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Q1. Economic Analysis, Industry Analysis, Company Analysis :-
(A).Economy analysis- First and foremost in a top-down approach would be an overall
evaluation of the general economy. The economy is like the tide and the various industry
groups and individual companies are like boats. When the economy expands, most industry
groups and companies benefit and grow. When the economy declines, most sectors and
companies usually suffer. Many economists link economic expansion and contraction to the
level of interest rates. Interest rates are seen as a leading indicator for the stock market as
well. Below is a chart of the S&P 500 and the yield on the 10-year note over the last 30 years.
Although not exact, a correlation between stock prices and interest rates can be seen. Once ascenario for the overall economy has been developed, an investor can break down the
economy into its various industry groups.
The level of economic activity has an impact on investment in many ways. If the
economic 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, the stocks prices are high reflecting
the prosperous outlook for sales and profits of the firms. The analysis of
macroeconomic environment is essential to understand the behavior of the stock
prices. The commonly analyzed macroeconomic factors are as follows: -
Gross Domestic Product (GDP) Savings and Investment Inflation Interest Rates Budget Tax Structure Balance of Payment Infrastructure Facilities Monsoon and Agriculture
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Gross Domestic Product (GDP)
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. Growth is
usually calculated in real terms, i.e. inflation-adjusted terms, in order to net out the
effect of inflation on the price of the goods and services produced.
Inflation Rate
In mainstream Economics, the word inflation refers to a general rise in prices
measured against a standard level of purchasing power. Previously the term was
used to refer to an increase in the money supply, which is now referred to as
expansionary monetary policy or monetary inflation. Inflation is measured by
comparing two sets of goods at two points in time, and computing the increase in
cost not reflected by an increase in quantity.
Interest Rate
Interest rate or the Bank rate affects the cost of financing to the firms. The interest
rate term structure is the relation between the interest rate and the time to maturity
of the debt for a given borrower in a given currency. 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 the
price of shares.
(B). Industry Analysis
An industry is a group of firms that have similar technological structure of production andproduce similar products and 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"). Irrespective of specific economic situations, some industries might be
expected to perform better, and share prices in these industries may not decline as much as in
other industries. This identification of economic and industry specific factors influencing
share prices will help investors to identify the shares that fit individual expectations
Industry Life Cycle: The industry life cycle theory is generally attributed to JuliusGrodensky. The life cycle of the industry is separated into four well defined stages.
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1) Pioneering stage: The prospective demand for the product is promising in this stage andthe technology of the product is low. The demand for the product attracts many producers
to produce the particular product. There would be severe competition and only fittest
companies survive this stage. The producers try to develop brand name, differentiate the
product and create a product image. In this situation, it is difficult to select companies for
investment because the survival rate is unknown.
2) Rapid growth stage: This stage starts with the appearance of surviving firms from thepioneering stage. The companies that have withstood the competition grow strongly in
market share and financial performance. The technology of the production would have
improved resulting in low cost of production and good quality products. the companies
have stable growth rate in this stage and they declare dividend to the shareholders. It is
advisable to invest in the shares of these companies.
3) Maturity and stabilization stage:the growth rate tends to moderate and the rate of
growth would be more or less equal to the industrial growth rate or the gross domestic
product growth rate. Symptoms of obsolescence may appear in the technology. To keep
going, technological innovations in the production process and products should be introduced.
The investors have to closely monitor the events that take place in the maturity stage of the
industry.
4) Decline stage:demand for the particular product and the earnings of the companies in the
industry decline. It is better to avoid investing in the shares of the low growth industry even
in the boom period. Investment in the shares of these types of companies leads to erosion of
capital.
Growth of the industry: The historical performance of the industry in terms of growth and
profitability should be analyzed. The past variability in return and growth in reaction to macro
economic factors provide an insight into the future.
(C). 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 analyzed to take better investment decisions. The
present and future values are affected by a number of factors.
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Competitive edge of the company: Major industries in India are composed of hundreds of
individual companies. Though the number of companies is large, only few companies control
the major market share. The competitiveness of the company can be studied with the help of
the following;
Market share: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. The companies in the market should be compared
with like product groups otherwise, the results will be misleading.
