Security Analysis

TOPICS TO BE COVERED/ LECTURE PLAN

 

Basics of Investment Management Learning about basic primary market operations. Various operations. techniques involved in raising money through Prospectus, Book Building etc. etc. Learning basic stock market operations. Types of orders, operations. trading mechanism, common stock exchange problems, margin trading. trading. Understanding risk return characteristics of securities. Types securities. of risks and returns, measurement of Beta. Beta. Exposure to Fundamental Analysis technique of Security valuation. valuation. Economy, Industry & Company Analysis Learning security valuation. Models of Security Valuation, valuation. Multiple Growth rates, Dividend Capitalization Approach .

Learning Technical Analysis. Basic features, patterns and Analysis. parameters Exposure to Bond valuation. Bond Analysis & Bond valuation. management. management. Bond Strategies, Duration, Immunization etc. etc. Understanding intricacies of portfolio mgt. Markowitz model, mgt. Sharpes Single Index model, Capital Asset Pricing model

Investing Defined
To consume, to save, or to invest a dollar that is earned ? Both saving and investing amount to consumption shifting through time. However, saving involves little, if any, risk, while investing is a risky endeavor.

What is Investing?


Criteria used to determine whether an investment of money is investing or something else, including:

Is it short-term or long-term? shortlong Is it productive or unproductive?  Is it legal or illegal?  Is it rational or irrational?



Investment Vs Speculation

Time Horizon Motive Information

INVESTMENT VS. SPECULATION INVESTOR

PLANNING HORIZON RISK DISPOSITION RETURN EXPECTATION BASIS FOR DECISIONS LEVERAGE LONG MODERATE MODEST FUNDAMENTAL NO

SPECULATOR
SHORT HIGH HIGH TECHNICAL HIGH

Investment Alternatives
Assets are things that people own. Financial assets have a corresponding liability, while real assets do not. Assets Financial Assets e.g. bond, stock Real Assets e.g. land

Security


What is a Security? What is Security Analysis? - Risk Return Analysis What is a Portfolio?

Why study Security Analysis at all?

Superior Analytical tools Superior forecasting abilities

Investment Alternatives
There are three broad categories of securities. Securities Equity Securities e.g. common stock Fixed Income Securities e.g. bonds, preferred stock Derivative Assets e.g. futures, options

INVESTMENT ALTERNATIVES
Investment Avenues Nonmarketable Financial Assets Bonds

Equity Shares

Money Market Instruments

Mutual Fund Schemes Real Estate

Life Insurance Policies Precious Objects

Financial Derivatives

Investment categories
Investment
Real Financial Debt Instruments
Real Estate, Jewelry, Automobiles and other tangibles

Equities Investment Companies Derivatives

INVESTMENT ATTRIBUTES RETURN RISK LIQUIDITY TAX SHELTER CONVENIENCE

SECURITIES MARKET The Battlefield

OUTLINE

Structure of the Securities Market Participants in the Securities Market Primary Equity Market Public Issue Secondary Equity Market (Stock Market) Trading and Settlement Buying and Selling Shares Stock Market Indices

STRUCTURE OF THE SECURITIES MARKET

Securities Market

Equity Market

Debt Market

Derivatives Market

Government Securities Market

Corporate Debt Market

Money Market

Options Market

Futures Market

PARTICIPANTS IN THE SECURITIES MARKET

y Regulators
CLB, RBI, SEBI, DEA, DCA SEC, FRB Stock Exchanges Listed Securities Depositories Brokers FIIs Merchant Bankers or Investment Bankers Mutual Funds Custodians Registrars Underwriters Bankers to an issue Debenture trustees Venture capital funds. Credit rating agencies

y y y y y y y y y y y y y y

PRIMARY EQUITY MARKET PUBLIC ISSUE

RIGHTS ISSUE

PRIVATE PLACEMENT

PREFERENTIAL ALLOTMENT

PUBLIC ISSUE IN INDIA

Approval of the board of directors y Approval of shareholders y Appointment of the lead manager y Due diligence by the lead manager y Appointment of other intermediaries like co-managers, advisors, underwriters, y bankers, brokers, and registrars y Preparation of the draft prospectus y Filing of the draft prospectus with SEBI y Application for listing in stock exchanges y Filing of the prospectus (after any modifications suggested by SEBI) with the y Registrar of Companies
y

