FUNDAMENTAL ANALYSIS

INTRODUCTION

Earlier period investment decision was considered as an art. But now it’s a combination
of both science and art.
Simple rule of investment is;
BUY a security that has a highest return per unit of risk or lowest risk per unit of return.
SELL a security which does not satisfy the above requirement.
BUT THE ABOVE RULE IS Very DIFFICULT TO PRACTICE

Investment decision making being continuous in nature should attempted systematically.

For this two approaches have been developed

Fundamental analysis
Technical analysis.

FUNDAMENTAL ANALYSIS; Investors looks at fundamental factors that affects risk

return characteristics of the security and he takes decision to buy or sell the security.

TECHNICAL ANALYSIS; Investors tries to identify the price trend which reflects these
characteristics. It concentrates on demand and supply of securities and relevant trend in
stock price measured by various market indices in stock market.

Fundamental analysis

A method of evaluating a security by attempting to measure its intrinsic value by

examining related economic, financial and other qualitative and quantitative
factors. Fundamental analysts attempt to study everything that can affect the security's
value, including macroeconomic factors (like the overall economy and industry
conditions) and individually specific factors (like the financial condition and management
of companies).
Fundamental analysis is a method used to determine the value of a stock by analyzing the
financial data that is 'fundamental' to the company. That means that fundamental analysis
takes into consideration only those variables that are directly related to the company
itself, such as its earnings, its dividends, and its sales. Fundamental analysis does not look
at the overall state of the market nor does it include behavioral variables in its
methodology. It focuses exclusively on the company's business in order to determine
whether or not the stock should be bought or sold.

Critics of fundamental analysis often charge that the practice is either irrelevant or that it
is inherently flawed. The first group, made up largely of proponents of the efficient
market hypothesis, say that fundamental analysis is a useless practice since a stock's price
will always already take into account the company's financial data . In other words, they
argue that it is impossible to learn anything new about a company by analyzing its
fundamentals that the market as a whole does not already know, since everyone has
access to the same financial information. The other major argument against fundamental
analysis is more practical than theoretical. These critics charge that fundamental analysis
is too unscientific a process, and that it's difficult to get a clear picture of a company's
value when there are so many qualitative factors such as a company's management and its
competitive landscape.

However, such critics are in the minority. Most individual investors and investment
professionals believe that fundamental analysis is useful, either alone or in combination
with other techniques. If you decide that fundamental analysis is the method for you,
you'll find that a company's financial statements (its income statement, its balance sheet
and its cash flow statement) will be indispensable resources for your analysis . And even
if you're not totally sold on the idea of fundamental analysis, it's probably a good idea for
you to familiarize yourself with some of the valuation measures it uses since they are
often talked about in other types of stock valuation techniques as well.

The biggest part of fundamental analysis involves delving into the financial statements.
Also known as quantitative analysis, this involves looking at revenue, expenses, assets,
liabilities and all the other financial aspects of a company. Fundamental analysts look at
this information to gain insight on a company's future performance

Fundamental analysis is about using real data to evaluate a security's value. Although
most analysts use fundamental analysis to value stocks, this method of valuation can be
used for just about any type of security.

DECISION RULE

IV > MP BUY

IV < MP SELL

IV = MP NO ACTION
(Where IV = intrinsic value, MP market price )

Fundamental factor mentioned may relate to economy or industry or company or

all/some of them.

The end goal of performing fundamental analysis is to produce a value that an

investor can compare with the security's current price in hopes of figuring out what sort
of position to take with that security (under priced = buy, overpriced = sell or short).

Fundamental analysis maintains that markets may misprice a security in the short run but
that the "correct" price will eventually be reached. Profits can be made by trading the
mispriced security and then waiting for the market to recognize its "mistake" and reprice
the security. Even if the investor believes he cannot beat the market index, he may still
pick stock for the challenge, for the fun of trying, and for the ego rush when he does beat
the market.

ECONOMY / ECONOMIC ANALYSIS

Economic decisions of individuals are made in the economic setup of particular country.
Here it is essential to understand economy of that country at macro level. As a part of this
there is a need to analyse how economy has done in past, how it is doing now and how it
will do.

Historical performance is a starting point, but analysts decision on investment will be

based on expected future performance of the overall economy.

THE COMMONLY USED MACRO ECONOMIC FACTORS ARE.

1) The Gross Domestic Product (GDP) - The sum of all goods and services produced
either by domestic or foreign companies. GDP indicates the pace at which a country's
economy is growing (or shrinking) and is considered the broadest indicator of
economic output and growth.
2) Amount of total Savings and investment

3) Inflation rate
4) Interest rates prevailing in the economy
5) Budget
6) Tax structure which includes rates of taxation on both direct and indirect taxes.
7) BOP ( measures strength of rupee)
8) Monsoon and agriculture.
9) Infrastructure facilities
10) Demographic factors ( population by age, occupation, literacy location etc helps to
forecast consumer demand)

ECONOMIC FORECASTING

To understand stocks price level changes, an analyst have to forecast many indicators at
different time horizons. They are
Short term ( up to 3 yrs even it may be restricted up to a year)
Intermediate term ( 3-5 yrs may go up to 10 yrs)
Long term ( beyond 10 years)
ECONOMIC INDICATORS

Indicators are those factors which indicate the present status, progress or slowdown of the
economy. These can be grouped into.
1 Leading indicators. These indicate what is going to happen in the economy. They
include
Fiscal policy,
Monitory policy ,
Rain fall,
Productivity,
Capital investment,
Stock indices.

