UNIT-II STOCK ANALYSIS AND VALUATION

TOPICS COVERED

Online trading of stocks

Understanding stock quotations

Types and placing of order

Risk: its valuation and mitigation

Analysis of the company:

Financial characteristics

ratio analysis

future prospects of the company

assessing quality of management using financial and non-financial data

balance sheet and quarterly results

cash flows

capital structure

comparative analysis of companies

Non-Financial characteristics

Stock valuations:

using ratios

PE ratio

PEG ratio

Price Revenue ratio

Use of Historic prices

simple moving average

basic and advanced interactive charts

Examining the shareholding pattern of the company

Pitfalls to avoid while investing:

high P/E stocks

low price stocks

stop loss

excess averaging

1. ONLINE TRADING OF STOCK

The act of buying and selling of security through on-line platform is on-line trading of

stock. Online trading generally requires an online trading platform offered by most online

brokers for order execution. The online trading platform for NSE is national automated

trading (NEAT) and for BSE is Bombay stock exchange on – line trading (BOLT).

On-Line Trading of Stock-Process: following are the steps in on-line trading:

Selection of a broker: The buying and selling of securities can only be done through

SEBI registered brokers who are members of the Stock Exchange. The broker can be

an individual, partnership firms or corporate bodies. So the first step is to select a

broker who will buy/sell securities on behalf of the investor.

Opening De-Mat Account with Depository: Second step in trading procedure is to

open a De-Mat account. De-Mat (De-Materialized) account refer to an account which

an Indian citizen must open with the depository participant to trade in listed securities

in electronic form. The securities are held in the electronic form by a depository.

Depository is an institution or an organization which holds securities. At present in

India there are two depositories: NSDL (National Securities Depository Ltd.) and

CDSL (Central Depository Services Ltd.) There is no direct contact between

depository and investor. Depository interacts with investors through depository

participants only. Depository participant will maintain securities account balances of

investor and intimate investor about the status of their holdings from time to time

Placing the Order: After opening the De-Mat Account, the investor can place the

order. The order can be placed to the broker (DP) either personally or through phone,

email, mobile App etc. Investor must place the order very clearly specifying the range

of price at which securities can be bought or sold.

Executing the Order: As per the Instructions of the investor, the broker executes the

order i.e. he buys or sells the securities. Broker prepares a contract note for the order

executed. The contract note contains the name and the price of securities, name of

parties and brokerage (commission) charged by him. Contract note is signed by the

broker.

Settlement: This means actual transfer of securities. This is the last stage in the

trading of securities done by the broker on behalf of their clients. There can be two

types of settlement.

On the spot settlement: It means settlement is done immediately and on spot

settlement follows i.e. T + 2 rolling settlement. This means any trade taking place

on Monday gets settled by Wednesday.

Forward settlement: It means settlement will take place on some future date. It

can be T + 5 or T + 7, etc. All trading in stock exchanges takes place between 9.15

am and 3.30 pm. Monday to Friday.

Advantages of on-Line Trading

It is convenient: In online trading, you only need to open a trading account via internet

and you’re good to go. You’re not bound by time and place as long as you have an

internet connection. Hence, online trading is convenient and accessible from

anywhere with limited hassle. It also saves time.

It is cheaper: In online stock trading, the stock broker fee which you will have to pay

is lower when compared to the commission charged by traditional method. If you trade

in a sufficiently large volume of stocks, it is possible for you to be able to negotiate

your broker’s fees.

Monitor of investments anytime: Online trading allows you to buy or sell shares

according to your convenience. It offers advanced interfaces and the ability for

investors to see how their money is performing throughout the day. You can use your

phone or your computer to evaluate your profit or loss.

It almost eliminates the middleman: Online trading allows you to trade with virtually

no direct broker communication. Apart from reducing the overall trading cost, this

benefit also makes the trading hassle free, making this service much more lucrative.

Investor has greater control: Online traders can trade whenever they wish to. On

the other hand, in traditional trading, an investor may be stuck until he or she is able

to contact their broker or when the broker is able to place their order. Online trading

allows nearly instantaneous transactions. Also, investors are able to review all of their

options instead of depending on a broker to tell them the best bets for their money.

They’re able to monitor their investments, make decisions and buy/sell stock on their

own without any outside interference; thus, giving them greater control over their

investment.

Faster Transactions: Online banking is fast and efficient. Funds can be transferred

between accounts almost instantly, especially if the two accounts are held at the same

banking institution. All it takes to be able to buy or sell stocks is a single click of the

mouse. Through this, a quicker exchange can be made which may also ensure quicker

earnings.

Better understanding of one’s money: This is a hidden advantage of online trading

which you wouldn’t want to pass up on. Just like conventional stock trading, you can

predict the market behavior and use this to predict a rise or fall in price of the stock.

You’ll be handling your own finances and be responsible for them. Over time, you

become more experienced in understanding the market, and good investment

opportunities from the bad ones. This knowledge about money is very useful, and

having this on your resume makes you more marketable to companies looking to fill a

well-paying position in the finance department.

Disadvantages of Online Trading

Technical Problems: Online trading platform are only as good as the underlying

servers and software. High volumes on volatile trading days can slow processing

speeds and information flow. Software bugs can lead to delays in getting price quotes

and information on order status. This also could result in trading losses, because you

might enter orders based on incorrect price quotes or delayed order-execution reports.

Investors depend on Internet and cellular service providers for researching information

and placing trades

Customer Service: Online brokers have a lean cost structure, which allows them to

offer discounts on commissions. You might need to place certain trades over the

phone if your online portal malfunctions or your Internet connection is down. In

addition, you might not be able to place certain types of orders over the phone, such

as spread orders involving options.

Feedback Mechanisms: Online trading means that you are your own investment

manager, but this independence comes at a price. You do not have the benefit of a

professional feedback loop, such as a reliable sounding board for your investment

decisions. Online brokers typically do not provide buy-sell recommendations. You

have to set aside time for research, such as reviewing financial statements on

corporate investor relations websites and price charts on financial websites

Addictive nature: Online traders can experience a certain high when trading that is

similar to what people experience when gambling, according to a recent study on

excessive trading published in the journal Addictive Behaviors. The study noted that

some investors choose short-term trading strategies that involve investing in risky

stocks offering the potential for large gains but also significant losses.

a) Understanding Stock Quotations

A stock quote is the price of a stock as quoted on an exchange. A basic quote for a

specific stock provides information, such as its bid and ask price, last-traded price and

volume traded.

Bid price represents the maximum price that a buyer or buyers are willing to pay for

a security.

Ask price represents the minimum price that a seller or sellers are willing to receive

for the security.

A trade or transaction occurs when the buyer and seller agree on a price for the security.

b) Types and Placing of Orders

There are four different types of orders:

Market order - this order is designed to be executed immediately, at the current

market price - no price is specified on the order.

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Limit order - this order does specify the price desired; however, there is no guarantee

that the order will be filled. There are two types of limit orders:

Buy limit order - this order is entered at a price below the current

market price.

Sell limit order - this order is placed above the current market price.

Stop order this order is used to trigger an execution only if the market reaches a

certain level; when this limit is reached, the stop order becomes a market order. As a

result, there is no way to predict the actual price the security will receive. As with limit

orders, there are two types:

Buy stop order these are used to limit losses on short stock positions and are

always placed above the current market price and filled only if the market rises.

