to continue to grow
and generate profits. A low P/E could mean that investors are wary of the company or it could
indicate a company that most investors have overlooked.

Either way, further analysis is needed to determine the true value of a particular stock.

3. Projected Earnings Growth Rate-PEG Ratio

A ratio used to determine a stock's value while taking into account earnings growth. The
calculation is as follows:

PEG is a widely used indicator of a stock's potential value. It is favoured by many over the
price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG
means that the stock is more undervalued.

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4. Price to Sales Ratio

When a company has no earnings, there are other tools available to help investors judge its
worth. New companies in particular often have no earnings, but that does not mean they are bad
investments. The Price to Sales ratio (P/S) is a useful tool for judging new companies. It is
calculated by dividing the market cap (stock price times number of outstanding shares) by total
revenues. An alternate method is to divide current share price by sales per share. P/S indicates the
value the market places on sales. The lower the P/S the better the value.

5. Price to Book Ratio

Book value is determined by subtracting liabilities from assets. The value of a growing
company will always be more than book value because of the potential for future revenue. The
price to book ratio (P/B) is the value the market places on the book value of the company. It is
calculated by dividing the current price per share by the book value per share (book value /
number of outstanding shares). It is also known as the "price-equity ratio".

P/B = Share Price / Book Value per Share

6. Dividend Yield

Some investors are looking for stocks that can maximize dividend income. Dividend yield
is useful for determining the percentage return a company pays in the form of dividends. It is
calculated by dividing the annual dividend per share by the stock's price per share. Usually it is
the older, well-established companies that pay a higher percentage, and these companies also

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usually have a more consistent dividend history than younger companies. Dividend yield is
calculated as follows:

7. Dividend payout ratio

Dividend payout ratio is the fraction of net income a firm pays to its stockholders in dividends:

The part of the earnings not paid to investors is left for investment to provide for future
earnings growth. Investors seeking high current income and limited capital growth prefer
companies with high Dividend payout ratio. However investors seeking capital growth may prefer
lower payout ratio because capital gains are taxed at a lower rate. High growth firms in early life
generally have low or zero payout ratios. As they mature, they tend to return more of the earnings
back to investors. Note that dividend payout ratio is calculated as EPS/DPS.

Calculated as:

The payout ratio provides an idea of how well earnings support the dividend payments. More
mature companies tend to have a higher payout ratio. In the U.K. there is a similar ratio, which is
known as dividend cover. It is calculated as earnings per share divided by dividends per share.

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8. Return on Equity

Return on equity (ROE) is a measure of how much, in earnings a company generates in a time
period compared to its shareholders' equity. It is typically calculated on a full-year basis (either
the last fiscal year or the last four quarters).
Expanded Definition
When capital is tied up in a business, the owners of the capital want to see a good return on that
capital. Looking at profit by itself is meaningless. I mean, if a company earns $1 million in net
Income, that's okay. But its great if the capital invested to earn that is only $2.5 million (40%
return) and terrible if the capital invested is $25 million (4% return).
Return on investment measures how profitable the company is for the owner of the investment. In
this case, return on equity measures how profitable the company is for the equity owners,
a.k.a. the shareholders.

The "average" is taken over the time period being calculated and is equal to "the sum of the
beginning equity balance and the ending equity balance, divided by two."

9. Book Value per Share

A measure used by owners of common shares in a firm to determine the level of safety associated
with each individual share after all debts are paid accordingly.

Should the company decide to dissolve, the book value per common indicates the dollar
value remaining for common shareholders after all assets are liquidated and all debtors are paid.
In simple terms it would be the amount of money that a holder of a common share would get if a
company were to liquidate.

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 a. Grahm and Dodds Investor ratios:

Eg.,

Earnings per share=

Earnings available for the common shares
Weighted average common shares outstanding

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3.6 Graham and Dodd Method of Investing

Definition
Fundamental investment tactics founded by Benjamin Graham and David Dodd in the
1930s. They wrote about their strategy in a book entitled "Security Analysis." In it, the two
advocatethat investors should purchase stocks in corporations with undervalued assets becaus
e they will eventually reach true market value and give investors a positive return. Criteria
that investors should look for in a company are: more current assets than current liabilities,
all long-term debt, and selling at a low price/earnings ratio. The theory does
not take into consideration the potential for earnings growth.

