SECURITY ANALYSIS AND PORTFOLIO

MANAGEMENT

SECURITIES CONTRACT REGULATION ACT HAS DEFINED SECURITY AS—

INCLUSIVE OF SHARES,SCRIPS,STOCKS,BONDS,DEBENTURE STOCK OR ANY MARKETABLE SECURITIES OF A LIKE NATURE

IN OR OF ANY DEBENTURES OF A COMPANY OR BODY CORPORATE, GOVERNMENT,SEMI GOVT.ETC.

WHAT IS A SECURITY

• SECURITY IS AN INSTRUMENT OF PROMISSORY NOTE OR A METHOD OF BORROWING OR LENDING, OR A SOURCWE OF CONTRIBUTING TO THE FUNDS NEEDED BY THE CORPORATE BODY OR NON-CORPORATE BODY.

• ( SUPERIOR REETURNS ARE POSSIBLE BY PROPEER SECURITY ANALYSIS, THROUGH BETTER FORECASTING ABILITIES AND SUPERIOR EXPEERTISE IN SECURITY ANALYSIS.)

• WHAT IS A PORTFOLIO

COMBINATION OF SECURITIES WITH DIFFERENT RISK-RETURN CHARACTERISTICS WILL CONSTITUTE PORTFOLIO OF THE INVESTOR

INVESTMENT AND SPECULATION

• SPECULATION INVOLVES INVESTMENT AND VICE-VERSA.

• IN INVESTMENT ,THE OBJECTIVES ARE LONG TERM OR MEDIUM TERM. INVESTOR TAKES DELIVERY OF SECURITIES AND BOOKS PROFIT WHEN THE RETURNS ARE HIGHER THAN HIS TARGET EXPECTATION.

• IN SPECULATION THE PERSPECTIVE IS SHORT TERM, NO INTENTION OF TAKING DELIVERY – BOOKS PROFIT FROM THE MOVEMENT OF PRICES

• IN INDIAN STOCK MARKETS 80% OF TRADE IS SPECULATION

SECURITY ANALYSIS

• SECURITY ANALYSIS IN TRADITIONAL SENSE IS ANALYSIS OF THE FUNDAMENTAL VALUE OF THE SHARE DAND ITS FORECAST FOR THE FUTURE THROUGH THE CALCULATION OF ITS INTRINSIC WORTH.

• MODERN SECURITY ANALYSIS RELIES ON FUNDAMENTAL ANALYSIS, RISK-RETURN ANALYSIS DEPENDING ON VARIABILITY OF RETURNS , SAFETY OF FUNDS AND PROJECTION OF FUTURE RETURNS.

• FORECAST OF SHARE PRICE DEPENDS U[PON ANALYSIS OF TRENDS OF THE ECONOMY,INDUSTRY AND SWOT ANALYSIS OF THE COMPANY ITSELF

CHARACTERISTICS OF INVESTMENT

• 1. Risk– depends on following factors—

a) Longer maturity period higher risk

b) Creditworthiness of borrower more– risks are lower (Govt.

securities)

c) Ownership securities as returns are based on net profit—rates are

variable.

2. Returns—

A major factor influencing pattern of investment is its return—i.e. yield plus capital appreciation .(Yield is interest or dividend). Yield has

to be calculated on the purchase price.

Nature of tax liability also influences returns. In case of tax free instruments net return would be higher

Characteristics of investment contd..

• 3. Safety– certainty of return of capital without loss of money or time• 4. If the capital asset is easily realisable, marketable then the

liquidity is higher. If there is time gap for realising proceeds then it is less liquid.

• 5. Marketability– Easy and quick means of transferability of an asset.

CLASSES IF INSTRUMENTS

1. OWNERSHIP– EQUITY,PREFERENCE SHARES

DEBT– DEBENTURES, BONDS.

2. TERM PERIOD– EQUITY HAS NO FIXED PERIOD.

DEBENTURES MAY BE 5/7/12 YEAR.BANK DEPOSITS FIXED PERIOD.