Sell stop order - these are used to limit losses on long stock positions and are

always placed below the current market price and filled only if the market fails.

Stop-limit order -this order is used to ensure that a specific price is received, but the

order is only placed when a specific stop price is reached. The stop price and the limit

price do not need to be the same. However, there is a risk that the stop price could be

reached, but the market never reaches the limit price. In that case, the order will never

be filled.

2. Risk : Its Valuation & Mitigation

Risk: Risk is associated with uncertainty. It refers to the possibility that you will lose some

or all of your investment or that an investment will yield less than its anticipated return.

Simply stated, risk is the probability that an investment will make or lose money. Every

investment carries some degree of risk because its returns are unpredictable. The more

volatile an investment more is the risk.

Each investment is subject to general risks associated with that type of investment. These

risks are called systematic risks and are caused by conditions outside a company or

industry. Risk also arises from factors and circumstances that are specific to a particular

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company, industry, or class of investments. These are called unsystematic or diversifiable

risks. As the name implies, unsystematic risks can be reduced by diversifying your

investment portfolio.

Types of Risk

Risk can be classified under two main groups:

Systematic Risk

Unsystematic Risk

SYSTEMATIC RISK

Systematic risk, also known as "market risk" or "un-diversifiable risk". It is the uncertainty

inherent to the entire market. Systematic risk consists of the day-to-day fluctuations in a

stock's price. Volatility is a measure of risk because it refers to the behavior, or

"temperament," of your investment rather than the reason for this behavior. Because

market movement is the reason why people can make money from stocks, volatility is

essential for returns, and the more unstable the investment the more chance there is that

it will experience a dramatic change in either direction.

Types of systematic Risk

Market Risk: Market risk refers to the change in the price of securities caused by

fluctuations in overall market conditions or in a specific sector of the market due to

outside forces.

Political events

Economic factors

war or disaster

Interest Risk: Interest rate risk is the risk of loss due to variation in the price of bonds

(debentures) because of changes in interest rates. When interest rates rise, bond

prices fall; when interest rates go down, bond prices rise.

Purchasing power, inflation risk, or price level risk: Purchasing power risk, also

referred to as inflation or price level risk, refers to the possibility that the return on your

investments won’t keep pace with increasing price levels. As prices rise, the value of

currency falls, resulting in a decreased ability to purchase goods and services. People

who hold cash, savings accounts, and bonds assume this kind of risk. The danger is

that their money may not grow enough over the years to allow them to achieve their

financial goals.

Social risk: Social risk refers to the possibility that a segment of society will institute

boycotts, litigation, publicity campaigns, or lobbying efforts against a company due to

its social policy or business practices. The actions of society can negatively affect that

company’s performance.

Reinvestment rate risk: Reinvestment rate risk refers to the possibility that you will

have to reinvest funds at a lower rate of return than the investment originally earned

Exchange rate or currency risk: Exchange rate or currency risk arises because of

fluctuating foreign exchange rates. These fluctuations may affect the value of foreign

investments or profits when converting them into other currency the corresponding

drop in the relative value of the foreign currency could cause your investments to lose

value.

Political risk: Political risk refers to possible changes in the government or legal

environment. For example, taxes may rise, tariffs may be imposed, or wages and

prices may be controlled. All of these things could result in reducing a company’s

profits

RISK VALUATION (Systematic risk (Beta)

Systematic risk, also known as "market risk" or "non-diversifiable risk", is the uncertainty

inherent to the entire market or entire market segment. Also referred to as volatility,

systematic risk consists of the day-to-day fluctuations in a stock's price. Volatility is a

measure of risk.

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in

comparison to the market as a whole. In other words, beta gives a sense of a stock's

market risk compared to the market. Beta is also used to compare a stock's market

risk to that of other stocks. Investment analysts use the Greek letter 'ß' to represent

beta. Beta is used in the capital asset pricing model (CAPM) to determine required

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rate of return. Beta is calculated using regression analysis, and you can think of beta

as the tendency of a security's returns to respond to swings in the market. A beta of 1

indicates that the security's price will move with the market. A beta of less than 1

means that the security will be less volatile than the market. A beta of greater than 1

indicates that the security's price will be more volatile than the market. For example,

if a stock's beta is 1.2, it's theoretically 20% more volatile than the market.

Negative beta - A beta less than 0 - which would indicate an inverse relation to the

market - is possible but highly unlikely. Some investors used to believe that gold and

gold stocks should have negative betas because they tended to do better when the

stock market declined, but this hasn't proved to be true over the long term.

Beta of 0 - Basically, cash has a beta of 0. In other words, regardless of which way

the market moves, the value of cash remains unchanged (given no inflation).

Beta between 0 and 1 - Companies with volatilities lower than the market have a beta

of less than 1 (but more than 0). Many utilities fall in this range.

Beta of 1 - A beta of 1 represents the volatility of the given index used to represent

the overall market against which other stocks and their betas are measured. The S&P

500 is such an index. If a stock has a beta of 1, it will move the same amount and

direction as the index. So, an index fund that mirrors the S&P 500 will have a beta

close to 1.

Beta greater than 1 - This denotes a volatility that is greater than the broad based

index.

UNSYSTEMATIC RISK

Unsystematic risk is due to the influence of internal factors prevailing within an

organization. Such factors are normally controllable from an organization's point of view.

It is a micro in nature as it affects only a particular organization. It can be planned, so that

necessary actions can be taken by the organization to mitigate (reduce the effect) the

risk. The types of unsystematic risk are depicted and listed below. This risk is diversifiable

risk

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Business failure risk: It refers to the risk associated with a particular company can

be caused by changes in a company’s sales due to operating problems, such as a

strike, an unfavorable outcome of litigation, or technical obsolescence.

Financial, credit, or default risk: Financial or credit risk arises when a company incurs

excessive debt. Financial risk is related to the company’s debt-to-equity ratio. That

means the company has a high fixed obligation (interest) to pay each year. If the firm

does not perform well, it may be unable to satisfy that obligation and pay bond holders.

Liquidity risk: Liquidity risk refers to the chance that an asset may not be easily

sold, or may not receive its full market value, especially with short notice.

RISK IDENTIFICATION

Risk identification is the process of determining risks that could potentially prevent

investment from achieving its objectives. Risk evaluation is concerned with assessing

probability and impact of individual risks, taking into account any interdependencies or

other factors outside the immediate scope under investigation:

Following are ways of risk mitigation

Diversification: it is the process of allocating capital in a way that reduces the

exposure to any one particular asset or risk. A common path towards diversification is

to reduce risk or volatility by investing in a variety of assets. The kinds of risk depend

on the combination of investments. One can reduce risk but cannot eliminate it

completely. One way to manage risk is by using an investment strategy called

diversification. Diversification means buying a variety of investments in different asset

classes, so as to minimize risk.

Risk Control: This is the process of actually managing the risk. Taking proactive steps

to reduce the identified risks wherever possible. Risk Control is the most widely used

strategy, when combined with the other strategies.

Risk Transfer: This is the proactive process of transferring unwanted risk away from

your organization to another person or organization. Risk can be transferred to another

party as follows:

By law

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Through a written agreement or contract between two parties, or

Through a conventional insurance policy.

