INVESTMENTS FINAL PROJECT BSC IV SECTION A

SUBMITTED TO: ASSISTANT PROFESSOR SALAAR FAROOQ

SUBMITTED BY : HAROON M JANJUA

Analysis of GDP of Pakistan Pakistan went through four severe shocks during the last two years. The first negative shock that it faced emerged from severe macroeconomic crisis. This was a result of the imbalances of the past several years induced by policies. This was followed by a second shock that involved a large deterioration in Pakistans net external terms of trade. This was the consequence of the increment in the world commodity prices during 2007 and large part of 2008. This resulted in a severe supply shock in the economy, especially in the case of the provision of energy. The third shock emanated from adverse effects of the turmoil in global financial markets, whose external demand for exports had been collapsed. Also, there was a sudden decline in the availability of external capital which was needed to finance its fiscal and current account deficits. The market was affected adversely by the global financial crisis. The investors in developing countries, including Pakistan came under great periods of stress. And finally, in the period of 2008-09 Pakistan witnessed a sever security challenge both in terms of the fight against extremism and in terms of knock-on effect on investment inflows and market confidence. The effect of all these challenges has resulted in the loss of growth momentum. The real GDP growth has fallen down from 4.1% to 2% as compared to the last fiscal year. The country is expected to maintain this average growth rate of 2-3% in the near future, keeping in view the world economic recovery.

Inflation Rate in Pakistan Pakistan had been witnessing a soaring inflation rate in the recent past to as high as 25% but with the economic recession setting in the implementation of a tight monetary policy by the SBP it has been brought down significantly to around 8- 9%. However, with an expectation of recovery in the world market as well as in the domestic economy, it might not be reasonable to expect that inflation levels would fall to much lower levels. In fact it might start to rise again as the SBP eases its monetary policy to expand economic recovery.

State Bank of Pakistans Expected Monetary Policy In view of inflationary pressures in the past, the SBP had been following tight monetary policy. The central bank raised interest rates by 2 percent back in November, which was the fourth consecutive increase since the global economic outlook receded in 2008. However, since the economy has been growing at its slowest rate for eight years, interest rates have been cut. At present the interest rates have been reduced to 12.5%. The overall level of risk and uncertainty in the economy has increased considerably, given the present law and order situation. As a consequence, the pressure on the fiscal position, especially from the financing side, has escalated and growth in the real economy was limited. The monetary policy is not expected to ease down significantly as inflationary pressures are still looming around the economy The stock market in Pakistan

The present turmoil being witnessed in this market and the world markets is nothing unusual and is the part of the game in the world of high finance. This has been around for centuries nowfrom lower levels, the markets begin to show positive signs of improvement, hope rises and people begin to buy but then the euphoria crosses the limits of rationality. It is the leverage or the borrowed money that is the root cause of financial chaos and havocbe it the great crash of 1929 or the sub prime episode of the 21st century. They have led to the most unusual and unprecedented step that has ever been taken by KSE to handle a situation: freezing of share prices at 27 August levels. Psychological effects of this freeze on the thought processes of the market participants have been more devastating than the misery that falling share prices cause. Optimistically, the situation is likely to improve at KSE. This means that the opportunity to make money shall continue to be there in this market. But the problem is that for the people, generally, the definition of coming back of good times at KSE is only that the index should be at 15600 levels again and the stock that someone bought at 319.70 must hit those levels again. Yes, that or nothing else. Unless the possibility of seeing those same old high numbers flashing on the screens again becomes a reality, majority of the people refuse to turn optimistic about the market. This is a very misleading and unreal yardstick to gauge the future of the market. The levels that the market has seen (index 15600, size 4.8 trillion rupees) were actually overdone, overstretched number. Those levels may be seen again in four months but also we may not see those levels again in four years even. In the meantime, the market will ultimately find its new range and stock prices will stabilize at levels that are in line with this new regime of higher cost of production and slumping sales. Investors will not be able to see the opportunity to make money in the stock market in the time

