Security Analysis

Module – 4
Investment Management

Dr. Raghu N
Associate Professor
Presidency Business School
 Security Analysis
• Security analysis is the evaluation and
assessment of stocks or securities to
determine their investment potential.
• Security analysis involves diligently
determining the intrinsic value of
securities, such as stocks and financial
instruments, to help investors make well-
informed decisions for optimal returns.
• Security analysis helps investors determine
the fair value of a security. By estimating
intrinsic value, investors can compare a
security's market price to its perceived
worth, making it easier to decide whether it
is overvalued, undervalued, or fairly priced

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 Types of Security Analysis
I. Fundamental and
II. Technical Analysis

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 I. 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.

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Dr. Raghu N, Associate Professor, Presidency Business School
 Fundamental Analysis

❖Economic Analysis(E)
❖Industry Analysis(I)
❖Company analysis(C)
❖Equity Valuation Model
(Dividend Discount Model-
DDM)
❖Financial Statement Analysis

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 EIC Analysis

• In security selection process, a

traditional approach of
• Economic
• Industry
• Company analysis is employed.
• The person conducting EIC analysis
examines the conditions in the
entire economy and then ascertains
the most attractive industries in the
light of the economic conditions.
• At last the most attractive
companies within the attractive
industries are pointed out by the
analyst.
E I C

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 Economic Analysis
•GDP
•Savings and Investment
•Inflation
•Interest rates
•Budget
•Foreign Exchange rates
•The tax structure
•The balance of payment
•Monsoon and agriculture
•Infrastructure facilities
•Demographic factors

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 GDP/PCI
• Gross domestic product (GDP) is the total monetary or market
value of all the finished goods and services produced within a
country's borders

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 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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18 Business School
 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.

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Business School 19
 • Economic factors reaching their peaks or
troughs after the economy has already
The Lagging reached its own.
indicators • Ex: Unemployment and inventory debtors.

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The Coincidental
indicators

A coincident indicator is an
economic statistical indicator that
changes (more or less)
simultaneously with general
economic conditions and therefore
reflects the current status of the
economy.
• The coincidental indicators are
gross national product,
industrial production, interest
rates and reserve funds.

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Business School 21
 ECONOMIC FORECASTING TECHNIQUES

• These techniques help him to decide the right time to

invest and the type of security he has to purchase i.e.
stocks or bonds or some combination of stocks and
bonds.
1. ANTICIPATORY SURVEYS
2. TREND ANALYSIS
3. DIFFUSION INDEX
4. MONETARY INDICATORS
5. ECONOMETRIC MODEL
6. OPPORTUNISTIC MODEL

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 Economic and Security Market Influences

• As we forecast economic growth, a number of

factors will influence our expectations
• Influences on Long-term Expectations
• Technology
• Population
• Labor force participation
• Productivity
• Resource availability
• Incentives to expand

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 Economic and Security Market Influences

•Influences on Short-term Expectations

• Influences caused by fluctuations in demand
• Liquidity and bank lending
• Monetary policy
• Inflation
• Interest rates
• International influences
• Consumer sentiment
• Tax and other fiscal policy
• Economic “shocks”

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 Forecasting Tools

• Ideally, a set of indicators that provides signals of

future economic directions will be developed
• Inflation Indicators
• Federal Reserve actions indicate likely trends in
inflation
• Money supply and money growth rates relative to
measures of economic growth
• Commodity prices
• Monetary Indicators
• Differences in Interest Rates
• Cyclical Economic Indicators
• Tracking “official” leading economic indicators
• Econometric Modeling
• Models developed to forecast economic variables

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 Industry Analysis

• An industry is a group of firms that have similar

technological structure of production and produce similar
products. For the convenience of the investors, the broad
classification of the industry is given in financial dailies
and magazines.
• Select a good industry to invest. It is difficult for a firm to do well
in a troubled industry
• Standard Industry Classification (SIC) code
• Value line Investment Survey - reports 1700 firms in 90 industries
• Two factors that determine the sensitivity of a firm’s earnings to
business conditions:
• Business risk,
• Financial risk

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 Types of Industries

➢ Food products
➢ Beverages, Tobacco and Tobacco products
➢ Textiles
➢ Wood and wood products
➢ Leather and leather products
➢ Rubber and plastic products
➢ Chemical and chemical products
➢ Non-metallic mineral products
➢ Basic metals, Alloys and metal products
➢ Machinery and Machine tools
➢ Transport equipment and parts
➢ Other Miscellaneous manufacturing industries

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Business School 34
 Links Between the Economy and
Industries
•Economic trends affect industry
performance
•Economic trends:
• Cyclical changes
• Ups and down of the business
cycle
• Different industries experience
unique results depending on the
point within the business cycle
• May call for a “rotation” strategy
• Structural changes
• Changes in government
institutions, regulatory
environment, changes in
technology, many more
• Need to anticipate structural
changes and analyze the likely
impact on various industries

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Dr. Raghu N, Associate
 Business cycle
• These industries can be classified on the basis of business
cycle i.e. classified according to their reactions to the different
phases of the business cycle.
• They are classified into following:
1. Growth,
2. Cyclical,
3. Defensive and
4. Cyclical growth industry.

