Which are the most Fundamentally Strong Stocks in India 2019?

[Updated: 09-Nov-2019] What it means by fundamentally strong stocks? These are stocks which has a strong underlying business. (check list of strong stocks here).

What it means by underlying business? The underlying business for a stock is the “company” which it represents.

Fundamentally strong stocks represent such companies, which will continue to do business even in worst of times. There are some inherent traits of their business that makes them stand tall even in tough weathers.

What helps them to do business even in adverse times? To answer this, we will have to think, what is essential for companies to do business? Capital.

Till there is enough capital flowing-in for the company, it can do business. The day capital-flow starts to fall below the necessary levels, business operations will also start getting weaker. Capital is the company’s fuel.

Employed Capital…

Fundamentally Strong Stocks - Employed Capital

Taking the analogy of “fuel” one step further. Suppose there is a company which is owned by a wealthy people like Jeff Bezos, Warren Buffett, or Mukesh Ambani. Such companies will ever ran out of fuel? It is unlikely.

Similarly, a company which is generating its own capital (fuel) to do business, is necessarily a company with a strong fundamentals. In business terms, the capital used to fund company’s ‘business operations’ is called “employed capital“.

Company use its employed capital to do the following:

  • Pay for all expenses.
  • Fund its capital purchases.
  • Etc.

Employed Capital & Debt

Fundamentally Strong Stocks - Employed Capital Breakup

Let’s see a simplified version of the formula of employed capital. This simplification works wonderfully for me to identify fundamentally strong stocks.

Employed Capital = (Share Capital + Reserves) + Low Debt – (i)

How to read this formula? A fundamentally strong company is one which can run its operations from its “share capital” plus “reserves“. It needs only low debt to do its business. It means, the company has low debt dependency. The lower will be the debt the better.

Zero debt is like a perfect score. The factor of “low debt dependency” is very important from shareholders point of view. Why? Because it makes the company more self-reliant and less risky. How? Please continue reading, this point will be further exemplified.

Employed Capital & Total Expense

Fundamentally Strong Stocks - Employed Capital Vs Total Expense

There is another formula which must be used in conjunction with the above (i). This formula highlights the important for the companies to keep their ’employed capital’ greater than their total expense requirement.

Employed Capital of Fundamentally Strong Stocks > Total Expense – (ii)

What does this formula signify? Suppose there is a company which operates in low debt [see formula (i) above]. [Its Employed Capital = Share Capital + Reserves + Low Debt.] 

But whether this employed capital is sufficient or not. How to know this? By using this formula (Employed Capital greater than Total Expense Requirement). Let’s understand the utility of this formula using the below 3 parameters:

  1. Use of Employed Capital: The ’employed capital’ is that fund which companies use to finance its “total expense requirements”. The company expends money to produce “goods and services“. These goods and services in turn generate revenue. Read more about Return on Capital Employed (RoCE).
  2. Equity Financing: Share capital plus reserves is called equity. Before the revenue is generated, the company must first spend money from its pocket. How much fund is there in company’s pocket? Share Capital plus Reserves (equity). If the equity component is enough (more than total expense requirement), the company will continue to produce “goods and services”, and earn revenue. Read more about how to calculate Return on Equity (ROE) .
  3. Use of debt: If equity is not enough, there will be shortfall of funds to run operations. Hence revenue will fall. Fall in revenue due to shortage of funds is a clear sign of “bad fundamentals”. Hence those companies which cannot fund its “employed capital needs” from its pocket, take debt. Read more about whether debt is good or bad for companies.

It is essential for investors to realise the effect of debt (positive or negative) on companies fundamentals.

The Debt Factor

Fundamentally Strong Stocks in India -1

If a company does not have sufficient money in its pocket, it can take debt. So in this case the employed capital will be, Share Capital + Reserves + Debt.

Availing debt is not always a bad thing for companies. But for majority companies, debt is like a short term relief and long term burden.

So generally speaking, the lower is the debt dependency of the company, higher will be its net profits. Hence this generalisation will not be wrong that, “low debt companies tend to be fundamentally stronger“.

Financially Independent Company

Fundamentally Strong Stocks - Employed Capital ZERO DEBT

This brings us to the concept of financially independent companies. Companies which has virtually zero reliance on debt (to fund its business operations), are financially independent. These are companies which has enough money in their own pockets. They need not rely on external debt to meet their needs for cash.

If a company is able to fund its ‘total expense’ by self, it can continue to operate indefinitely. Such companies are fundamental power houses. How?

Total Expense can be financed from where? From the employed capital. The employed capital is built from three entities.