3. TYPE OF ISSUER– PRIVATE/PUBLIC/GOVERNMENT

NON CORPORATE INVESTMENTS

• BESIDES SECURITIES IN CORPORATE SECTOR IN WHICH HOUSEHOLD SAVINGS ARE TO MINOR EXTENT—THERE ARE OTHER AVENUES

• DEPOSITS WITH COMMERCIAL BANKS/CO-OP.BANKS• POST OFFICE SAVINGS BANK• NATIONAL SAVINGS CERTIFICATES• INSURANCE• PURCHASE OF REAL ESTATE,GOLD,SILVER

• CLASSIFICATION OF THE ABOVE INVESTMENTS• MARKETABLE- REAL ESTATE,GOLD..NON MARKETABLE(BANK DEPOSITS)

• INTEREST PAYABLE REGULARLY OR CUMULATIVE• PAYMENT LINKED TO EVENT (LIC POLICY/PROVIDENT FUND)

• REGULAR SAVINGS MEDIA OF INVESTMENT OR LUMP/SUM INVESTMENT

SECONDARY MARKET STRUCTURE

• REGULAR STOCK EXCHANGE—

FOR BIG COMPANIES WITH PAID UP CAPITAL 5 CRORES OR 10 CRORES –BOMBAY,CALCUTTA DELHI PRINCIPAL EXCHANGES AND REGIOANL EXCHANGES LIKE COCHIN,INDORE,

OVER THE COUNTER EXCHANGE OF INDIA—OCT.1992

COMPUTERISED TRADING FOR SMALLER COMOPANIES WITH PAID UP CAPITAL OF 30 LAKHS TO 25 CRORES ..NO TRADING RING…UPPER LIMIT REMOVED IN 1997

• NATIONAL STOCK EXCHANGE

RECOGNISED IN APRIL 93 – STARTED OPERATIONS IN GOVT.SECURITIES AND MONEY MARKETS INITIALLY..EQUITY TRADING STARTED IN NOVEMBER 1994. COMPUTERISED TRADING WITH COUNTRY WIDE NETWORK

INTERCONNECTED STOCK EXCHANGE

RECOGNISED BY SEBI IN NOV.1998..ELECTRONIC TRADING OF 15 REGIONAL EXCHANGES..

PLAYERS IN THE MARKET– MERCHANT BANKERS, REGISTRARS, UNDERWRITERS,BROKERS,

STOCK MARKET INTERMEDIARIES

• 1.CLIENT BROKERS• 2. JOBBERS AND MARKET MAKERS • 3. ARBITRAGUERS – DOING INTER MARKET DEALS – WHERE

THERE IS PRICE DIFFERENCE AT ANY POINT OF TIME• 4. BADLA FINANCIERS – WHO FINANCE CARRY FORWARD

DEALS IN SPECIFIED GROUP FOR INTEREST,, THEY LEND MONEY OR SHARES TO THE BROKERS WHO ARE IN OVERBOUGHT OR OVERSOLD POSITION AT THE TIME OF SETTLEMENT

RISKS AND RETURNS

• INVESTORS HAVE DIFFERENT MOTIVES FOR INVESTING— • REGULAR INCOME—DIVIDEND/INTEREST

• CAPITAL GAINS OR CAPITAL APPRECIATION

• HEDGE AGAINST INFLATION I.E. POSITIVE REAL REETURNS.

• SAFETY OF FUNDS– REGTULAR RETURNS AND REFIND ON MATURITY

• LIQUIDITY AND MATURITY

• SECURITY ANALYSIS INVOLVES AN EXAMINATION OF EXPECTED RETURNS AND ACCOMPANYING RISKS. THE FIRST THREE MOTIVES REFER TO THE RETURNS, LAST TWO ARE RELATED TO RISKS..

• RETURNS DEPEND ON RISKS– INVESTORS WANT MORE RETURNS AND LOWER RISKS.