ahead until and unless they consciously accept the new environment in which the share prices will have gone through after an intense phase of downward adjustment. Another reality that must be accepted is that the days of making easy money or making money easily in the stock market are over now for the time being. In the bull run witnessed during past some years, even casual participation in the market would prove fruitful. It would not even fall in a straight line thereby making the option of going short as fatal as the decision to hurriedly pick up stocks at apparently discounted prices. On the other hand, staying completely away from the market till things are clear will not be viable either because, as they say, we miss 100% of the shots that we never take. Peter Lynch said about working in the stock market, It is important to be able to make decisions without complete or perfect information. Things are almost never clear on the Wall Street or when they are, it is too late to profit from them" So since times are difficult now, in order to survive and grow in the market there must be some business plan to which must be adhered to with great discipline. The main goal should be preserving capital by preventing it from being wiped out. Such a plan requires strict profit and loss targets to be observed with extreme exactness. Outlook of Oil The price of oil has been at a record high since the last few years. The simple explanation being that the demand for oil is increasing rapidly whereas the production is near capacity for several producers and the ever increasing demand for oil threatens to surpass the worlds oil production. New oil fields and technologies being used have not given any satisfactory results and have failed not only to provide the expected supply growth but have also failed in relaxing the pressure on the oil industry. The domestic oil value assessed in Pakistan is on the international value basis. About 85 percent of the oil required for domestic uses in Pakistan is imported. Back in the year 2004 various subsidies were given by the government on the oil price as an attempt to protect the citizens from the prospective record fuel costs and an attempt to reduce the rate of inflation in the country. Financing these subsidies was a major burden on the economy and as a result the Pakistani

government was under major financial stress. It is estimated that this subsidy amounted $232 million per month. When the new government took over the rule of Pakistan in February 2008, it could not endure the fuel bills. Hence this stress being faced by the government was a significant factor for the hike in the oil prices. All these factors led to the first ever increase in the price of gasoline and diesel in Pakistan in almost twenty two months. This increase took place on the 1st of March 2008 against the last increase that was witnessed in 2006 in the month of May. The price at that time was raised by 4.2 percent and before that implementation of the increment in oil prices the nationwide price of gasoline was 53.7 rupees per liter whereas the price of diesel was 32.57 rupees per liter. The new prices of gasoline and diesel were increased by 5 Pakistani rupees per liter and 3.5 Pakistani rupees per liter respectively. In January 2009 the price of petrol in the international market was around US$36 a barrel and in Pakistani Rupees this translates into PKR 13.60 per liter in a barrel but Pakistani Government did not decrease prices instead to cover the debt government was facing, it charged record high prices of oil to even RS. 80 per liter. This hike in the oil prices was expected, the reason being that owing to the record prices of crude oil import. For e.g. In February the price of crude oil in the New York market was around $101.84 per barrel which was close to its record price of $103.05 in same month. In May 2009, the oil prices were reduced jus a bit. Petrol and HOBC was reduced by Rs. 1.45 per litre and Rs. 1.80 per litre respectively. The prices of Kerosene Oil and Light Diesel Oil (LDO) have been kept unchanged at Rs. 51.87 per litre and Rs. 48.00 per litre respectively. The price of High Speed Diesel (HSD) has also been reduced by Rs. 1.43 per litre which will be notified In June-September2009 world prices did increase to 60-80 dollar a barrel and so the prices in Pakistan reached to the level between RS. 60-70 per litre. There was reduction in tax from Supreme Court in October which resulted in decrease in prices of around RS 10 per litre but government could not bear this as it is the most easy income generating source for them. And so this prices reduction could not last for long. The prices at that time were RS. 51.7 and it was again increased to around RS. 62 per liter and remained around this level during whole November Outlook of Gold