  • Share capital: What is share capital? Share capital is a fund raised by the company by issuing shares.
  • Reserves: These are retained profits of the company accumulated over a period of time. Company use share capital and reserves to fund its operating costs. If “share capital and reserves” is enough to fund the business operations of a company, it can be tagged as fundamentally strong. Read more about retained earning of companies.
  • Debt: When reserves and share capital is not enough to fund the total expenses of the company, debt financing is the alternative. Read more on how debt effects the enterprise value of companies.

For a company to be financially independent, they must reduce their dependency on debt. But only reduced debt dependency is not enough. They must do more.

Cash Flow of Fundamentally Strong Companies

Fundamentally Strong Stocks - Employed Capital - Fast Payment Collection

All companies which has managed to earn the tag of being ‘fundamentally strong’, has worked hard to manage their cash flows. How? Here cash flow is not only cash-out (payments to vendors etc), but also cash-ins (collection from customers). Emphasis is more on collection.

Complete reliance on “share capital and reserves” means two things for the company: (a) First is the obvious, company is using zero debt, (b) and the second is, the company is collecting cash fast enough.

For a company to become financially independent, along with low debt dependency, it must also have faster cash in-flows. How fast cash flow helps?

  • It ensures liquidity. 
  • Hence current liabilities can be paid on time.
  • As current liability is taken care, debt can be eliminated. 

Examples of a Fundamentally Strong Company

Here we will discuss business fundamentals of three Indian companies. What we will discuss? We will compare their employed capital with their total expense requirement. In the process of this comparison, we will also check their debt levels. By this way we will try to judge which of the three is fundamentally strongest.

1. Bata India

Bata India –Mar’19Mar’18Mar’17Mar’16Mar’15Average (5Y)
Share CapitalA64.2664.2664.2664.2664.26 –
ReservesB1,682.271,414.451,261.021,091.97931.09 –
EquityC=A+B1,746.531,478.711,325.281,156.23995.35 –
Total DebtD0.000.000.000.000.000.00
Employed Capital (EC)E=C+D1,746.531,478.711,325.281,156.23995.351,340.42
........
Total Expense (TE)F2,533.682,333.372,215.892,133.852,469.682,337.29
EC as % of TEE/F69%63%60%54%40%57%

Its debt level is zero in last five years. Its employed capital is Rs.1,746 crore. Its annual expense is Rs.2,533 Crore. Hence, employed capital is 69% of the total expense requirement. What does it mean?

It means, though Bata is debt free, but its total expense requirement is  higher than its equity base. So how the company is managing its cash-out flows?

Probably the company is able to manage the cash out-flows because of its payment terms. To buy the products of Bata, majority customers pay for the goods first and then take delivery. Hence we can say that cash flow need is taken care by quick-payment-collection model.

2. Bosch India

Bosch India –Mar’19Mar’18Mar’17Mar’16Mar’15Average (5Y)
Share CapitalA29.4930.5030.5031.4031.40 –
ReservesB9,096.719,950.808,769.109,503.507,315.60 –
EquityC=A+B9,126.209,981.308,799.609,534.907,347.00 –
Total DebtD0.000.000.0014.9055.5014.08
Employed Capital (EC)E=C+D9,126.209,981.308,799.609,549.807,402.508,971.88
........
Total Expense (TE)F10,279.719,557.408,594.507,740.8010,171.109,268.70
EC as % of TEE/F89%104%102%123%73%98%

Compared to its equity levels, the company has managed to keep its debt levels very low. It is almost like being debt free.

Moreover, the average employed capital of Bosch (in last 5 years) takes care of 98% of its total expense requirement.

You can see that, though both Bata India and Bosch are debt free, but still Bosch looks fundamentally stronger. Why? Because Bosch has enough money in its pocket to fund almost 90% of “total capital needs”.

3. Hindustan Zinc

Hindustan Zinc –Mar’19Mar’18Mar’17Mar’16Mar’15Average (5Y)
Share CapitalA845.00845.00845.00845.00845.06 –
ReservesB32,760.0035,087.0029,960.0036,540.0042,508.01 –
EquityC=A+B33,605.0035,932.0030,805.0037,385.0043,353.07 –
Total DebtD2,538.000.007,908.000.000.002,089.20
Employed Capital (EC)E=C+D36,143.0035,932.0038,713.0037,385.0043,353.0738,305.21
........
Total Expense (TE)F10,512.009,314.008,210.008,627.007,514.268,835.45
EC as % of TEE/F344%386%472%433%577%442%

In FY ending Mar’19, Hindustan Zinc reported a debt of Rs.2,538 crore. This debt level is way higher than that of Bata and Bosch. But Hindustan Zinc’s fundamentals still looks stronger than Bata and Bosch. How?

