Fundamental Analysis – Risk and Return sources of Risk – Dividend Policy and valuation – Leverage and valuation. Technical Analysis - Security price movements –Market Hypotheses – Behaviour of stock prices.

Fundamental Analysis Fundamental analysis is a combination of economic, industry and company analyses, to obtain a stock’s current fair value and to predict its future value.

Economic Analysis

An analysis of macro economic environment is essential to understand the behavior of stock prices. When the level of economic activity is low, stock prices are low and vice-versa.

Macro Economic Indicators Gross Domestic Product: Money value

of the goods and services produces in the economy during a specific period.

Growth in GDP Growth in economy and business and more returns for the investors.

Savings and Investments: Higher the savings higher the investment and higher the GDP.

Inflation: Higher inflation rate has a negative impact on the stock market.

a) High raw material cost b) Non-availability of cheap credit c) Low earnings Interest rates: Base rate, CRR, SLR, Repo rate Budget and Fiscal Deficit Monsoon and Agriculture Infrastructure Facilities

Tax Structure Balance of Payments FDI Investment by FIIs Business Cycles and Investor Psychology: a) Boom : High profit, high turnover, business expansion, mergers and acquisitions . Investors are optimistic about the market and the stock market reaches a new high.b) Recession: Economic growth declines, Fear grips the market.c) Depression: Investor becomes pessimistic about the market and the stock market reaches a low level.d) Recovery: Economy slowly recovers. The mood changes to hope and caution.

Economic ForecastingEconomic Indicators: Any economic variable that predicts the future of financial or economic trends. Early diagnosis of cyclical movements To identify the turning points of business cycles. To know the present status, progress /slow down

of the economy.Classification of Indicators: Leading Indicators Coincidental Indicators lagging Indicators

Leading Indicators: Indicates what is going to happen in the economy. Helps to predict the path of the economy. Popular Leading indices- Fiscal policy, Monetary

policy, Capital investment, Stock Indices.Coincidental Indicators: Indicates the state of the economy. Popular Coincidental indices- GNP, Industrial

Production, Interest rates and reserve funds.Lagging Indicators: Unemployment rate, Consumer Price Index and

flow of foreign funds.Diffusion and Composite IndicesEconometric Models

Industry AnalysisAn analysis of performance, prospects and problems of an industry of interest is known as industry analysis.An industry is a group of firms that have a similar technological structure of production and produce similar products. Kinds of Industries: Growth Industry Cyclical Industry Defensive Industry Cyclical growth industry

Industry Life Cycle Pioneering Stage: Severe competition and only the

fittest company can survive. Tough to select companies for investment because the survival rate is unknown.

Rapid Growth Stage : The companies survived the first stage remain here. Uses improved technology, produces high quality products. Companies have high earnings and declare dividends. It is advisable to invest in the companies of the industry that is in growth stage.

Maturity and stabilization stage: Less growth rate, obsolescence in technology. Investors should closely monitor the events.

Declining Stage: Growth declines and investment in the companies lead to loss.

Other Factors Cost Structure and Profitability

Nature of the product

Nature of the competition

Government Policy

Labour

Research and Development

Pollution Standards

Analytical Tools SWOT Analysis

Porter’s Five Force Model: a) Entry of new competitors b) Threat of substitutes c) Suppliers’ Bargaining Power d) Buyers’ Bargaining Power e) Rivalry among existing firms

Company AnalysisEvaluating the financial performance of a company on the basis of qualitative and quantitative factors is called company analysis. Quantitative

Factors

Value of the

shares

Business ModelManagement

Corporate GovernanceCorporate Culture

EarningCompetitive EdgeFinancial Leverage

Operational LeverageProduction Efficiency

Qualitative Factors

Qualitative Factors Business Model : It provides a description of the

company’s operations, mode of revenue generation, nature of expenses, organization structure, and its sales and marketing efforts.

Management: The basic objective of the management is to attain the stated objectives of the company for the good of all stakeholders.

Corporate Governance: Set of systems and practices put in place by company to ensure accountability, transparency, and fairness in dealings to safe guard the interest of the stakeholders.

- Structure of the board of directors - Financial and Information Transparency - Corporate Culture

Quantitative FactorsEarnings of the company: Operating Income Non-operating IncomeMeasurement of Earnings: Gross Profit = Sales – Cost of Goods Sold EBITTDA= Gross Profit – Operating Expenses EBIT = EBITDA – (Depreciation and

Amortization) EAT = EBIT – Tax Earning Per Share:EPS = Net Income – Dividends on Preferred Stock -------------------------------------------------------- Average Outstanding Shares

Factors affecting number of outstanding shares:Stock options, Conversion of Warrants, Convertible preferred stock, Bonus and Right issues to existing share holders, Share split, and reverse share split. Growth in earnings:Dupont Analysis: Return on Equity/EquityLerner and Carleton Model:EPS =(1-T)[R+(R-1)L/E] E ---------------------- Number of shares outstandingR= Return on assets before tax, T-Effective Tax RateI- Effective Interest Rate L-Total Liabilities E-Equity Utilization of assets in the company Margin on sales Effective cost of the borrowed funds Debt-equity ratio Equity base of the company Effective Tax Rate

Price – Earning MultiplesP/E ratio = Market price per share/Earning per share

If the current P/E ratio is bigger than the expected P/E ratio, then the stock is overpriced.

If the current P/E ratio is smaller than the expected P/E ration, the stock is underpriced.

If both are equal, no significant changes in prices are likely to occur.

Financial Leverage The degree of utilization of borrowed funds in business is known as financial leverage. Capital Structure: Proportion of long term debt capital and equity capital in the company. A high usage of debt capital (Financial Leverage) affect

the EPS due to high interest payment. Financial leverage is advantageous during boom. The debt limit depends on the firm’s earning capacity and

its fixed assets. Degree of financial leverage (DFL) = % in EPS --------------- (or) % in EBIT DFL = EBIT/(EBIT – Interest)

Operating LeverageIf a firm’s fixed costs are a major portion of total cost, the firm is said to enjoy high degree of operating leverage. A relatively small change in sales result in a

large change in return on equity.

Competitive Edge: Market Share Growth of annual sales Stability of annual salesProduction Efficiency: producing maximum output at minimum cost per unit of output Increase in profitability Low operational costs Optimum use of company resourcesProductivity: Relationship between inputs and outputs in a company Unit costs Stock levels Capacity utilization

Financial Statement Analysis Comparative Financial Statements Trend Analysis Common size statement Fund Flow Analysis- Utilization of profit, financial

source for dividend/capital expenditure/repayment of debt, usage of sale proceeds of fixed assets/share/debentures/fixed deposits

Cash flow analysis Ratio Analysis- Liquidity ratios, Turn over ratios,

Leverage ratios, Profitability ratios, Leverage ratios.