Loss Reduction: This is a “post-loss” strategy that is essentially a response plan that

addresses what will be done if a loss does occur. An effective Loss Reduction strategy

can effectively reduce the impact of a loss and can make the difference between an

inconvenience and a catastrophe.

3. Analysis of The Company

It is a process carried out by investors to evaluate securities, collecting info related to the

company’s profile, products and services as well as profitability. It is also referred as

‘fundamental analysis.’ A company analysis incorporates basic info about the company.

During the process of company analysis, an investor also considers the company’s

history, focusing on events which have contributed in shaping the company. Also, a

company analysis looks into the goods and services offered by the company. If the

company is involved in manufacturing activities, the analysis studies the products

produced by the company and also analyzes the demand and quality of these products.

Fundamental Analysis

Fundamental analysis is a “bottom up” valuation technique used to determine the market

value of a stock, common share or equity security. Fundamental analysis is a “bottom up”

valuation technique used to determine the market value of a stock, common share or

equity security. All securities can be valued by calculating the present value of their future

cash flows.

The information needed to value a company is clearly stated in its financial statements.

The Balance Sheet totals up the value of the Total Assets of a company and equates this

to the value of the Total Liabilities plus the “Owner’s Equity”. Some simple algebra

establishes that, at any point in time, the value of the “Owners’ Equity” of a company

equals the value of its Total Assets minus its Total Liabilities.

A Fundamental Analysis or “Bottom Up” financial analysis of a company is used to

establish it’s actual or “Intrinsic Value”. When you divide this value by the number of

common shares, you get the “Intrinsic Share Value” on a per share basis.

The tools required for fundamental analysis are extremely basic, most of which are

available for free. Specifically you would need the following:

i) Annual report of the company – All the information that you need for FA is available

in the annual report. You can download the annual report from the company’s website

for free.

ii) Industry related data – You will need industry data to see how the company under

consideration is performing with respect to the industry. Basic data is available for free,

and is usually published in the industry’s association website.

iii) Access to news – Daily News helps you stay updated on latest developments

happening both in the industry and the company you are interested in. A good

business newspaper or services such as Google Alert can help you stay abreast of

the latest news.

a) Financial Characteristics

Financial statements, such as comparative statements, common size percentages, trend

analysis, cash flow statement and ratios analysis are used in analyzing company.

Financial statements are prepared to meet external reporting obligations and also for

decision making purposes. They play a dominant role in setting the framework of

managerial decisions. But the information provided in the financial statements is not an

end in itself as no meaningful conclusions can be drawn from these statements alone.

However, the information provided in the financial statements is of immense use in

making decisions through analysis and interpretation of financial statements.

i) Ratio Analysis: Ratio analysis is a tool that was developed to perform quantitative

analysis on numbers found on financial statements. Ratios helps in linking the three

financial statements together and offer figures that are comparable between

companies and across industries and sectors. Ratio analysis is one of the most widely

used fundamental analysis techniques. Financial ratios fall into several categories. For

the purpose of this analysis, the commonly used ratios are grouped into four

categories: activity, liquidity, solvency and profitability.

Activity Ratios: Activity ratios are used to measure how efficiently a company

utilizes its assets. The ratios provide investors with an idea of the overall

operational performance of a firm. The activity ratios measure the rate at which the

company is turning over its assets or liabilities. In other words, they present how

many times per year inventory is replenished or receivables are collected.

Inventory turnover: It is calculated by dividing cost of goods sold by average

inventory. A higher turnover than the industry average means that inventory is

sold at a faster rate, signaling inventory management effectiveness.

Additionally, a high inventory turnover rate means less company resources are

tied up in inventory.

Receivables turnover: this ratio is calculated by dividing net revenue by

average receivables. This ratio is a measure of how quickly and efficiently a

company collects on its outstanding bills. The receivables turnover indicates

how many times per period the company collects and turns into cash its

customers’ accounts receivable.

Payables turnover: it measures how quickly a company pays off the money

owed to suppliers. The ratio is calculated by dividing purchases (on credit) by

average payables. The payables turnover increases as more purchases are

made or as a company decreases its accounts payable. A high number

compared to the industry average indicates that the firm is paying off creditors

quickly, and vice versa. An unusually high ratio may suggest that a firm is not

utilizing the credit extended to them, or it could be the result of the company

taking advantage of early payment discounts. A low payables turnover ratio

could indicate that a company is having trouble paying off its bills or that it is

taking advantage of lenient supplier credit policies.

Asset turnover: Asset turnover measures how efficiently a company uses its

total assets to generate revenues. The formula to calculate this ratio is simply

net revenues divided by average total assets. A low asset turnover ratio may

mean that the firm is inefficient in its use of its assets or that it is operating in a

capital-intensive environment. Additionally, it may point to a strategic choice by

management to use a more capital-intensive (as opposed to a more labor-

intensive) approach.

Liquidity Ratios: It is one of the most widely used ratios, they are especially

important to creditors. These ratios measure a firm’s ability to meet its short-term

obligations. The level of liquidity needed varies from industry to industry. Certain

industries are more cash-intensive than others.

Current ratio: The current ratio measures a company’s current assets against

its current liabilities. The current ratio indicates if the company can pay off its

short-term liabilities in an emergency by liquidating its current assets. Current

assets include items such as cash and cash equivalents, accounts receivable

and inventory, among others. A low current ratio indicates that a firm may have

a hard time paying their current liabilities. A high ratio indicates a high level of

liquidity and less chance of a cash squeeze. A current ratio that is too high,

however, may indicate that the company is carrying too much inventory,

allowing accounts receivables to balloon with lax payment collection standards

or simply holding too much in cash.

Quick ratio: The quick ratio is a liquidity ratio that is more stringent than the

current ratio. This ratio compares the cash, short-term marketable securities

and accounts receivable to current liabilities. The major item excluded in the

quick ratio is inventory, which can make up a large portion of current assets but

may not easily be converted to cash.

Solvency Ratios: Solvency ratios measure a company’s ability to meet its longer-

term obligations. Analysis of solvency ratios provides insight on a company’s

capital structure as well as the level of financial leverage a firm is using. Some

solvency ratios allow investors to see whether a firm has adequate cash flows to

consistently pay interest payments and other fixed charges. If a company does not

have enough cash flows, the firm is most likely overburdened with debt and

bondholders may force the company into default.

Debt-to-assets ratio: The debt-to-assets ratio is the most basic solvency ratio,

measuring the percentage of a company’s total assets that is financed by debt.

The ratio is calculated by dividing total liabilities by total assets. A high number

means the firm is using a larger amount of financial leverage, which increases

its financial risk in the form of fixed interest payments.

Debt-to-capital ratio: The debt-to-capital ratio is very similar, measuring the

amount of a company’s total capital (liabilities plus equity) that is provided by

debt (interesting bearing notes and short- and long-term debt). Once again, a

high ratio means high financial leverage and risk. Although financial leverage

creates additional financial risk by increased fixed interest payments, the main

benefit to using debt is that it does not dilute ownership. In theory, earnings are

split among fewer owners, creating higher earnings per share. However, the

increased financial risk of higher leverage may hold the company to stricter

debt covenants. These covenants could restrict the company’s growth

opportunities and ability to pay or raise dividends.