COMPONENTS OF RETURNS

• RETURN IS MEASURED BY TAKING THE INCOME PLUS THE PRICE CHANGE.

• THE TERRM YIELD IS ALSO USED IN RESPECT OF FIXED INCOME SECURITIES.

• THE RETURN IS TO BE CALCULATED ON THE PURCHASE PRICE.

• THE EXPECTED RETURN MAY DIFFER FROM REALISED RETURNS AND THIS VARIATION IS A RISK FACTOR.

• TOTAL RETURN IS CALCULATED • INCOME RECEIVED + PRICE CHANGE

DIVIDED BY PURCHASE PRICE OF ASSET

MEASUREMENT OF RETURN

• ARITHMATIC AVERAGE—• IT IS A SUMMATION OF RETURNS OVER A GIVEN NUMBER OF

YEARS.

• GEOMETRIC RETURN MEASURES THE COMPOUND CUMULATIVE RETURNS OVER TIME.

• THE MEASUREMENT OF RETURN ON ANY SECURITY IS GENERALLY DONE ON THE BASIS OF THE MARKET RETURN, WHICH IS BASED ON AN APPROVED INDEX –SUCH AS B.S.E. SENSETIVE INDEX (30 SCRIPS). BASE 1978-79=100

RISK ELEMENTS

• THE COMPONENTS OF RISKS ARE BROADLY TWO—• 1. SYSTEMATIC RISKS– THAT PORTION OF VARIABILITY OF

RETURN CAUSED BY COMMON FACTORS AFFECTING THE

PRICES OF ALL SECURITIES IN THE MARKET ALIKE THROUGH ECONOMIC,POLITICAL AND SOCIAL FACTORS.

• EXAMPLES OF SYSTEMATIC RISKS—• 1) MARKET RISKS– CHANGES IN MARKET CONDITION• 2) INTEREST RATE RISKS– CHANGES IN INTEREST RATES.• 3) INFLATION RISKS• 4) TRADE CYCLES/BUSINESS CONDITION OR MONSOON FOR

AGRICULTURE BASED ECONOMIES.

RISK ELEMENTS CONTD..

• UNSYSTEMATIC RISKS—• THAT PORTION AFFECTING THE VARIABILITY OF RETURNS

CAUSED DUE TO UNIQUE FACTORS—RELATING TO THE PARTICULAR INDUSTRY/FIRM THROUGH SUCH FACTORS SUCH AS MANAGEMENT FAILURES,LABOUR STRIKE,RAW MATERIAL SCARCITY,SUBSTITUTE PRODUCTS.

• EXAPMLES OF UNSYSTEMATIC RISKS—• 1) FINANCIAL RISKS – HEAVY INTEREST/INEFFICIENT CAPITAL

MANAGEMENT.• 2) MANAGEMENT RISKS– INEFFICIENCY/POOR PLANNING• 3) LABOUR AND OTHER INPUT RISKS

RISKS AND UNCERTAINTY

• RISKS AND UNCERTAINTY GO TOGETHER .INVESTOR KNOWS THAT THERE ARE SOME POSSIBLE CONSEQUENCES BUT IN UNCERTAINTY OUTCOME IS NOT KNOWN.

• SOME RISKS CAN BE PREDICTED AND CONTROLLED BY THE INVESTORS AND SOME BY ISSUERS BUT THERE ARE SOME RISKS WHICH CANNOT BE CONTROLLED.

• WHAT CAUSES THE RISKS– • WRONG DECISION ABOUT THE INVESTMENT ALTERNATIVE• WRONG TIMING OF INVESTMENT• NATURE OF INSTRUMENTS• CREDITWORTHINESS OF THE ISSUER• MATURITY PERIOD /LENGTH OF INVESTMENT • AMOUNT OF INVESTMENT

WHAT CAUSES RISKS—CONTD..

