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Each equity share can be analyzed through …

Each equity share can be analyzed through …. Either Fundamental Analysis Or Technical Analysis. THE FUNDAMENTAL ANALYSIS. The Basic premises of the Fundamental Analysis

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Each equity share can be analyzed through …

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  1. Each equity share can be analyzed through … Either Fundamental Analysis Or Technical Analysis www.pptmart.com

  2. THE FUNDAMENTAL ANALYSIS • The Basic premises of the Fundamental Analysis • A share has a value because it pays a future stream of cashflows in terms of dividend and capital gains. According to it, the value of a share is equal to the present value of future cash flows. • Dividends are major source of future cash flows to an equity share. Since dividends are determined by the earning capacity of a firm which in turn is determined by some fundamental factors. Therefore, evaluation of a share’s worth must be in terms of such fundamental factors. • The price of a share can not be much different for long from its underlying value.

  3. The fundamental analysis follows four-phase process of determining the worth of a share which is THE G- E - I - C MODEL GLOBAL ECONOMY DOMESTIC ECONOMY INDUSTRY COMPANY • This model follows TOP-TO-BOTTOM approach as shown below:

  4. Why to study the ECONOMY …… ??? • Because there exists a strong relationship between the aggregate economy and the stock market. It is believed that economic activities affect corporate profits, investors’ attitude and expectations and ultimately share prices.

  5. SHOCKS!!!!!!!!! • Oil Prices have gone up!!! • Wage Rates have gone up!!! • Cost of Raw Materials have gone up!!! Such shocks are called SUPPLY SHOCKS. What will be the impact of such shocks on stock market?

  6. DEMAND SHOCKS!!!!!!!!! Demand Shocks affect the demand for goods and services in an economy • Reduction in Taxes!!! • Huge FIIs Inflows!!! • Pay revision of Government Employees!!! What will be the impact of such shocks on stock market?

  7. OTHER IMPORTANT ECONOMIC AGGREGATES …… ??? • The some of the important economic aggregates that are supposed to influence share price are: • Inflation rate • Indices of production • Balance of payment • Besides the above, there may be non-economic factors which one should consider like - political stability, industrial environment, social conditions, war conditions etc.

  8. THE ECONOMY …… ???(continued…) • Do the changes in economic activities take place before the turn in share prices? • Some say that share prices are leading indicatorswhile others believe that it is the economy’s performance that is reflected in the share prices. • A DILEMMA …….???

  9. Does a boom and its bust in a stock market have any impact upon the macro economy?

  10. THE INDUSTRY …… ??? Given the same set of economic conditions, it is experienced and documented that all industries do not perform in the same manner - some perform better than others. And, industry analysis helps in identifying the growing industries which would bring higher rate of returns to shareholders. Each industry has its own set of strength, weaknesses, possible threats and potential opportunities. Therefore, one should study industry to determine the future prospect and growth of it. The basic purpose of industry analysis is to determine and assess the general health and future position of an industry.

  11. THE INDUSTRY …… ???(continued…) • While analysing an industry, one should look at the following factors/indicators/characteristics of an industry: • The Industry Life Cycle • Pioneering Stage • Expansion Stage • Stabilization Stage • Decay Stage • The Business Cycle • The Structural Analysis • Intensity of competition among the firms of an industry determines its profitability. • Michael Porter’s model has suggested the way one can study structure of competition in an industry. It has identified the following five competitive forces: • Threat of entry • Threat of substitution • Bargaining powers of buyers • Bargaining powers of suppliers • Rivalry among existing competitors

  12. THE INDUSTRY …… ???(continued…) • The vulnerability of an industry for Government regulations and control • Price and income elasticity of the products of an industry • Imports and exports of industry • At the end, one should determine the expected future profitability and risk associated with an industry by using a number of ratios like • ROI • ROE • EPS • Profit Margins • Degree of leverages • Variations in earnings of the industry • Growth rate of sales volume and profits

  13. THE COMPANY ……??? • Having analysed Economy and Industry, finally one should analyse the company for which one is planning to buy shares. • The purpose of the company analysis is to search the superior performer in an industry. • For that one has to analyse financial and non-financial strengths and weaknesses of a company. • Financial strengths and weaknesses can be determined by doing detailed Financial Statement Analysis.

  14. THE COMPANY ……???(continued…) • Some of the important non-financial parameters to be studied may be • Quality of the management • Product Range • Collaborations • Shareholders pattern and listing • R&D • Diversification • Government Regulations • Disputes and Contingent liabilities • Availability of inputs • Industrial Relations

  15. HOW TO DETERMINE THE VALUE OF SHARE ………?????? • Dividend Capitalisation Models • No growth model • Constant growth model • Variable growth model • Super Normal Growth model or H model • Earnings Multiplier Approach or P/E Approach

  16. T H E H - M O D E L H 2H • It is a simplified three-stage model developed by Fuller and Hsia. • The model allows for an initial high growth rate,ga , a linear transition to a normal growth rate,gn , over a period of 2H years and subsequent long-run growth at the rate,gn . It is shown below: • Under the above stated conditions, the value of a share can be approximated as

  17. Now, something more about P/E Ratio ...

  18. What does P/E Ratio really mean? • Is it good to have higher P/E Ratio? Lower P/E Ratio? • Does it indicate health of the market? • Can it be used as a trading - rule?

  19. RELATION BETWEEN DIVIDEND GROWTH MODEL AND PRICE/EARNING RATIO • Consider the following Dividend Growth Model: P = D/(r – g) • Dividing both sides of the above equation by E (that is EPS), we obtain – P/E = (D/E)/(r – g) • Where • P/E = Price Earning Ratio • D/E = Dividend Payout Ratio • It shows that P/E Ratio is determined by Dividend Payout Ratio, Required Rate of Return and Growth Rate in Dividend.

  20. WHAT IS Price-Earning-Growth RATIO? • PEG Ratio is P/E Ratio divided by Growth Rate in EPS. • This is a ratio that considers- • existing P/E Ratio and • future annulaised growth rate in EPS • It provides a trading rule specially for GROWTH SHARESand that is - • PEG Ratio Action .50 or less Buy .50 to .65 Look to buy .65 to 1.00 Watch (or "hold") 1.00 to 1.30 Look to sell 1.30 to 1.70 Consider shorting Over 1.70 Short

  21. How to decide which shares should be purchased for the investment purposes? • Select shares with • Higher present values of future streams of dividends • Low Price/Earnings Ratio • Low Price/Dividend Ratio • Low Price/Book Value Ratio • Low Price/Sales Ratio • Low Price/Net Current Ratio • Small Capitalisation

  22. Classification of Shares... • Shares are classified for two reasons: • first, to eliminate types that are of no interest to the investors, and • second, to form groups in which the shares are roughly homogeneous with respected to expected performance and the kinds of analysis required. • SLOW-GROWTH SHARES:shares of that company whose earnings are expected to grow no faster than economy. The company earns a low return on equity and consequently can not grow very fast. In it, the dividend yield has to be high. • STALWARTS: shares of that company whose earning are expected to grow at an annual rate of more than 5% but not much more than 10%, assuming a moderate rate of inflation.

  23. Classification of Shares…(continued) • FAST-GROWTH SHARES: the shares of that company whose earnings are expected to grow at a rate of more than 10% for at least several years. • CYCLICAL SHARES: shares of that company whose earnings fluctuate widely with changes in economic conditions. Prices of cyclical shares fluctuate widely along with the earnings. • ASSET PLAYS: a share with a price lower than the estimated realizable value of the assets. • TURNAROUND SHARES: shares of that company that has come on hard times and are expected to recover.

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