Debt-to-equity ratio: The debt-to-equity ratio measures the amount of debt

capital a firm uses compared to the amount of equity capital it uses. A ratio of

1 indicates that the firm uses the same amount of debt as equity and means

that creditors have claim to all assets, leaving nothing for shareholders in the

event of a theoretical liquidation.

Interest coverage ratio: The interest coverage ratio, also known as times

interest earned, measures a company’s cash flows generated compared to its

interest payments. The ratio is calculated by dividing EBIT (earnings before

interest and taxes) by interest payments. With interest coverage ratios, it’s

important to analyze them during good and lean years. Most companies will

show solid interest coverage during strong economic cycles, but interest

coverage may deteriorate quickly during economic downturns.

Profitability Ratios: Profitability ratios are the most widely used ratios in

investment analysis. These ratios include “margin” ratios, such as gross, operating

and net profit margins. These ratios measure the firm’s ability to earn an adequate

return. When analyzing a company’s margins, it is always prudent to compare

them against those of the industry and its close competitors. Margins will vary

among industries.

Gross profit margin: Gross profit margin is simply gross income (revenue less

cost of goods sold) divided by net revenue. For most firms, gross profit margin

will suffer as competition increases. If a company has a higher gross profit

margin than industry, it likely to holds a competitive advantage in quality,

perception or branding, enabling the firm to charge more for its products.

Alternatively, the firm may also hold a competitive advantage in product costs

due to efficient production techniques or economies of scale.

Operating profit margin: Operating profit margin is calculated by dividing

operating income (gross income less operating expenses) by net revenue.

Operating expenses include costs such as administrative overhead and other

costs that cannot be attributed to single product units. Operating margin

examines the relationship between sales and management-controlled costs.

Increasing operating margin is generally seen as a good sign, but investors

should simply be looking for strong, consistent operating margins.

Net profit margin: Net profit margin compares a company’s net income to its

net revenue. This ratio is calculated by dividing net income, by net revenue. It

measures a firm’s ability to translate sales into earnings for shareholders. Once

again, investors should look for companies with strong and consistent net profit

margins.

ROA and ROE: Two other profitability ratios are also widely used—return on

assets (ROA) and return on equity (ROE). Return on assets is calculated as

net income divided by total assets. It is a measure of how efficiently a firm

utilizes its assets. A high ratio means that the company is able to efficiently

generate earnings using its assets. As a variation, some analysts like to

calculate return on assets from pretax and pre-interest earnings using EBIT

divided by total assets. While return on assets measures net income, which is

return to equity holders, against total assets, which can be financed by debt

and equity, return on equity measures net income less preferred dividends

against total stockholder’s equity. This ratio measures the level of income

attributed to shareholders against the investment that shareholders put into the

firm. It takes into account the amount of debt, or financial leverage, a firm uses.

Financial leverage magnifies the impact of earnings on ROE in both good and

bad years. If there are large discrepancies between the return on assets and

return on equity, the firm may be incorporating a large amount of debt. In that

case, it is prudent to closely examine the liquidity and solvency ratios.

Return on Investment: Return on investment or ROI is a profitability ratio that

calculates the profits of an investment as a percentage of the original cost. In

other words, it measures how much money was made on the investment as a

percentage of the purchase price. It shows investors how efficiently each dollar

invested in a project is at producing a profit. Investors not only use this ratio to

measure how well an investment performed, they also use it to compare the

performance of different investments of all types and sizes.

Conclusion:

Ratio analysis is a form of fundamental analysis that links together the three financial

statements commonly produced by corporations. Ratios provide useful figures that are

comparable across industries and sectors. Using financial ratios, investors can develop

a feel for a company’s attractiveness based on its competitive position, financial strength

and profitability.

ii) Future Prospects of The Company

Analysing the expected future performance is also crucial as it is the future expected

appreciation in stock price which helps in defining gains over the long term. While

analysing the expected future performance of a company following factors need to be

checked:

Latest quarterly EPS and sales figures of the company

Information on the company's business, Industry and economy in which it operates

Assessment of the Sensible Investing community

As an investor, one should look at only that set of data that together is necessary and

sufficient to analyze whether the company has a great financial track record and is worth

investing in.

iii) Assessing Quality of Management Using Financial and Non-Financial Data

Recently, multiple cases of fraud have come to light where shareholders have suffered

near permanent loss of their capital because of dubious promoters or management. So

in addition to the financial and business analysis, assessing the quality of management

is equally important. Before investing in any company you must evaluate management’s

Competency and Integrity.

Some of the indicators of dubious management and poor corporate governance are

Poor quality of earnings

Excessive management remuneration

Excessive related party transactions

Convolute company structure

Constant change of auditors

Very high auditor remuneration of independent directors etc.

iv) Balance sheet and quarterly results

Assets, liability and equity are the three main components of the balance sheet. Carefully

analyzed, they can tell investors a lot about a company's fundamentals.

Assets: There are two main types of assets:

Current Assets: Current assets represent all the assets of a company that are

expected to be conveniently sold, consumed, utilized or exhausted through the

standard business operations, which can lead to their conversion to a cash value

within one business cycle, normally one year period. Current assets include cash,

cash equivalents, accounts receivable, stock inventory, marketable securities, pre-

paid liabilities and other liquid assets. Current assets are important to businesses

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because they can be used to fund day-to-day business operations and to pay for

ongoing operating expenses.

Current Assets = Cash + Cash Equivalents + Inventory + Accounts Receivables +

Marketable Securities + Prepaid Expenses + Other Liquid Assets

Non-current assets are defined as anything not classified as a current asset. This

includes items that are fixed assets, such as property, plant and

equipment (PP&E). Unless the company is in financial distress and

is liquidating assets, investors need not pay too much attention to fixed assets.

Since companies are often unable to sell their fixed assets within any reasonable

amount of time they are carried on the balance sheet at cost regardless of their

actual value.

Liabilities: There are current liabilities and non-current liabilities. Current liabilities

are obligations the firm must pay within a year, such as payments owing to suppliers.

Non-current liabilities, represent what the company owes in a year or more time.

Typically, non-current liabilities represent bank and bondholder debt. Generally

speaking, if a company has more assets than liabilities, then it is in decent condition.

By contrast, a company with a large amount of liabilities relative to assets ought to be

examined with more diligence

Equity: Equity represents what shareholders own, so it is often called shareholder's

equity. Equity is equal to total assets minus total liabilities. The two important equity

items are paid-up capital and retained earnings. Paid-up capital is the amount of

money shareholders paid for their shares. Retained earnings is part of earnings the

company has chosen to reinvest in the business rather than pay to shareholders.

Investors should look closely at how a company puts retained capital to use and how

a company generates a return on it.

v) Cash Flow Statement

A cash flow statement must depict the cash flows within the period classifying as

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Operating activities: Cash flows from operating activities predominantly result from

the main revenue-generating activities of an enterprise.

For example:-

Cash received from the sale of goods and services

Cash received in form of fees, royalties, commissions and various other revenue

forms

Cash paid to a supplier of goods and services

Investing Activities: Cash flows from investing activities represent outflows are

made for resources intended for generating cash flows and future income.

For example:-

Cash paid for acquiring fixed asset

Cash received from disposal of fixed assets (including intangibles)

Cash paid for acquiring shares, warrants or debt instruments of other companies

Financing activities: Financing activities are those which brings changes in

composition and size of owner’s capital and borrowings of an enterprise.