• METHOD OF INVESTMENT –SECURED OR UNSECURED• TERMS AND CONDITIONS OF INVESTMENT–

SERVICING,REDEMPTION• NATURE OF INDUSTRY/BUSINESS • NATIONAL AND INTERNATIONAL FACTORS.

• In addition to the above risks there are other risks such as political risks, changes in govt. policies, budgetary provisions; marketability risks involving loss of liquidity or loss of value in conversion from one asset to other asset.

• Sometimes the risks are because of natural calamities, accidents etc. where there may be heavy loss.

ECONOMIC ANALYSIS

• INVESTMENT DECISION IS BASED ON AVAILABILITY OF MONEY AND INFORMATION ON THE ECONOMY, INDUSTRY AND COMPANY— CURRENT SHARE PRICE AND EXPECTED PRICE.

• CRITERIA FOR INVESTMENT DECISIONS—• 1. MOOD OF THE MARKET– FUTURE MOVEMENT OF SHARE.• 2. PAST,PRESENT AND EXPECTED PERFORMANCE OF THE

COMPANY.• 3. INVESTORS PERCEPTION ABOUT THE SHARE PRICE–

RIGHT, OVERVALUED,UNDERVALUED.• 4. INVESTORS PREFERENCES/FANCIES/MOOD.

ECONOMIC AND INDUSTRY FACTORS--

• COMPANY SPECIFIC(UNSYSTEMATIC RISKS ) CAN BE REDUCED BY DIVERSIFYING. BUT SYSTEMATIC RISKS NEED TO BE STUDIED AND TIMING OF INVESTMENT DECIDED CAREFULLY.

ECONOMIC AND INDUSTRY FACTORS

• WHATEVER IS HAPPENING IN THE ECONOMY /IS LIKELY TO HAPPEN IN NEAR FUTURE NEEDS TO BE ANTICIPATED.(ECONOMY FORECASTS)

• SURVEY RESULTS OF THE ECONOMY– GDP GROWTH RATE, INFLATION RATE, INTEREST RATES, MONEY SUPPLY, GOVERNMENT DEFICIT , FOOD STOCKS, EXPECTATION ABOUT MONSOON, INTERNATIONAL TRADE, CURRENCY RATE FLUCTUATIONS, INDEX OF INDUSTRIAL PRODUCTION.

• IN INDIA CMIE, FICCI, GOVERNMENT DEPARTMENT, INDUSTRY ASSOCIATIONS , C.S.O PUBLISH ECONOMY DATE FROM TIME TO TIME.

INDUSTRY INFORMATION

• INSTALLED CAPACITY, TREND OF DEMAND, COMPETING UNITS, CAPACITY UTILISATION,EXPORTS, COST OF INPUTS, SUBSTITUTE PRODUCTS, IMPORTS OF INPUTS, GOVERNMENT POLICY, LABOUT SCENARIO, TECHNOLOGY CHANGES.,TAX STRUCTURE, INFLOW OF NEW INVESTMENTS

COMPANY INFORMATION

• INFORMATION IS AVAILABLE IN DAILY FINANCIAL NEWSPAPERS/FORTNIGHTLY JOURNALS, BOMBAY STOCK EXCHANGE ALSO PUBLISHES DIRECTORY OF COMPANIES

• ANNUAL REPORTS OF THE COPMPANIES/HALF YEARLY UNAUDITED RESULTS ALSO USEFUL.

• BIG BROKER FIRMS ALSO SEND NEWSLETTERS TO THEIR CLIENTS AND OTHER INVESTORS. INFORMATION ON THE BASIS OF THEIR RESEARCH,

• SECURITY PRICE INFORMATION IS PUBLISHED EVERYDAY IN FINANCIAL NEWSPAPERS/INTERNET SITES OF SELECTED FINANCE ORGANISATION

• DATA ON MUTUAL FUNDS IS PUBLISHED IN FINANCIAL NEWSPAPERS AND JOPURNALS—CURRENT SCHEME/NAVS OF DIFFERENT SCHEMES/MARKET PRICE-REDEMPTION PRICE/REPURCHASE PRICE