Public Issue (Contd)

        

Promotion of the issue Printing and distribution of applications Statutory announcement Collection of applications Processing of applications Determination of the liability of underwriters Finalisation of allotment Giving of demat credit (or dispatch of share certificates) and refund orders Listing of the issue

IPO
Why IPO? To promote a new company  To expand an existing company  To meet the regular working capital requirement  To capitalize the reserves


Who Are All The Financial People?

    

Managers to the issue Registrars to the issue Underwriters Bankers to the issue Brokers and Sub-brokers Sub-

PRICING OF THE ISSUE

Fund raising


The PROSPECTUS route  Bought out deals  Private Placement  Rights issue-Pre emptive rights issue Book building and reverse book building

PUBLIC ISSUES IN THE U.S In the U.S., public offerings of both stocks and bonds are typically marketed by investment bankers who perform the role of underwriters. Generally, the lead investment banker forms an underwriting syndicate with other investment bankers to share the responsibility of the issue.

BOOK BUILDING Book building is a method of offering shares to investors in which the issue price is not fixed in advance (as is done in a fixed price offer) but is determined through a bidding process.

STOCK MARKET IN INDIA y As of January 2005 there were 23 stock exchanges recognised by the central government. y The most important development in the Indian stock market was the establishment of the National Stock Exchange (NSE) in 1994. y Within a short period it emerged as the largest stock exchange surging ahead of the Bombay Stock Exchange (BSE)

SCREEN BASED SYSTEM

The kind of screen based system adopted in India is referred to as the open electronic order (ELOB) market system.

ELOB
Buyers and sellers place their orders on the computer Limit order Market order Computer instantly tries to match mutually compatible orders on a price-time priority The limit order book, the list of unmatched limit orders is displayed on the screen

Secondary market
Trading in stock exchanges:A,B1,B2 category of stocks  Settlement day  Depositories  Clearing corporations  Indices: Sensex and Nifty  Insider Trading  Demat


BUYING AND SELLING OF SHARES

Locating a Broker Placement of Order Execution of Order Internet Trading

Types of market transactions

Buy order  Sell long order  Short selling Order Sizes: 1)odd lot 2)round lot


Order types
Based on price limits  Market order  Limit order: 1)Buy limit order 2)Sell limit order  Stop Order

LIMIT ORDER BOOK

Shares

Buyside

Sellside

500 501 502 503 504

505

506 507 508

509 510 511 512

Limit Price

Order types
Based on time constraint  Day order  Week order  Month order  Open order

Settlement Cycle
Security transactions are settled through electronic delivery facilitated by depositories  Presently, the settlement of all trades is a rolling settlement on a T+2 basis


y Price filters  Intraday price bands

Carry forward transactions

Settlement can be done by  DVP: delivery against payment  Squaring up transactions  Carrying over settlement to the next period

MARGIN TRADING
Carry forward Transaction: Only for Specified Group shares Transaction: Settlement Methods: Methods: Delivery against payment Squaring the transaction Carry forward  Different from Margin  Borrowing money from a bank or a broker to execute a transaction  Margin (%)= Customers Equity/ Market value of Securities  Initial Margin Requirement  Maintenance Margin Requirement  Example: IMM: 50%, MM: 20%, Buy 1000 shares at Rs.20 each Case I : Price goes down to Rs. 17, Rs.13, Rs.14.28. (Loan/1(Loan/1MM)


Case II: Price moves up to Rs.25

Fundamental Analysis

Company Analysis and Stock Valuation



 

After analyzing the economy and stock markets for several countries, you have decided to invest some portion of your portfolio in common stocks After analyzing various industries, you have identified those industries that appear to offer aboveabove-average risk-adjusted performance over riskyour investment horizon Which are the best companies? Are they overpriced?