For example:-

Cash received from issuing shares.

Cash received from issuing loans, debentures, bonds or long-term

borrowings.

Borrowings repaid.

Grouping the activities provide information which enables the users in assessing the

impact of such activities on the overall financial position of an enterprise and also

assess the value of change in cash and cash equivalents.

vi) Capital structure

Capital structure analysis is a periodic evaluation of all components of

the debt and equity financing used by a business. The intent of the analysis is to

evaluate what combination of debt and equity the business should have. This

mix varies over time based on the costs of debt and equity and the risks to which

a business is subjected. Capital structure analysis is usually confined to short-

term debt, leases, long-term debt, preferred stock, and common stock. The

analysis may be on a regularly scheduled basis, or it could be triggered by one

of the following events:

The upcoming maturity of a debt instrument The need to find funding for the

acquisition of a fixed asset

The need to fund an acquisition

A demand by a key investor to have the business buy back shares

A demand by investors for a larger dividend

An expected change in the market interest rate

vii) Comparative Analysis of Companies

Comparative statements deal with the comparison of different items of the Profit and Loss

Account and Balance Sheets of two or more periods. Separate comparative statements

are prepared for Profit and Loss Account as Comparative Income Statement and for

Balance Sheets.

Comparative Income Statement: Three important information are obtained from the

Comparative Income Statement. They are Gross Profit, Operating Profit and Net

Profit. The changes or the improvement in the profitability of the business concern is

find out over a period of time. If the changes or improvement is not satisfactory, the

management can find out the reasons for it and some corrective action can be taken.

Comparative Balance Sheet: The financial condition of the business concern can

be find out by preparing comparative balance sheet. The various items of Balance

sheet for two different periods are used. The assets are classified as current assets

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and fixed assets for comparison. Likewise, the liabilities are classified as current

liabilities, long term liabilities and shareholders’ net worth. The term shareholders’ net

worth includes Equity Share Capital, Preference Share Capital, Reserves and Surplus

and the like.

Common Size Statements: A vertical presentation of financial information is followed

for preparing common-size statements. Besides, the rupee value of financial

statement contents are not taken into consideration. But, only percentage is

considered for preparing common size statement.

The total assets or total liabilities or sales is taken as 100 and the balance items are

compared to the total assets, total liabilities or sales in terms of percentage. Thus, a

common size statement shows the relation of each component to the whole. Separate

common size statement is prepared for profit and loss account as Common Size

Income Statement and for balance sheet as Common Size Balance Sheet.

Trend Analysis: The ratios of different items for various periods are find out and then

compared under this analysis. The analysis of the ratios over a period of years gives

an idea of whether the business concern is trending upward or downward. This

analysis is otherwise called as Pyramid Method.

b) Non – Financial characteristics

n order to analyze overall performance, an investor should also analyze non-

financial parameters along with the financial parameters. Some non- financial

indicators are:

Nature of the business: an investor should try to analyze the performance on the

basis of nature of product and the position of business in the industry in which the

company is operating. Eg: whether goods are consumable or capital goods? What

is the link between future prospects of the company and future outlook of the

industry?

Share of the company in the market: the investor should know about the shares

of the company in the market. The share in the market should be reasonable. If

the share in the market is optimum, there should be a better chance of leading the

market and earning the sufficient profits.

Efficiency of the management: the management of the company should be

honest, efficient, goal-oriented and dedicated. The vision and operational

efficiency should be examined because these matters a lot in shaping the destiny

of the company.

Long term prospective: the expansion policy and long term plan should be

examined. Company’s asset should be satisfactory. Long term plans should be

able to stabilize its profit earning capability from unfavorable fluctuations in the

future.

Availability of raw material: if the raw material is available in the domestic

company, the operational efficiency will be better than the situation where the

company is dependent on imported raw material. Any shortage in raw material or

escalation in the cost will adversely affect the cost of production.

Research and development: the companies who spend a substantial amount on

research and development for upgrading the techniques, introducing new

products, manufacturing import substitution etc. have bright scope for growth and

expansion.

Government policy: the government policy also affect the efficiency of the

company. If the government policy is not in favour of future prospect and growth

of company, then investment should not be made.

Product range/ diversification: an investor should examine the progressiveness

and diversification status of the company. A company is progressive if it launches

new products frequently as per new liking and taste of the customers. A well-

diversified company is always better for investment because in such case business

risk and operational risk can be reduced.

Competitive strength of the company: before making investment, the

competitive strength in form of both financial and non – financial asset should be

examined. The competitive position of a company within an industry can be

determined through the amount of annual sales, the growth of annual sales and

the stability of annual sales.

Technology: technology plays an important role in the success and failure of the

organization. A company operating with latest technology has a higher chances of

survival than a company having obsolete technology. Companies depending

mainly on the labour are sensitive to labour strike and unrest etc. in this case

availability of skilled labour, unskilled labour with wage level should be analyzed.

4. STOCK VALUATION

Stock valuation: Stock (Security) valuation is important to decide on the portfolio of

an investor. All investment decisions are to be made on a scientific analysis of the

right price of a share. Hence, an understanding of the valuation of securities is

essential. Investors should buy underpriced shares and sell overpriced shares. Share

pricing is thus an important aspect of trading. Valuation ratios put that insight into the

context of a company’s share price, where they serve as useful tools for evaluating

investment potential. Here is a list of principle valuation ratios.

a) Valuation of stock using ratio:

Valuation of Stock

Fundamental analysis

Dividend Based

Earning Based

Price Earning(P/E)

Ratio PEG Ratio

Price to Sales Ratio

OtherRatios:

(a) EPS

(b) DPS

(c) D/P Ratio

Revenue Based

Technical Analysis

charting / graphical

represenations

(a) Line

(b) Bar

(c) Candle -Stick

(d) Point and figure

market indicators

(a) Trends

(b) Moving average

(c) confidence index

(d) Breadth of Market

(e) Relative Strenght

i) Price Earnings Ratio (P/E): The price-earnings ratio (P/E Ratio) is the ratio for

valuing a company that measures its current share price relative to its per-share

earnings. The price-earnings ratio can be calculated as:

Market Value per Share / Earnings per Share

For example, suppose that a company is currently trading at Rs.43 a share and

its earnings over the last 12 months were Rs.2 per share. The P/E ratio for the stock

could then be calculated as 43/2, or 21.5

Significance of P/E Ratio

The P/E ratio indirectly incorporates key fundamentals of the company such as

future growth and risk. Generally, it takes into account the following factors:

Past Performance: If the company has proven track record, it would have a higher

P/E relative to a company, which has had an erratic performance.

Future Growth: This is the most important factor built into the P/E ratio. High

growth companies (sale and earnings both) will have higher P/E than the low

growth companies within the same industry.

Risk (Leverage): P/E ratio is highly dependent on capital structure. Leverage (i.e.

debt taken on by the company) affects both earnings and share price in a variety

of ways, including the leveraging of earnings growth rates, tax effects and impacts

on the risk of bankruptcy, and can sometimes dramatically affect the company’s

results. Thus, lower the leverage, higher the P/E ratio. As a result, high capital-

intensive industry gets lower P/E than low capital-intensive industry.

Corporate Governance: A company with strong corporate governance will have

higher P/E than its peer group

Dividend Payout: Generally, high and stable dividend paying companies get high

P/E because it shows the fundamental strength of the company and the company’s

commitment to rewarding its shareholders.