Check its ratio of employed capital and total expense. In Mar’19 EC/TE raotio was 344%. On an average, in last five years, EC/TE ratio was 442%.

It means, shareholders equity capital of Hindustan Zinc is almost 3.5 times higher than its total expense requirement. The company is too cash-rich. In near future, there is almost negligible chance that Hindustan Zinc will run out of cash.

Cash Flow Analysis

Fundamentally Strong Stocks - Employed Capital - Fast Collection

There are also companies which has lower employed capital compared to its ‘total expense requirement’, but are still fundamentally strong. How?

Because these companies collects money from its customers very fast. Hence, such companies can enjoy the luxury of keeping their employed capital lower than their total expense requirement.

Most of the companies operating in India, carry debt, but still their total expense cannot be funded. Such companies are dependent on their sales collection to pay invoices/bills. Companies which has very fast Cash Conversion Cycle are safe companies.

But companies which sell their products and services on long-credit, pose a big risk for investors.

How to identify such companies?

The above discussed companies follow this formula [Shareholder Equity + Debt + EFFECTIVE COLLECTION = Total Expense]

What is effective collection? “Net cash flow from operations” minus “CAPEX” is effective collection. In financial term the effective collection is also called as free cash flow. So now the equation becomes as below:

Fundamentally Strong Stocks in India -3

What does the above formula represent? The total expense requirement of the company is fulfilled using equity (E), debt (D) and payment collection (FCF). But here one must ask that, how much portion of Total Expense is dependent on FCF? 

Ideally, total expense requirement should not be heavily dependent on FCF (collection from customers). So what will be the optimum ratio? 

Fundamentally Strong Stocks in India -3.1

The above infographic suggests that, company should not be more than 20% dependent on FCF to manage its total expense requirement. This is not a hard and fast rule, but this screening criteria has worked well for me. 

Reserves must also grow with time

There are companies which may be debt free, and also has employed capital more than their total expense, but they can still be fundamentally weak. How? This will happen if the company’s reserves are showing negative growth.

Why it is an indicator of bad fundamentals? Because negative reserves growth is an indicator that the company’s PAT and EPS is negative.

Hence this proves that, to judge companies fundamentals it is important to look at the following in tandem:

  1. Debt levels.
  2. Employed Capital vs total expense.
  3. Reserves (or Net worth) growth.

Stocks with Strong Fundamentals

(Updated: 09-Nov-2019)

  • Mcap: Market Capitalisation (Rs.Crore).
  • D/E: Debt to Equity Ratio (DE < 0.5).
  • EQ/TE: Equity to Total Expense Ratio (EQ/TE > 0.667).
  • EC/TE: Employed Capital to Total Expense Ratio (EC/TE > 0.8).
  • NWG: Net worth Growth (5Y) is high. 
NameM.CapD/ENWGEQ/TEEC/TE
Godrej Consumer75,170.480.47140.931.36
Bharat Electronics 26,668.5106.051.061.07
Alkem Laboratories 24,328.490.1716.050.861.01
Mphasis 16,393.550.12.820.820.91
City Union Bank 15,676.130.116.412.903.19

Handpicked Articles:

11 Comments

  1. Never invest on the basis of fundamentals only, always keep an eye on technical always. Better way to earn in the market is through technical analysis with support of fundamental fundamental.

    • When fundamental analysis is done in totality, it takes care of the “price valuation”.
      A long term investor does not need to take care of the “effect of price momentum” while investing.
      Thanks for your comment.

  2. I am Prakash Modak from Pune.

    Excellent explanation anbout fundamental kindly add me in your email for next post.

  3. Very well explained! Many thanks for the same. Could you please suggest the site to check the updated fundamental parameters of companies and also for comparison.

  4. I have to say its a good read but the stocks that you have selected under low cap stocks have very poor performance, some of them like Advanced Enzymes are near their 52 weeks low while some others have lost more than 20% within the month like Tejas Networks and it is in bear phase since at least 1 year where it has lost more than 50% of its value.

    • Thanks for posting your view.
      “Poor performance” does not always guarantee that the underlying fundamentals of the stocks are poor. Price is not the indicator which can talk about stocks fundamentals.

  5. I am very much impressed with the way matter is discussed. I am very much newbie and this is what the information I have been looking over the web for days. I am so much thankful to you.

    I am very much interested in value investing. Please explain identifying fundamentally strong stocks and under valued stocks using their financials

    I request you to explain them having a chronological balance sheet, cash flow statement, profit and loss ..etc

    Waiting for your reply!!

  6. Eye-soothing article, but reliable enough for Indian Market… the top rated ‘Vakrangee’ is the biggest loser of 2018.

Leave a Reply

Your email address will not be published.


*