BASIS FOR COMPANY ANALYSIS

• STOCK PRICE IS GENERALLY DEPENDENT ON INTRINSIC VALUE TO THE EXTENT OF 50 %

• INTRINSIC VALUE IS THAT VALUE WHICH IS JUSTIFIED BY THE FACTS OF ASSETS, EARNINGS AND DIVIDENDS

• THE ANALYST HAS TO PROJECT THE FUTURE (EXPECTED)EARNINGS PER SHARE, DISCOUNT THEM TO THE PRESENT TIME AND COME TO INTRINSTIC VALUE.

• ANOTHER METHOD IS TAKE EXPECTED EARNINGS AND MULTIPLY IT BY INDUSTRY AVERAGE P/E MULTIPLE.

• INVESTMENT DECISION IS TO BUY UNDER VALUED STOCK AND SELL OVER VALUED STOCK.

VALUATION OF SHARES

• SHARE IS UNDERVALUED IF ITS RISKS ARE LOWER THAN THE MARKEET RISK, AND RETURN IS HIGHER THAN MARKET RETURN.MARKET PRICE CAN BE COMPARED TO BOOK VALUE, OR P/E RATIO CAN BE COMPARED TO SIMILAR COMPANIES IN THE SAME INDUSTRY.

• PRICE DEPENDS ON – SPECULATIVE ACTIVITY– TECHNICAL, MANIPULATIVE, PSYCHOLOGICAL

• FUTURE VALUE FACTORS– MANAGEMENT, COMPETITION, PROSPECTS, CHANGES IN COSTS AND PRICES.

• INTRINSTIC VALUE FACTORS – SALES, EARNINGS & DIVIDENDS, ASSETS, CAPITAL STRUCTURE..

FINANCIAL ANALYSIS

• FINANCIAL MANAGEMENT INVOLVES PROCUREMENT AND UTILISATION OF FUNDS– COST INVOLVED FOR RAISING FUNDS AND REVENUES GENERATED BY USING SUCH FUNDS.

• OVERALL CAPITAL STRUCTURE, STRUCTURE OF WORKING CAPITAL NEEDS TO BE STUDIED. CAPITAL UNNECESSARILY BLOCKED, UNDERUTILISED WILL NOT GENERATE INCOME.

• FINANCIAL ANALYSIS IS ANALYSIS OF FINANCIAL STATEMENTS TO ASSESS FINANCIAL SOUNDNESS.

• FINANCIAL STATEMENTS ARE PROFIT AND LOSS ACCOUNT AND BALANCE SHEET. STATEMENT INDICATING APPROPRIATION OF PROFIT ALSO NECESSARY.

FINANCIAL ANALYSIS –CONTD..

• THE ANALYSIS INVOLVES FOLLOWING STEPS A) COMPARISON OF STATEMENTS OF 3/5 YEARS.

B) RATIO ANALYSIS C) FUNDS FLOW ANALYSIS D) TREND ANALYSIS -OVER 5/10 YEARS.

A) COMPARISON OF FINANCIAL STATEMENTS 1) FIGURES OF THIS YEAR WITH EARLIER YEARS.

2) INTER FIRM COMPARISON—WITHIN INDUSTRY 3) FIGURES OF ONE PRODUCT WITH OTHER PRODUCTS 4) COMPARISON OF BUDGETED WITH ACTUAL FIGURES.

RATIO ANALYSIS

• RATIO IS A STATISTICAL YARDSTICK THAT PROVIDES A MEASURE OF RELATIONSHIP BETWEEN ANY TWO VARIABLES.

• BALANCE SHEET RATIOS– CURRENT ASSEETS TO CURRENT LIABILITIES (CURRENT RATIO)

• LIQUIDITY RATIO

• DEBT TO EQUITY RATIO

• ASSETS TO EQUITY RATIO.