Economic Cycle: Industries which are affected by economic cycle usually trade

at lower P/E’s than defensive sectors (those which are unaffected by the economic

cycle). For example, FMCG and Pharma sector have higher P/E than Textile and

Capital Goods sectors.

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ii) Price / Earnings to Growth [PEG]: Price/earnings-to-growth ratio is the relationship

between the P/E ratio and the projected earnings growth of a company. It is calculated

by dividing the P/E ratio by the earnings-per-share growth. PEG ratio = PE Ratio/

EPS Growth Rate.

Generally, a company that is growing fast has a higher P/E ratio. This may give an

impression that is overvalued. Thus, P/E ratio divided by the estimated growth rate shows

if the high P/E ratio is justified by the expected future growth rate. The result can be

compared with that of peers with different growth rates.

A PEG ratio of one signals that the stock is valued reasonably. A figure of less than one

indicates that the stock may be undervalued.

PEG is a widely employed indicator of a stock's possible true value. Similar to PE ratios,

a lower PEG means that the stock is undervalued more. Many over the price/earnings

ratio favor it because it also accounts for growth.

The PEG ratio of 1 is sometimes said to represent a fair trade-off between the values of

cost and the values of growth, indicating that a stock is reasonably valued given the

expected growth. A crude analysis suggests that companies with PEG values between 0

and 1 may provide higher returns.

A PEG Ratio can also be a negative number if a stock's future earnings are expected to

drop (negative growth number).

iii) Price revenue ratio, or (Price Sales Ratio) PSR, is a valuation metric for stocks. It is

calculated by dividing the company's market cap by the revenue in the most recent

year; or divide the per-share stock price by the per-share revenue.

The smaller this ratio (i.e. less than 1.0) is usually thought to be a better investment

since the investor is paying less for each unit of sales. However, sales do not reveal

the whole picture, as the company may be unprofitable with a low P/S ratio. Because

of the limitations, this ratio is usually used only for unprofitable companies, since they

don't have a price–earnings ratio (P/E ratio). The metric can be used to determine the

value of a stock relative to its past performance. It may also be used to determine

relative valuation of a sector or the market as a whole.

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PSRs vary greatly from sector to sector, so they are most useful in comparing similar

stocks within a sector or sub-sector. Comparing P/S ratios carries the implicit

assumption that all firms in the comparison have an identical capital structure. This is

always a problematic assumption, but even more so when the assumption is made

between industries, since industries often have vastly different typical capital

structures (for example, a utility vs. a technology company). This is the reason why

P/S ratios across industries vary widely.

b) Valuation of Stock on Basis of Historic Prices

Technical Analysis can be defined as an art and science of forecasting future prices based

on an examination of the past price movements. Technical analysis is not astrology for

predicting prices. Technical analysis is based on analyzing current demand-supply of

commodities, stocks, indices, futures or any tradable instrument. Technical analysis

involve putting stock information like prices, volumes and open interest on a chart and

applying various patterns and indicators to it in order to assess the future price

movements. The time frame in which technical analysis is applied may range from

intraday, daily, weekly or monthly price data to many years.

Basic Premises of Technical Analysis

The basic premises underlying technical analysis, as articulated by Robert A. Levy, are

as follows:

Market prices are determined by the interaction of supply and demand forces.

Supply and demand is influenced by a variety of factors, both rational and irrational.

These include fundamental factors as well as psychological factors.

Barring minor deviations, stock prices tend to move in fairly persistent trends.

Irrespective of why they occur, shifts in demand and supply can be detected with the

help of charts of market action

Shifts in demand and supply bring about changes in trends.

Because of the persistence of trends and patterns, analysis of past market data could

be used to predict future price behavior.

Tools of Technical Analysis

There are numerous tools and techniques for doing technical analysis. Basically this

analysis is done from the following four important points of view:-

Prices: Whenever there is change in prices of securities, it is reflected in the changes

in investor attitude and demand and supply of securities.

Time: The degree of movement in price is a function of time. The longer it takes for a

reversal in trend, greater will be the price change that follows.

Volume: The intensity of price changes is reflected in the volume of transactions that

accompany the change. If an increase in price is accompanied by a small change in

transactions, it implies that the change is not strong enough.

Width: The quality of price change is measured by determining whether a change in

trend spreads across most sectors and industries or is concentrated in few securities

only. Study of the width of the market indicates the extent to which price changes have

taken place in the market in accordance with a certain overall trends.

The tools of technical analysis can be divided into two main categories, namely, Charting

Techniques and Technical indicators Charting techniques is based on chart patterns and

the analyst's tries to identify price patterns. Their goal is to profit from trading when

patterns occur, some of the important chart patterns are Head & Shoulders, Support &

Resistance, Gap Analysis, Trend Lines, Triangles, Rectangles, Double Tops and Double

Bottoms. These are broadly classified below:

Charting or Graphical Representation

Charting is the basic tool in technical analysis, which provides visual assistance in

defecting changing pattern of price behaviour. The technical analyst is sometimes called

the Chartist because of importance of this tool. The Chartists believe that stock prices

move in fairly persistent trends. There is an inbuilt inertia, the price movement continues

along a certain path (up, down or sideways) until it meets an opposing force due to

demand-supply changes. Chartists also believe that generally volume and trend go hand

in hand. When a major ‘up’ trend begins, the volume of trading increases and also the

price and vice-versa. The essence of Chartism is the belief that share prices trace out

patterns over time. These are a reflection of investor behaviour and it can be assumed

that history tends to repeat itself in the stock market. A certain pattern of activity that in

the past produced certain results is likely to give rise to the same outcome should it

reappear in the future. The various types of commonly used charts are:

Line Charts: The simplest form of chart is a line chart. Line charts are simple

graphs drawn by plotting the closing price of the stock on a given day and

connecting the points thus plotted over a period of time. Line charts take no notice

of the highs and lows of stock prices for each period.

Bar Charts: It is a simple charting technique. In this chart, prices are indicated on

the vertical axis and the time on horizontal axis. The market or price movement for

a given session (usually a day) is represented on one line. The vertical part of the

line shows the high and low prices at which the stock traded or the market moved.

A short horizontal tick on the vertical line indicates the price or level at which the

stock or market closed:

Point and Figure Chart (PFC): Though the point and figure chart is not as

commonly used as the other two charts, it differs from the others in concept and

construction. In PFC there is no time scale and only price movements are plotted.

As a share price rises, a vertical column of crosses is plotted. When it falls, a circle

is plotted in the next column and this is continued downward while the price

continues to fall. When it rises again, a new vertical line of crosses is plotted in the

next column and so on. A point and figure chart that changes column on every

price reversal is cumbersome and many show a reversal only for price changes of

three units or more (a unit of plot may be a price change of say one rupee).

Point & Figure charts consist of columns of X’s and O’s that represent filtered price

movements. X-Columns represent rising prices and O-Columns represent falling

prices. Each price box represents a specific value that price must reach to warrant

an X or an O. Time is not a factor in P&F charting. No movement in price means

no change in the P&F chart.

Japanese chart or Candle stick chart: Another kind of chart used in the technical

analysis is the candlestick chart, so-called because the main component of the

chart which represents prices looks like a candlestick, with a thick ‘body’ and

usually, a line extending above and below it, called the upper shadow and lower

shadow, respectively.