Economic, Industry, and Structural Links to Company Analysis



Company analysis is the final step in the top-down topapproach to investing Macroeconomic analysis identifies industries expected to offer attractive returns in the expected future environment Analysis of firms in selected industries concentrates on a stocks intrinsic value based on growth and risk

Economic and Industry Influences



If trends are favorable for an industry, the company analysis should focus on firms in that industry that are positioned to benefit from the economic trends Firms with sales or earnings particularly sensitive to macroeconomic variables should also be considered Research analysts need to be familiar with the cash flow and risk of the firms

Structural Influences


Social trends, technology, political, and regulatory influences can have significant influence on firms Early stages in an industrys life cycle see changes in technology which followers may imitate and benefit from Politics and regulatory events can create opportunities even when economic influences are weak

Company Analysis
Can be done through 1)Measuring Earnings: 4Cs: Correctness, completeness, consistent, comparable 2)Forecasting Earnings 3)Applied Valuation

Factors Influencing the performance of a Company

 

  

Competitive edge: market share, growth and stability of sales, Earnings: different from sales, costs also come in picture Capital Structure: Financial leverage Management: composition of BODs Operating efficiency: BE analysis, operating leverage Financial Analysis

Financial Statement Analysis



Comparative Financial Statement Analysis :Vertical, Horizontal  Trend Analysis: base year  Common size statements  Ratio Analysis

Common-Sized Financial Statements

Express each item as a percentage of a common base number  Such as Assets or Sales  Useful when comparing  A firm over time  Different sized firms  Firms from different countries


Financial Ratios


A financial ratio combines multiple values to produce a new, meaningful value  Used to quantify, summarize and interpret financial data Types of ratios  Solvency or liquidity ratio  Measure firms ability to meet short-term shortobligations  Turnover ratios  Measure rate of activity  Coverage ratios

Financial Ratios
Leverage ratios  Measure extent to which firm has been financed by creditors  Profitability ratios  Measures productivity of money invested in firm  Per share data  Examines items that affect common stocks market price per share  Growth ratios


Grey Areas
Income from other sources  Revaluation of Assets  Inventory accounting  Depreciation accounting  Consolidated Financial Statements


Forecasting Earnings
ROI approach  Market Share/Profit margin Approach  Independent Subjective Approach  The Operating Cycle


Dividend Discount Model



Value of an equity share is equal to the present value of all the dividends expected and the market price of the share at the time of exit. Assumptions:

-Dividends are paid annually. -The first dividend is received one year after the common share is bought.

Single-period Valuation Model

 

Investor expects to hold the equity share for one year. Valuation of Equity can be calculated with following formula:

P0 = D t + Pt (1+r) Where Dt = Dividends for year 1; t = 1year r = Investors required rate of return P0=Market price at the beginning of period

Single-period Valuation Model



r=Pt-P0+Dt P0 rP0 =Pt-P0+Dt rP0 + P0 = Pt + Dt P0(1+r) = Pt + Dt P0 = Pt + Dt (1+r)

   

Single-period Valuation Model

We can say


P0=f (Pt , Dt) Pt=f (Dt+1, Pt+1) Pt+1 = f (Dt+2, Pt+2)

Single-period Valuation Model



In case of the price of the equity share is expected to grow at a rate of g% annually:

P0 becomes P0 (1+g%) and we get, P0 = D0 + (1+g%)P0 (1+r)

Multi-period Valuation Model



Equity shares have no maturity period. Hence, they may be expected to generate a dividend stream of infinite duration. Mathematical Expression of the model

Zero Growth Model

Assume that the dividend per share remains constant year after year at a value D  Here; P0= D + D + D ------------ + D (I+r) (I+r)2 (I+r)3 (I+r) P0= D/r


Constant Growth Model



Also known as Gorden Model Proposed by Myron.J.Gorden Mathematics