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 The Stock Market and
the Business Cycle
Basic
Industries
Excel

C CY
Consumer

MI Consumer peak Staples Excel

O
Durables
C

Excel
N

LE
ECO

Capital Goods
trough Excel
Financial Stocks
Excel
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 Structural
Influences
• In addition to economic changes,
various other trends also represent
structural influences that will having
varying effects across industries
• Social Influences
• Demographics: baby boom
and beyond
• Lifestyles: changing definition
of “traditional”
• Social values: environment,
alcohol, tobacco
• Technology
• Politics and Regulation

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Presidency Business School 42
 Industry life cycles

Start-up Build-up Maturity Decline

A. Start-up: increasing growth
B. Build-up/consolidation: stabilized growth
C. Maturity: slower growth
D. Decline: shrinking growth
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 Industry Analysis

1. Firm competitive strategies

2. Low cost strategy
3. Differentiation strategy
4. Focus strategy
5. Competitive 5 forces necessitate
competitive strategies of MICHAEL
PORTER.
a. Current rivalry
b. Threat of new entrants
c. Potential substitutes
d. Bargaining power of
suppliers
e. Bargaining power of
buyers
6. SWOT analysis

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 Company Analysis
and Stock
Selection
• Good companies are not
necessarily good investments
• In the end, we want to compare the
intrinsic value of a stock to its
market value
• Stock of a great company may
be overpriced
• Stock of a lesser company may
be a superior investment if it is
undervalued

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 Company Analysis

• In the company analysis the investor assimilates the

several bits of information related to the company and
evaluates the present and future values of the stock.
• The risk and return associated with the purchase of the
stock is analysed to take better investment decision.
• The valuation process depends upon the investors’
ability to elicit information from the relationship and
interrelationship among the company related variables.
• The present and future values are affected by a number
of factors.

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 Company Analysis

• The present and future values are

affected by a number of factors.
1. The competitive edge of the
company
2. Measuring earning/Forecasting
Earning (based on sales, costs,
depreciation)
3. Capital structure.
4. Management:-( Leadership, HR,
Management,)
5. Operating efficiency.
6. Financial performance:-(P/L A/C.
B/S, cash flow, ratio analysis etc)

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 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

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 Steps of company analysis

A. Measuring earnings

B. Forecastings earnings

C. Applied valuations

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 A. Measurement Earnings

• Measurement of earnings is based on two types of information:

1. Internal Information(Made public by firms)
2. External sources (sources generated about the company
independently outside the company)

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 1. Internal Information

I. Income statement
It gives past records of the firm that forms a base for making
predictions of the firm.
II. Balance sheet
It shows the assets and liabilities of a firm along with
shareholder s equity
III. Statement of Cash flows
It shows how a company's cash balance changed from one
year to the next
IV. Ratio Analysis
It makes intra firm and inter firm comparisons.

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 2. External sources information

▪ Rating agencies
▪ Economic research and surveys

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 B. Forecasting
Earnings
1. Asset productivity and earnings.
a. EBIT
b. EBT
c. EAT
d. EPS
e. DPS
f. Return on Assets=
EBIT/Assets
g. Operations and Earnings: ROI
= EBIT/ Investments
2. Equity financing: equity shares
3. Debt financing and Earnings
a. Cost of Borrowed capital/
Effective Interest rate=
=Interest
expense/Total liabilities
b. Benefits of borrowed money = R-
I(Return on Assets- Effective
Interest rate)
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Business School 77
 B. Forecasting Earnings
Methods

• Forecast not only the Expected Return but also the

Expected Risk of an investment.
• There are 2 methods:
1. Traditional methods:
a. Earnings model: Analysis EAT and EBT
b. Market share: tracking of historical record
and net income
c. Projected financial statements: projections of
earnings
2. Moderns Methods
a. Regression Analysis: It is the measure of the
average relationship between two or more
variable in terms of the original units of the
data
b. Correlation analysis - It is to reduce the range
of uncertainty of our prediction
c. Trend analysis - It refers to collecting
information and attempting to spot a pattern
d. Decision trees - It used to forecast earnings
as security values.