The top of the upper shadow represents the high price, while the bottom of the

lower shadow shows the low price. Patterns are formed both by the real body and

the shadows. Candlestick patterns are most useful over short periods of time, and

mostly have significance at the top of an uptrend or the bottom of a downtrend,

when the patterns most often indicate a reversal of the trend.

The wider part of the candlestick is shown between the opening and closing price.

It is usually colored in black/red when the security closes on a lower price and

white/green the other way around. The thinner parts of the candlestick are

commonly referred to as the upper/lower wicks or as shadows. These show us the

highest and/or lowest prices during that timeframe, compared to the closing as well

as opening price.

The relationship between the bodies of candlesticks is important to candlestick

patterns. Candlestick charts make it easy to spot gaps between bodies.

A slight drawback of candlestick chart is that candlesticks take up more space than

OHLC bars. In most charting platforms, the most you can display with a candlestick

chart is less than what you can with a bar chart.

Market indicators Apart from charting techniques, stock valuation can also be done by

considering various market indicators:

Movements and Trends:

A trend can be defined as the direction in which the market is moving. Up trend is the

upward movement and downtrend is the downward movement of stock prices or of the

market as measured by an average or index over a period of time, usually longer than six

months. Trend lines are lines that are drawn to identify such trends and extend them into

the future. These lines typically connect the peaks of advances and bottoms of declines.

Sometimes, an intermediate trend that extends horizontally is seen.

Trends can be classified into following major types:

UPTREND: Uptrend is classified as a series of higher highs and higher lows. It is also

called as higher top and higher bottom formation. As mentioned in below diagram, point

3 is higher than point 1 which was a previous high, then point 5 is greater than point 3

which was a previous high this indicates continuous formation of higher high and higher

low. Hence, we say that the stock is trading in uptrend.

Higher highs indicate that the stock is making consecutive peaks than previous highs.

Higher lows indicate that bottom is higher than the previous lows, this can be easily seen

on charts.

DOWNTREND: Downtrend is consists of lower lows and lower high. It is also called as a

lower top and lower bottom formation in technical analysis.

When the stock is making lower highs & lower lows, it is considered to be in trading in a

downtrend. Lower highs mean that previous peak is higher than the current peak. Lower

lows mean the current bottom is lower than the previous bottom which is shown in

above diagram as point 3 is lower than point 1 and at the same time point 4 is less than

point 2

SIDEWAYS TREND: When the stock trades in a range, it is called sideways trend. In this

trend prices make higher top and lower bottom or lower top and higher bottom formations,

where as it is very difficult for trader to trade in this trend. Generally accumulations and

distributions happens in this range.

Sideways trend occurs when the force of demand & supply are nearly equal. A

sideways trend is also called ‘horizontal trend’ or ‘consolidation’.

DOUBLE TOPS A double top forms when the price makes a high within an uptrend, and

then pulls back. On the next rally the price peaks near the prior high, and then falls below

the pullback low. It's called a double top because the price peaked in the same area twice,

unable to move above that resistance area.

DOUBLE BOTTOMS A double bottom forms when the price makes a low within a

downtrend, and then pulls back to the upside. On the next decline the price stalls near

the prior low, then rallies above the pullback high. It's called a double bottom because the

price stalled in the same area twice, unable to drop below that support area.

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HEAD AND SHOULDERS TOP A HS top is formed when the price makes a high, pulls

back, makes a higher high, pulls back, and then makes a lower swing high. This creates

three peaks, with the one in the middle being the highest. The topping pattern is typically

only relevant if seen after a substantial advance.

HEAD AND SHOULDERS BOTTOM The head and shoulders (HS) bottom, or inverse

head and shoulders, occurs after a downtrend, and signals an uptrend may be starting or

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underway. The pattern is created by a swing low, followed by a rally, a lower swing low,

a rally, and then a higher low.

i) Moving average analysis:

The statistical method of moving averages is also used by technical analysts for

forecasting the prices of shares. While trends in share prices can be studied for possible

patterns, sometimes it may so happen that the prices appear to move rather haphazardly

and be very volatile. Moving average analysis can help under such circumstances. A

moving average is a smoothed presentation of underlying historical data. It is a summary

measure of price movement which reduces the distortions to a minimum by evening out

the fluctuations in share prices. The underlying trend in prices is clearly disclosed when

moving averages are used. To construct a moving average the time span of the average

has to be determined. A 10 day moving average measures the average over the previous

10 trading days, a 20 day moving average measures the average values over the previous

20 days and so on. Regardless of the time period used, each day a new observation is

included in the calculation and the oldest is dropped, so a constant number of points are

always being averaged. The moving averages are worked out in respect of securities

studied and depicted on the graph. Whenever the moving average price line cuts the

actual price line of the security or of the market index from the bottom it is a signal for the

investors to sell the shares. Conversely, when the moving average price line cuts the

actual price line from above, it is the right time to buy shares. The moving average

analysis is quite a useful method in finding out the trends in security prices when it is

based on long-term approach. However, a point of caution is in order. Moving average

analysis always invariably provide signal to buy or sell, after the trend reversal has begun.

These are neither lead indicators nor juncture points for change in trends. The moving

averages should therefore, be used only with other indicators, otherwise these may

provide true, but mathematically inaccurate information. The technical analysts can use

three types of moving averages -simple, weighted or exponential.

Relative Strength

The empirical evidence shows that certain securities perform better than other securities

in a given market environment and this behaviour remains constant over time. Relative

strength is the technical name given to such securities by the technical analysts because

these securities have stability and are able to withstand both depression and peak

periods. Investors should invest in such securities, because these have constant strength

in the market. The relative strength analysis may be applied to individual securities or to

whole industries or portfolios consisting of stock and bonds.

The relative strength can be calculated by:

Measuring the rate of return of securities

Classifying securities

Finding out the high average return of securities

Using the technique of ratio analysis to find out the strength of an individual security.

Technical analysts measure relative strength as an indication for finding out the return of

securities. They have observed that those securities displaying greatest relative strength

in good markets (bull) also show the greatest weakness in bad markets (bear). These

securities will rise and fall faster than the market. Technical analysts explain relative

strength as a relationship between risk and return of a security following the trends in the

economy. After preparing charts from different securities over a length of time, the

technician would select certain securities which showed relative strength to be the most

promising investment opportunities.

Resistance and Support Level

The peak price of the stock is called the resistance area. Resistance level is the price

level to which the stock or market rises and then falls repeatedly. This occurs during an

uptrend or a sideway trend. It is a price level to which the market advances repeatedly

but cannot break through. At this level, selling increases which causes the price fall.

Support level shows the previous low price of the stock. It is a price level to which a stock

or market price falls or bottom out repeatedly and then bounce up again. Demand for the

stock increases as the price approaches a support level. The buying pressure or the

demand supports the price of stock preventing it from going lower.

5. Examining the shareholding pattern of the company.

Reviewing the shareholding pattern and the change in shareholding pattern could be

useful to the investors. It shows how shares of a company are split among the entities

that make up its owners.

The Shareholding structure is declared every quarter.

BASIC RULES.

As a rule of thumb, higher promoter’s stake is perceived as positive and a lower equity

stake could mean low confidence of promoters in their own company. Rise in

promoter stake is considered positive because promoters will commit additional fund

only when they are optimistic about future growth of their company.