Growth of sales:The rapid growth in sales would keep the shareholder in a better position
than one with stagnant growth rate. Investors generally prefer size and growth in sales
because the larger size companies may be able to withstand the business cycle rather than the
company of smaller size.
Stability of sales:If a firm has stable sales revenue, it will have more stable earnings. The
fall in the market share indicates the declining trend of company, even if the sales are stable.
Hence the stability of sales should be compared with its market share and the competitors
market share.
Earnings of the company: Sales alone do not increase the earnings but the costs and
expenses of the company also influence the earnings. Further, earnings do not always increase
with increase in sales. The companys sales might have increased but its earnings per share
may decline due to rise in costs. Hence, the investor should not only depend on the sales, but
should analyze the earnings of the company.
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 investment
prospects 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 statement helps
to predict the future and the current information aids to analyze the present status of the
company. The two main statements used in the analysis are Balance sheet and Profit and Loss
Account.
Ratio analysis: Ratio is a relationship between two figures expressed mathematically.
Financial ratios provide numerical relationship between two relevant financial data. Financial
ratios are calculated from the balance sheet and profit and loss account. Ratios for investment
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purposes can be classified into profitability ratios, turnover ratios, and leverage ratios.
Profitability ratios are the most popular ratios since investors prefer to measure the present
profit performance and use this information to forecast the future strength of the company.
The most often used profitability ratios are return on assets, price earnings multiplier, price to
book value, price to cash flow, and price to sales, dividend yield, return on equity, present
value of cash flows and profit margins.
Q2 - Moving average
Moving averages are one of the most popular and easy to use tools available to the technical
analyst. They smooth a data series and make it easier to spot trends, something that is
especially helpful in volatile markets. They also form the building blocks for many other
technical indicators and overlays.
The two most popular types of moving averages are the Simple Moving Average
(SMA)and the Exponential Moving Average (EMA).
Simple Moving Average (SMA)
A simple moving average is formed by computing the average (mean) price of a security over
a specified number of periods. While it is possible to create moving averages from the Open,
the High, and the Low data points, most moving averages are created using the closing price.
For example: a 5-day simple moving average is calculated by adding the closing prices for
the last 5 days and dividing the total by 5.
Uses for Moving Averages
There are many uses for moving averages, but two basic uses stand out:-
Trend identification/confirmation
The first trend identification technique uses the direction of the moving average to determine
the trend. If the moving average is rising, the trend is considered up. If the moving average is
declining, the trend is considered down. The direction of a moving average can be determined
simply by looking at a plot of the moving average or by applying an indicator to the moving
average. In either case, we would not want to act on every subtle change, but rather look at
general directional movement and changes.
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The second technique for trend identification is price location. The location of the price
relative to the moving average can be used to determine the basic trend. If the price is above
the moving average, the trend is considered up. If the price is below the moving average, the
trend is considered down.
The third technique for trend identification is based on the location of the shorter moving
average relative to the longer moving average. If the shorter moving average is above the
longer moving average, the trend is considered up. If the shorter moving average is below the
longer moving average, the trend is considered down.
Support and Resistance level identification/confirmation
Another use of moving averages is to identify support and resistance levels. This is usually
accomplished with one moving average and is based on historical precedent. As with trend
identification, support and resistance level identification through moving averages works best
in trending markets.
Conclusions
Moving averages can be effective tools to identify and confirm trend, identify support and
resistance levels, and develop trading systems. However, traders and investors should learn to
identify securities that are suitable for analysis with moving averages and how this analysis
should be applied. Usually, an assessment can be made with a visual examination of the price
chart, but sometimes it will require a more detailed approach.
The advantages of using moving averages need to be weighed against the disadvantages.
Moving averages are trend following, or lagging, indicators that will always be a step behind.
This is not necessarily a bad thing though. After all, the trend is your friend and it is best to
trade in the direction of the trend. Moving averages will help ensure that a trader is in line
with the current trend. However, markets, stocks and securities spend a great deal of time in
trading ranges, which render moving averages ineffective. Once in a trend, moving averages
will keep you in, but also give late signals. Don't expect to get out at the top and in at the
bottom using moving averages. As with most tools of technical analysis, moving averages
should not be used on their own, but in conjunction with other tools that complement them.
Using moving averages to confirm other indicators and analysis can greatly enhance technical
analysis.
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