Comparing it based on global surge of the yellow metal, one tola rate also hit a new peak of Pak Rs 38,000. One tola is equal to 11.66 grams. Current trading of gold is at Pak Rs 32,271 per 10-gram and Pak Rs 37,650 per tola. Gold price in Pakistan was Pak Rs 200 per tola higher than Dubai. The international gold rate thereon soared to an all-time high of $1,195 per ounce and it was expected the rising price trend may continue to persist amid sharp increase in demand by investors and central banks of some countries. In Pakistan, the ongoing marriage season will pick up pace after Eidul Azha. Consumers who try to purchase gold jewellery on spot rather going for advance booking are the worst-hit in view of surging prices. Pakistans gold imports in JulyOctober 2009 surged to 673 kg ($20 million) as compared to 363kgs ($11 million) in the same period of 2008, according to Federal Bureau of Statistics (FBS). The gold price movement would largely depend on the rupees strength against the dollar and trend on international bullion markets. Contrary to the situation in the international market where people invest heavily in gold, it is not hold any big attraction for investors in Pakistan. However, in the international market, in light of the rising trend in gold Analysis of Stock Positions Active Portfolio This portfolio was designed with the object of diversification so that adverse changes in one sector could be compensated by favorable changes in another sector. The objective of this essentially is to hedge the risk that may be borne by buying securities in the same industry or field Moreover, a general idea about the performance of the different sectors of the economy during the past year aided the selection procedure. For example, the fertilizer industry and the cement industry were among those few industries that registered positive growth amid the economic recession in Pakistan. Therefore, investment was made in Lucky Cement and D.G.Khan Cement as well as Fauji Fertiliser Limited. A hefty buying of Rs 10, 00,000 is done in the first week of the analysis and then buying and selling decisions have been made in the subsequent 7 weeks. In week two the emphasis is laid on having some cash in hand for unforeseen opportunities, which explains selling decisions for stocks of Engro and Lucky Cement. On a market tip the stocks of Shield Corporation are bought

to be sold in the subsequent week. Week 3 also focuses on selling more than buying. Because of the declining rate in the Oil sector in the preceding weeks it was decided to buy back the stocks for Attock Petroleum which according to our analysis was undervalued at 340 Rs but this decision proved otherwise and we sold it off in week 7 at 331 Rs. In week 5 because of the availability of excess cash in hand we decided to buy back stocks which had shown an increase in price. And the market at that time showed some positive trend so it seemed like a good opportunity to invest in some stocks for Banks and paper firms. We will conclude our analysis by focusing on week 8 in which we made some buying decisions based on increase activity and increase index values and after selling the stocks for JS Global our final balance corrected for profit and loss showed an increase of cash in hand of about 16 %.

Passive Portfolio The companies chosen to be maintained in this portfolio were those which were expected to be performing relatively at stable growth rates. An investment of approximately Rs 10, 00,000 was made in these companies with the number of shares being bought depending on their relative share prices. This portfolio was maintained for the two months of October and November 2008. As no trading was done for this portfolio, all the shares were just marked to market at the closing price of the weeks Friday. In the first week, this portfolio lost value by almost 30% but it gained 77% in value by the end of the second week. At the end of the last week of November, the value of this portfolio stood at Rs1,012, 209 compared to the portfolios value of Rs 999,984 implying an average weekly compounded growth rate of 15.2%.

Index Portfolio

In order to compare the market return with the portfolio return, the KSE 100index was marked to market at the end of every week. At the start of trading in October, the index stood at 9508.27 points which reduced to 9206.21 points at the end of November 2009 implying that the market had lost, on average, by 40% in the eight weeks under consideration Thus comparing the returns from the three portfolios, it is evident that the stock portfolios performed better than the market in general. Comparatively, the active portfolio performed better than the passive portfolio even though the difference is not very much. However, it might be stated that more active trading and a sharper and closer look on the market could have helped to magnify returns further. Intrinsic Values One of the greatest limitations in calculating the intrinsic values of the stocks in the portfolio has been the unavailability of data at the official site of the Karachi Stock Exchange. The annual statements provided are of very limited number of listed companies and unfortunately, most of the companies included in the stock portfolios are not among those very few companies. As a result, intrinsic values are calculated for ten of those companies whose financial data, primarily earnings per share (EPS) are available for both the year 2005 and 2009. The intrinsic values are calculated using the multiple growth models. The values of EPS have been used to calculate the average historic growth rate of the company (g) and this g is then adjusted upwards or downwards according to the expected performance of that company, the expected performance of the industry it operates and the expected performance of the economy of Pakistan to calculate the expected earnings over the next years. Beyond ten years, a different g, usually a relatively lower number is used to reflect the expected long-run growth rate of the company. Another important variable regarding the calculation of a shares intrinsic value has been the discount rate, also known as the required rate of return (k). Theoretically, k is calculated as the sum of the risk-free rate and the product of the companys beta and market risk premium. As beta is unique for every company, k is different for every company. However, for simplicity of calculation and time constraints, k is kept constant for all the companies. Also since it is relatively complicated to calculate individual betas, it is also held constant, implying that the required return is equal to the market return. This makes intuitive