Similarly a higher FIIs stake is considered as positive and a lower FII participation

could mean low confidence of FIIs in the company. Rise in FII stake is considered

positive as they will commit funds only when they are totally optimistic and confident

about the future prospects of the company.

Too high or too low of promoters stake or FII holding is not favorable.

SHARE HOLDING PATTERN

Data regarding the share holding pattern is available in the stock exchange’s website, all

financial websites as well as in the company’s website and annual reports. Share holding

pattern of a company generally involves:-

Promoters’ Holding – Promoters may include domestic and foreign promoters.

Promoters are the entities that floated the company, and to a large extent have seats

on the Board of Directors or the management.

Persons acting in concert with the Promoters. Relatives of the promoters who hold

shares fall under this class and are termed as the promoter group.

Holding of the Non-Promoters – these include institutional investors like Banks,

Financial Institutions, Insurance Companies, Mutual Funds, Foreign Institutional

Investors and others like private Corporate bodies, Trusts, Foreign Companies you

and me .

PROMOTERS AND FIIs – The two categories of shareholders to watch.

While analysing the shareholding pattern of the company, the two important categories

to be watched are the promoter’s stake and the FIIs stake in that company. An increase

in promoter stake does not always constitute a sign of confidence. It is also necessary to

see whether fresh funds have come in. If fresh fund have been invested, where will they

be invested. Answers to these questions would help investors to determine whether jump

in promoter stake is beneficial to the company. However, an increase in FIIs stake is a

good sign – It shows that they are bullish on the stock. At the same time, the flip side of

huge FII holding is that the stock price will be subject to huge price volatility when they off

load the stake.

Analysing the holdings of various categories of investors would give you insights into the

pattern of control in the company.

Here’s a collection of tips for you –

Rise or fall in promoters holding is to be studied by looking at two aspects. First what

is purpose of promoters in raising or reducing their equity stakes and second, the

methods promoters have adopted to increase or reduce their ownership.

If the promoters are increasing their stake to pay off debts and strengthen their

balance sheet. This is certainly positive for the shareholders.

Companies that have gone for share buyback also see rise in promoter’s stake. The

core objective of a buyback is to create wealth, but it also increases promoter’s equity

stake at no additional cost. A rise in promoter’s stake due to merges or buyback means

little for investors in real terms.

Promoters of companies that have opted for rights issue are forced to step in and bail

out the unsubscribed portion just in case the rights are undersubscribed. Here, there

will be an unintentional rise in promoter’s stake. Shareholders declining to subscribe

to rights issue and promoters chipping to rescue the issue do not qualify to be positive

development.

A decline in promoter holding should also be analyzed in detail. Decline in promoter

holding can be due to various factors such as issuing fresh share towards employee

stock option, or it could be due to offloading/issuing of fresh shares to

strategic/financial partners. These changes should be carefully studied.

Promoters offloading their holdings in the open market are a warning signal. Some

dubious companies announce positive development periodically; promoters keep on

offloading equity stake at the same time. It is well laid-out trap for investors.

If you see promoters increasing their stakes in successive quarters, you know that

the financial performance is going to be good and the stock prices would possibly be

higher. However, it’s unusual to see promoters’ holding increase on a regular basis.

They usually step in to buy after a sharp market decline to shore up their holdings.

A very high promoter holding is not a good sign. A diversified holding and a good

presence of institutional investors indicates that promoters have little room to make

and carry out random decisions that benefit them without gauging how it would affect

earnings and other shareholders.

Very low stake of promoters is perceived as diminishing confidence of promoters. This

results in rampant sell off which results in loss for investors.

FII holdings in stocks are used as indicators in stock selections; stocks with high FII

holdings are largely favored. However, such stocks could take a hit should the FIIs

decide to sell their stake. Retail investors may perceive such selling off to be a lack of

faith in the stock by the FII.

Holding by mutual funds and insurance companies is an indicator on how favored a

stock is. Multiple funds holding the stock could be a sign of growth potential. Therefore,

such high institutional holding may mean your investment is a tad safer since that

company may then be more professionally run.

While looking at the shareholding pattern, figures for a single period is also unlikely to

tell you much. Compare holding patterns with those of the previous quarters to check

how holdings have changed.

Along with holding patterns, companies also disclose the entities — other than the

promoters — that hold more than 1 per cent in the share capital. Companies are also

required to declare the promoters’ shares that have been pledged as debt collateral.

6. Pitfalls to avoid while investing

a) High P/E stocks: The P/E ratio measures the relationship between a company's stock

price and its earnings per share. The P/E ratio is calculated by dividing a company's

current stock price by its earnings per share (EPS). A high P/E ratio indicates that

investors expect higher earnings. However, a stock with a high P/E ratio is not

necessarily a better investment than one with a lower P/E ratio, as a high P/E ratio

can indicate that the stock is being overvalued. If you invest in an overvalued stock,

you run the risk of losing money if it doesn't meet investors' high earnings

expectations. On the other side, when a company's stock has a low P/E ratio, it may

indicate that the stock is undervalued. Investors can often buy undervalued stock at a

discount and then profit when the price of that stock climbs.

b) Low price stocks: There is a common saying: “Don’t judge a book by its cover.”

Some equally valid words of wisdom for investors could be: “Don’t judge a stock by its

share price.” Despite so much information available for investors, many people still

incorrectly assume that a stock with a lower price is cheap, while another with a heftier

price is expensive. This notion can lead investors down the wrong path and into some

bad decisions for their money. The cheapest stocks, known as “penny stocks” also

tend to be the riskiest. A stock that just went from Rs40 to Rs4 may end up at zero,

while a stock that goes from Rs10 to Rs20 might double again to Rs40. Looking at a

stock’s share price is only useful when taking many other factors into account.

c) Stop loss: A stop-loss order is an order placed with a broker to sell a security when

it reaches a certain price. Stop-loss orders are designed to limit an investor’s loss on

a position in a security. Although most investors associate a stop-loss order with a

long position, it can also protect a short position, in which case the security gets bought

if it trades above a defined price. A stop-loss order takes the emotion out of trading

decisions and can be useful if a trader is on vacation or cannot watch his or her

position. However, execution is not guaranteed, particularly in situations where trading

in the stock halts or gaps down (or up) in price. A stop-loss order may also be referred

to as a “stop order” or “stop-market order.” If an investor uses a stop-loss order for a

long position, a market order to sell is triggered when the stock trades below a certain

price; the order then gets filled at the next available price. This type of order works

efficiently in an orderly market; however, if the market is falling quickly, investors may

get a fill well below their stop-loss order price.

d) Excess averaging: If the stock you purchased drops, don’t try to buy more shares to

bring down your average buying price. Investors often try to cover their losses by

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buying more of the same shares at the lower price. There is merit in averaging down

the price provided the stock’s fundamentals are strong and the current drop is external

to the company or owing to a temporary event. If your bet is right, the upside on the

investment will be much higher. However, if the fundamentals have deteriorated, then

averaging is like catching a falling knife; your losses will only worsen as you buy more

of the same junk. There is no point throwing good money after bad. “Averaging down

is a good idea only if the underlying stock is of good quality. Even then, fix a limit to

the extent to which you want to increase exposure.