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Some are able to earn more profits through them while the
others simply lose their money.
And sell the security which does not satisfy the above
requirements.
Thus a security which had highest return per unit of risk at one
point of time and was considered to be good buy might turn into
a less attractive proposition and could be considered later on
as possible candidate for disinvestments.
They are :
o Fundamental Analysis
o Technical Analysis.
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In the first approach the investor attempts to look at
fundamental factors that affect risk return of the security.
Fundamental analysis
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Broad sources/ Company Manage- Industry factors Macro
form of specific ment economic
earnings factors factors
Sale Competitive Industry National
strength demand/supply Income,
spending,
savings,
monetary,
Fiscal, credit,
export- import
policies,
population,
price levels.
Less: Cost of Operating Industry wage National Wage
Sales Efficiency level, Industrial Policy, price
infrastructure. levels,
Infrastructure,
Raw material,
production.
Import and
export policy
Earning before
interest,
depreciation&
Taxes
(EBIDT)
Less: Interest Capital Industry cost of Interest rates in
structure/Financial capital the economy,
leverage Policy capital market
conditions
Less: Operating leverage Industry Capital goods
Depreciation Policy practices import policy
Less: Taxes Tax planning and Industry Lobby Fiscal policy
management
Net earning
after tax
Less: Capital structure Industry policy Interest rate
preference Policy structure,
dividend capital market
conditions
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Distributable
earnings
Less: equity Dividend policy Industry Fiscal policy,
dividend practices credit policy,
capital market
conditions
Retained
earnings
Economic analysis
The investment decisions of individuals and the institutions are
made in the economic set up of particular country.
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It becomes essential, therefore to understand the state of the
economy of that country at macro level.
The way people earn their income and the way people spend
their surplus on which sectors has a great bearing on growth of
that sector.
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Economic forecasting
Anticipatory Surveys
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Barometric or indicator approach
o Leading indicator
o Roughly coincidental indicator
o Lagging indicator.
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Roughly coincidental indicator: These are the indicators that
reach their peaks and troughs at approximately the same time as
the economy.
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The rate of change in the money supply in the economy affects
the corporate profits, GNP, interest rates and stock prices.
Industry Analysis
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Some of the more useful basis for classifying industries from
investment decision making point of view are as follows:
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As risk and return are positively co- related, the investment at
this stage is quite rewarding.
But for risk averse investor looking for steady long term
returns, such stage is to be avoided.
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o How is the competition among domestic and foreign firms
both in domestic and foreign markets? How do the domestic
firms performs there?
It very essential that there must be growth but its mere presence
does not guarantee profitability.
Ratios are not an end in itself, but they indicate possible areas
for further investigation.
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3. Technology and Research
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The impact of all these factors have to be translated in terms of
two most crucial numbers i.e., sales and profitability- their level
and expected rate of change during short, intermediate and long
term.
15
This value is dependant on economic, industry and company
fundamentals.
The share prices, growth in share prices of Tata Steel, SAIL and
Ispat etc will be quite different.
16
That is what the investor will find out after undertaking
company analysis. It is not that in steel industry you will buy the
share of the company with lowest price.
There is no denying the fact that all investors look for increasing
their return on their investment.
If sells at the end of the year, the total returns received by him
would be capital gains and dividend received at the end of the
year, i.e,
This looks very simple so long as the value of the variables are
available.
But the price which will be at the end of his holding period and
the dividend he is going to receive is not known to him.
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Nevertheless it is an important part.
Quantitative analysis
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The formula is:
D D
1 2
PV = ------- + ---------- + ………..
1 2
(1+k) (1+k)
If dividends are expected to grow at a constant rate of ‘g’ per cent per year, then
above equation becomes:
2
D D (1+g) D (1+g)
1 1 1
PV= ---------- + ---------------- + ----------------- +.. infinity
1 2 3
(1+k) (1+k) (1+k)
D
1
This simplify to PV = ------------
k–g
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Substituting the above in our formula we get
EPS (1-b)
PV = -------------
k- g
k = r f + rp
Thus higher the risk free interest rate (rf) with risk premium
(rp) remaining same would increase the discount rate and thus
will decrease the value of the equity.
In the same way the higher risk premium with risk free rate
remaining same would increase the discount rate and
consequently decrease the value of equity.
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P = EPS ×P/E ratio
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Indeed both these methods are interrelated.
D0/E0 (1-g)
P0/E0 = ---------------
k-g
D0 (1-g) = D1
o Higher the P/E ratio, other things remaining the same the
higher will be value of the security.
o Lower the P/E ratio other things remaining the same, lower
would be the value of an equity
o Dividend payout
o Growth
o Risk free rate
o Business Risk
o Financial risk.
24
Thus other things remaining the same,
o ROI approach
o Market share approach
o Independent estimate approach.
o Regression and co-relation analysis
o Use of trend analysis
o Decision tree approach
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Qualitative analysis
o Availability of infrastructure
o Inventory size, value, risk
o Order book position
o Product risk
o Marketing and distribution
o Components of cost as , fixed and variable
o Availability of raw materials and other inputs
o Cost of inputs
o Quality of personnel
o Quality of management
o Future Plans
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Of all the qualitative factors the quality of management is most
important.
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