sense because investors require a return at least equal to the markets rate of return. So the value of k used to discount future expected earnings is 12.54% which is calculated as the average compounded rate of return of the KSE-100 in the last five years, from 4473.93 points (Jan 2, 2004) to 9087.7 points (Dec 2, 2009). Also, firstly, since data for dividends is not readily available for most of the companies, and secondly, some companies have not been paying dividends lately as the average financial performance has not been very good in the past two years in particular, therefore, the value for the most recent EPS is used to calculate future expected earnings. This is likely to make a logical sense as these earnings are either paid out as dividends or reinvested in the company, in both cases they benefit the shareholder, directly in the former case and indirectly, in the latter case. Thus the intrinsic value of each share is calculated as the present value of future earnings compounded at a rate of g1 for the first ten years and g2 for the eleventh year onwards, discounted at the rate of k.
Rs Company Name Attock Petroleum Shell LPG Engro Chemicals XD Indus Motors Lucky Cement Fauji fertilizers Limited D. G. Khan Cement Glaxo smith Kline Pak Hub Power Co Ghani Glass Limited Symbol APL SGLLR ENGRO INDU LUCK FFL DGKC GLAXO HUBC GHGL Intrinsic Value 119 1312 344 413 2024 265 17 110 21 57 Rs (12/03/09) Market Price 332.78 60 179.52 205.42 63.26 25.96 27.82 96.12 30.6 52.35

1 2 3 4 5 6 7 8 9 10

over/ under valued over valued under valued under valued under valued under valued under valued over valued under valued over valued under valued

Buy/Sell sell buy buy buy buy buy sell buy sell buy

. As shown in the table above, Shell LPG, Engro Chemicals XD, Indus Motors, Lucky Cement, Fauji Fertilizers Limited, Glaxo smith Kline Pak and Ghani Glass Limited are undervalued and these shares could be bought as it is likely that their price will rise in the future, allowing for capital gains. Similarly, Attock Petroleum, D.G. Khan Cement and Hub Power Co. are overvalued as their current price is above their intrinsic values and therefore they should be sold as their prices would eventually fall. However, some very odd intrinsic calculations are obtained for SGLLR and LUCK which are difficult to explain. One possible reason is that SGLLR has had a high EPS of 93.76 while LUCK has had a high average growth rate of 35% accounting for such high intrinsic values.

Company Name Attock Petroleum Shell LPG Engro Chemicals XD Indus Motors Lucky Cement Fauji fertilizers Limited D. G. Khan Cement Glaxo smith Kline Pak Hub Power Co Ghani Glass Limited

Symbol APL SGLLR ENGRO INDU LUCK FFL DGKC GLAXO HUBC GHGL

% Historic growth rate 0.7 7.6 7.07 11.5 35.2 7.6 -26.4 -8.8 -16.6 -4.5

g1 3 6 10 7 37.5 10 1.5 2.5 2 1

g2 1 4 5 3 10 5 0.5 1 1 0.5

ACTIVE PORTFOLIO

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WEEK 2

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WEEK 4

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WEEK 6

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WEEK 8

PASSIVE PORTFOLIO

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WEEK2

WEEK 3

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WEEK 5

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WEEK 7

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KSE 100 INDEX