The Benjamin Graham formula is a formula proposed by investor and professor of

Columbia University, Benjamin Graham, often referred to as the "father of value investing".
Published in his book, The Intelligent Investor, Graham devised the formula for lay investors
to help them model growth formulas in vogue at the time of the formula's publication.

Formula calculation
In Graham's words: "Our study of the various methods has led us to suggest a
foreshortened and quite simple formula for the evaluation of growth stocks, which is intended
to produce figures fairly close to those resulting from the more refined mathematical
calculations."
The formula as described by Graham in the 1973 edition of The Intelligent Investor, is as
follows.

V = the value expected from the growth formulas over the next 7 to 10 years

EPS = trailing twelve months earnings per share

8.5 = P/E base for a no-growth company

g = reasonably expected 7 to 10 year growth rate

Revised formula
Graham later revised his formula based on the belief that the greatest contributing
factor to stock values (and prices) over the past decade had been interest rates. In 1974, he
restated it as follows.

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 The drawback of the Benjamin Graham formula is that growth is a big element of
the overall valuation.

You can change 8.5 to whatever you feel is the correct PE for a no growth company.

Depending on your conservativeness, anything between 7 and 8.5 should be fine.

Application
In The Intelligent Investor, Graham was careful to include a footnote that this formula
was not being recommended for use by investors-- rather, it was to model the expected results
of other growth formulas popular at the time. However, a misconception arose that he was
using this formula in his daily work due to a later reprinted edition's decision to move
footnotes to the back of the book, where fewer readers searched for them. Readers who
continued on in the chapter would have found Graham stating "Warning: This material is
supplied for illustrative purposes only, and because of the inescapable necessity of security
analysis to project the future growth rate for most companies studied. Let the reader not be
mislead into thinking that such projections have any high degree of reliability, or, conversely,
that future prices can be counted on to behave accordingly as the prophecies are realized,
surpassed, or disappointed."

The movement of the footnote in the reprint has led to an assortment of advisers and
investors recommending this formula (or revised versions of it) to the public at large-- a
practice that continues to this day. Benjamin Clark, the founder of the blog and investment
service ModernGraham, acknowledges the footnote and argues that "I consider the footnote
to be more of a reminder from Graham that the calculation of an intrinsic value is not an
exact science and cannot be done with 100% certainty."

Graham also cautioned that his calculations were not perfect, even in the time period
for which it was published, noting in the 1973 of The Intelligent Investor: "We should have
added caution somewhat as follows: The valuations of expected high-growth stocks are
necessarily on the low side, if we were to assume these growth rates will actually be
realized." He continued on to point out that if a stock were to be assumed to grow forever, its
value would be infinite.

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Three value investing lessons from Graham and Dodd

1. Intrinsic Value has nothing to do with market price

We must recognize, however, that intrinsic value is an elusive concept. In general

terms it is understood to be that value which is justified by the facts, e.g. the assets, earnings,
dividends, definite prospects, as distinct, let us say, from market quotations established by
artificial manipulation or distorted by psychological excesses. But it is a great mistake to
imagine that intrinsic value is as definite and as determinable as is the market price.”

2. Price-Earnings ratios are arbitrary

Security analysts cannot presume to lay down general rules as to the “proper value” of
any given common stock. Practically speaking, there is no such thing. The bases of value are
too shifting to admit of any formulation that could claim to be even reasonably accurate. The
whole idea of basing the value upon current earnings seems inherently absurd, since we know
that the current earnings are constantly changing. And whether the multiplier should be ten or
fifteen or thirty would seem at bottom a matter of purely arbitrary choice.

3. Predicting anything, especially the future, is difficult

In addition to emphasizing strongly the current showing of a company, the stock

market attaches great weight to the indicated trend of earnings. There is a two-fold danger in
the magnification of the trend; the first being that the supposed trend might prove deceptive,
and the second being that valuations based upon trend obey no arithmetic rules and therefore
may too easily be exaggerated…
Hence instead of taking the maintenance of a favorable trend for granted, as the stock
market is wont to do, the analyst must approach the matter with caution, seeking to determine
the causes of the superior showing and to weigh the specific elements of strength in the
company’s position against the general obstacles in the way of continued growth.”

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