Security Analysis

Fundamental Analysis

Security Analysis Examining the Risk – Return characteristics of individual

securities. Determination of the Intrinsic Value of a Security –

Equity/Debt. By forecasting the earnings and dividends/interest expected

from the security By choosing a discount rate which reflects the risk of the

security.

Strategize investment policy: Buy under-priced securities and Sell over-priced securities Build the portfolio of your choice

Approaches to Security Analysis

Fundamental Analysis E-I-C Model

Technical Analysis Dow Theory, Price Charts, Moving Averages,

etc.. Efficient Market Theory

Random Walk Theory

Fundamental AnalysisMeaning: It is a logical and systematic approach to estimate the

future dividends and share price.

It is based on the basic premise that share price is determined by a number of fundamental factors relating to the economy, industry and company.

Purpose: To evaluate the present and future earning capacity of a

share based on the Economy, Industry and Company fundamentals and thereby assess the intrinsic value/economic worth of the share.

Fundamental Analysis E – I – C Frame work

ECONOMY

INDUSTRY

ANALYSIS

ANALYSIS

COMPANYANALYSIS

Fundamental Analysis Researchers have found that stock price changes can be

attributed to the following factors: Economy-wide factors: 30% - 35% Industry factors: 15% - 20% Company factors: 30% - 35% Other factors: 15%- 25%

FA involves a three-step examination, which calls for: Understanding of the macro- economic environment and

developments (Economy Analysis) Analyzing the prospects of the industry to which the firm

belongs (Industry Analysis) Assessing the projected performance of the company and the

intrinsic value of its share (Company Analysis).

Economy Analysis A study of the economic variables would give an idea

about future corporate earnings and the payment of dividends and interest to investors.

Economy-wide Factors: Growth rates of the economy

GDP, GNP, NNP Inflation rate Interest rates Government Revenue, Expenditure and Deficits Exchange rates Infrastructure Monsoon Economic and political stability

Economic Forecasting

The central theme in economic forecasting is to forecast the national income with its various components. GNP

It is an indicator of the level and rate of growth of economic activities.

Economic Forecasting Techniques Anticipatory Surveys Barometric or Indicators Approach

Leading Indicators Coincidental Indicators Lagging Indicators

Econometric Model Building Opportunistic Model Building or Sectoral

Analysis

Industry Analysis It refers to an evaluation of the relative strengths

and weakness of industries. Objective:

To assess the prospects of various industries

Industry Analysis This section is divided into four parts:

Sensitivity to the Business Cycle Industry Life Cycle Analysis Study of the Structure and Characteristics of an

Industry Profit Potential of Industries: Porter Model

Industry AnalysisSensitivity to the Business Cycle

The sensitivity of the firm’s sales to business conditions

The Operating Leverage Financial Leverage

Industry Analysis

Industry Life Cycle Analysis To determine the stage of growth through which the

industry is passing.

Stages: Pioneering Stage Rapid Growth or Expansion Stage Maturity or Stagnation Stage Decline Stage

Industry AnalysisStudy of the Structure and characteristics of

an Industry: Demand and Supply Gap Competitive Conditions in the Industry Permanence Labour Conditions Attitude of Government Supply of Raw Materials Cost Structure

Industry Analysis

Profit Potential of Industries: Porter Model The profit potential of an industry depends on the

combined strength of the following 5 basic competitive forces: Threat of new entrants Rivalry among the existing firms Pressure from substitute products Bargaining power of buyers Bargaining power of sellers

Micheal E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competition , The Free Press, 1980.

Forces Driving Industry Competition

Threat of New Entrants

Bargaining power of Buyers

Threat of Substitute Products

Bargaining power of suppliers