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Business School 78
 C. Applied Valuations
• 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 value share P/B
• 6. Dividend Payout Ratio
• 7. Dividend Yield
• 8. Book Value per share
• 9. Return on Equity

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 GRAHM AND
DODDS INVESTOR
RATIOS:
❑ The strategy of selecting stocks that trade for less than
their intrinsic values.
❑ Value investors actively seek stocks that are undervalued
by the market.
❑ Typically, value investors select stocks with lower-than-
average price-to-book or price-to- earnings ratios and/or
high dividend yields.
❑ The Price to Earnings Ratio (PE ratio) is the primary
valuation ratio used by most equity investors. It is a
measure of the price paid for a share relative to the
annual net income or profit earned by the firm per share.
❑ The Graham & Dodds price-to-earnings ratio, commonly
known as CAPE or Shiller P/E, is a valuation measure
usually applied to stocks or equity markets. It is defined as
price divided by the average of ten years of earnings.
❑ Compare prices with average earnings across multiple
years (taking into account inflation) to derive a cyclically-
adjusted P/E ratio (also known as CAPE).
❑ Value of a share is determined by its present value of its
future income.

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Business School 90
 Theory of Valuation
• The value of a financial asset is the present
value of its expected future cash flows
• Required inputs:
• The stream of expected future returns, or cash flows
• The required rate of return on the investment

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 Investment Decision Process

•Once Intrinsic value is calculated (using

expected cash flows and the required rate
of return), the investment decision is
rather straightforward and intuitive:
• If Intrinsic Value > Market Price, buy
• If Intrinsic Value < Market Price, do not buy

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 Approaches to Common Stock Valuation

• Discounted Cash Flow Techniques

• Present value of Dividends (DDM)
• Present value of Operating Cash Flow
• Present value of Free Cash Flow
• Relative valuation techniques
• Price-earnings ratio (P/E)
• Price-cash flow ratios (P/CF)
• Price-book value ratios (P/BV)
• Price-sales ratio (P/S)

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II. Technical
Analysis
 Introduction to technical
analysis

• Basics & definitions

• Stock charts & chart types
• Moving Averages
• Trends / Channels
• Support & Resistance
• Volume

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 Technical Analysis

Technical analysis is an
Technical analysis is a
analysis methodology for
trading discipline employed
analysing and forecasting
to evaluate investments and
the direction of prices
identify trading opportunities
through the study of past
in price trends and patterns
market data, primarily price
seen on charts.
and volume.

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 Basic Terms

VOLATILITY FLUCTUATIONS 52-WEEK HIGH / PRICE /

LOW TRADING RANGE

OPEN / CLOSING
PRICE

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 Settlements

• Until 2001, stock markets had a weekly

settlement system. The markets then
moved to a rolling settlement system of
T+3, and then to T+2 in 2003. T+1 is
being implemented despite opposition
from foreign investors. The United
States, United Kingdom and Eurozone
markets are yet to move to the T+1
system.

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Business School 111
 Charts

• Maps price performance

• Sheds light on supply and

demand

• “Investment roadmap”

• Price / volume relationship

important

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 Chart Types - Line Charts

• Most basic of all charts

• Just a line that connects the closing

prices over a time frame

• No trading range

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 Chart Types – Bar Chart

• Vertical line represents highs/lows of the day

• Horizontal line represents closing price
• Red = down
• Blue/Black = up

Daily High
Closing Price
Daily Low Price Gap
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Chart Types – Candlestick Charts

• Vertical line represents the trading range

• Wide bar represents open and close
• White bar – Up and closes above opening price
• Red Bar – down
• Black bar – up, but closes below the opening price

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 Chart Basics –
Time Scale

• Time Scale
• Dates along bottom of chart
(varies from seconds to
decades)

• Common Types: intraday, daily,

weekly, monthly

• Subtle differences between

different time scales

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 Chart Basics – Time Scale

Daily Chart Weekly Chart

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Volume

• Amount of shares that trade

hands between seller and buyers

• Price movements more

significant when volume is above
average

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Business School 118
 Price and Volume

Average
Volume

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 Trends are your Friends

• Trend: general direction of stock

• Uptrend: higher highs, higher lows

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 Sometimes, trends difficult to see

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 Trendlines

• Simply put, a line

drawn on a chart to
represent the overall
trend

• Upward trendline,
connecting the lows,
represents support

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 Channels
• Two parallel trend lines that act as areas of support
and resistance (more later)
• Any break through the channel is a break of the trend,
otherwise the price should stay in range

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 Moving Averages
Technical Analysis: Introduction to Stock Charts

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 Moving Averages (DMA or WMA)

• Most popular are

50-day and 200-
day
• Shows the average
price of the last #
days and plots it
on a line
• Often acts as
areas of support
and/or resistance
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 WIRE – Support @ 10 WMA

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 WIRE – Support @ 10 WMA

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 Relative
Strength
Line

Volume Moving
averages

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 THANK YOU

130 Dr. Raghu N, Associate Professor, Presidency Business School