• P & L ACCOUNT RATIOS– GROSS PROFIT TO SALESS (GROSS PROFIT MARGIN)

• NET PROFIT RATIO

• STOCK TURNOPVER/TURNOVER OF INVENTORY

• RATIO ANALYSIS WILL BE USEFUL TO FIND OUT FINANCIAL PERFORMANCE, OPERATIONAL EFFICIENCY, PROFIT MARGINS

OF THE SAME COMPANY – INTER COMPANY COMPARISONS..

FUNDS FLOW ANALYSIS

• THE OPERATIONS OF BUSINESS INVOLVES CONVERSION OF CASH INTO DIFFERENT ASSETS AND THEN AGAIN BACK TO CASH

• STATEMENT SHOWING SOURCES AND USES OF FUNDS IS KNOWN AS FUNDS FLOW STATEMENT.

• CHANGES REPRESENTING SOURCES MAY BE ISSUE OF DEBENTURES, INCREASE IN FUNDS, RESERVES & SURPL;US,RETENTION OF EARNINGS.

• CHANGES IN USE OF FUNDS INCLUDE –A) ADDITION TO ASSETS (2) ADDITION TO INVESTMENT © DECREASE IN LIABILITIES BY PAYING OFF LOANS., DECREASE IN NET WORTH ( INCURRING LOSSES)

TREND ANALYSIS

• IT IS A COMPARISON OF SOME IMPORTANT RATIOS AND RATES OF GROWTH OVER A TIME PERIOD OF FEW YEARS.

• TRENDS OF GPM,SALES TURNOVER, RATE OF DIVIDEND, EPS,ASSET/SALES GROWTH ARE USEFUL TO MEASURE OPERATIONAL PERFORMANCE.

• USE OF ANY RATIO WITHOUT REFERENCE TO OTHER RATIO MAY BE MISLEADING

• RATIOS ARE ONLY PRELIMINARY STEPS IN INTERPRETATION AND MUST BE SUPPLEMENTED BY INVESTIGATION INTO ALL OTHER ASPECTS OF OPERATIONS

• SCRUTINY OF DIRECTORS REPORTS,AUDITORS REPORTS IS ALSO NECESSARY IN RESPECT OF CONTIGENT LIABLITIES, UNPAID TAXES, DOUBTFUL DEBTS.

FUNDS FLOW AND CASH FLOW

• FUNDS FLOW IS USED TO INDICATE WORKINMG CAPITAL CASH FLOW IS FOR ONLY CASH INFLOWS AND OUTFLOWS

• THE USEFULNESS OF CASH FLOW STATEMENT IS TO ASSESS THE CASH GENERATED, FINANCIAL ACTIVITIES AND INVESTMENT ACTIVITIES AND ADEQUACY OR OTHERWISE OF THE CASH… THE TIMING OF FLOWS AND WHETHER OUTFLOWS CAN BE MET BY INFLOWS –REFLECTS THE ABILITY OF THE COMPANYTO BE SOLVENT..

TYPES OF SHARES IN THE MARKET • BLUE CHIPS• EMERGING BLUE CHIPS— INDUSTRIAL UNITS EXPANDING AND GROQWING

GENERALLY MARKET LEADERS HAVING GOOD MARKET SHARE.CAPACITY TO DIVERSIFY/HIGHER SALES TURNOVER/GROWING PROFIT MARGINSPURPOSEFUL TAX PLANNING MANAGEMENT OUTLOOK IS DYNAMIC COMMITMENT TO RESEARCH AND DEVELOPMENT– QUICK TO ADAPT NEW TECHNOLOGIES AND LOWER COSTS

• GROWTH SHARES – EXPANDING HENCE GOOD FOR LONG TERM• CYCLICAL SHARES-RELATED TO BUSINESS CYCLES.• DEFENSIVE SHARES –PRICES ARE STABLE , REGULAR DIVIDEND• DISCOUNT SHARES – CURRENT REETURNS ARE LOW BUT LIKELY

TO GROW IN FUTURE