2 Coincidental indicators

These indicates what the economy is. They are

Industrial production,
Interest rates,
Reserve fund,
Manufacturing and trade sales.

3 Lagging indicators

Changes that are happening in leading and coincidental indicators are reflected in
lagging indicators. They are
Unemployment
Consumer price index
Flow of funds.

Difusion index
It is a composite or consensus index. This index consists of leading, coincidental and
lagging indicators. Constructed by national bureau of economic research in USA, this
index indicates overall growth in the economy.
 INDUSTRY ANALYSIS

Each industry has differences in terms of its customer base, market share among firms,
industry-wide growth, competition, regulation and business cycles. Learning about how
the industry works will give an investor a deeper understanding of a company's financial
health. INDUSTRY is a group of firms that have similar technological structure of
production and produce similar product.

CLASSIFICATION OF INDUSTRY.

On the basis of business cycle ie., according to reaction to the different phases of
business cycle.
A) Growth
High rates of earnings and growth in expansion are major symptoms of this segment.
Growth in this industry is independent of business cycle. Expansion in this segment
mainly depends on technical changes. Eg IT, pharma, Telecom, colour television in
past. Etc.
B ) Cyclical industry
Here growth and profitability moves along with business cycle.
Eg Washing machine, refg, two wheeler.
C ) Defensive industry.
This segment defies movement of business cycle. This industry type can withstand
depression. This type of industry will grow at a constant and steady phase. Eg; food,
housing etc
D ) Cyclical growth industry.
This industry segment has got the characteristics of both Cyclical and growth
industry.

Another useful criteria to classify industries is the various stages of development.

Based on the stages in life cycle, industries may be classified as follows.

1) Pioneering stage.

Demand for product is promising. This demand attracts many players into the
industry but only few survives because of severe competition prevailing in the economy.
Here it is very difficult to select any company for investment because survival of
particular is unknown.

2) Rapid growth stage.

This stage starts with survivors from last stage. The survivors will grow strong in
market share and financial performance. Companies will have stable growth in this stage.
In this stage growth rate is more than average growth rate of the industry. It is advisable
to invest at this level.
 3) Maturity and stabilization stage.

Growth rate tend to be moderate which is equal to average industry growth.

Symptoms of obsolescence may appear in technology, therefore Companies should go
for innovation for their survival. Investors have to be cautious in their investment activity.

4) Declining stage.

Demand for products and earnings of the companies declines. Even in boom period
growth is less and during recession declines at a higher rate. Investors should avoid
investing when industry is passing through this stage.

Apart from industry life cycle investors has to analyse some other factors.

Growth of industry (historical)

Cost structure and profitability.
Nature of product ( dependability on other industry)
Nature of competition
Government policy
Labour aspects
R&D
 COMPANY LEVEL ANALYSIS

Simple rule of buying at low price and selling at high price is difficult to apply.
Problem is how to find whether price is overvalued or undervalued.
Which benchmark to use to compare the price of shares.
Fundamental analysis provides “Intrinsic Value “

“Intrinsic Value “ deponds upon economy, industry and company.

out of above three company analysis is important because it will have direct link with
investment. Fundamental analysis seeks to determine the intrinsic value of a company's
stock. But since qualitative factors, by definition, represent aspects of a company's
business that are difficult or impossible to quantify, incorporating that kind of information
into a pricing evaluation can be quite difficult. On the flip side, as we've demonstrated,
you can't ignore the less tangible characteristics of a company.

PRESENT AND FUTURE VALUES OF SHARES ARE AFFECTED BY A NUMBER

OF FACTORS

1) Competitive advantage of the company

A company's long-term success is driven largely by its ability to maintain a

competitive advantage - and keep it. Powerful competitive advantages, such as Coca
Cola's brand name and Microsoft's domination of the personal computer operating
system, create a moat around a business allowing it to keep competitors at bay and
enjoy growth and profits. When a company can achieve competitive advantage, its
shareholders can be well rewarded for decades.

Harvard Business School professor Michael Porter, distinguishes between strategic

positioning and operational effectiveness. Operational effectiveness means a company is
better than rivals at similar activities while competitive advantage means a company is
performing better than rivals by doing different activities or performing similar activities
in different ways. Investors should know that few companies are able to compete
successfully for long if they are doing the same things as their competitors.

Professor Porter argues that, in general, sustainable competitive advantage gained by:

• A unique competitive position

• Clear tradeoffs and choices vis-à-vis competitors
• Activities tailored to the company's strategy
 • A high degree of fit across activities (it is the activity system, not the parts, that
ensure sustainability)
• A high degree of operational effectiveness

Competitive advantage can be studied with the help of the following.

a) Market share
b) Growth of sales
c) Stability of sales

Sales forecast: has to be done with the help of historical sales and other macro economic
data.

2) Earnings of the company

Earnings, here refers to excess of sales over cost. Cost also influences earnings.
Investors should be aware that income of the company vary due to the following
reasons.
Change in sales,
Change in cost,
Depreciation method,
Taxes,
Inventory valuation,
Wages, salary and benifits

3) Capital structure.

Equity holders returns can be raised with the help of financial leverages. Use of
excess of debt will magnify share holders earnings but on the other hand it will leads to
financial crisis.

4) Management.

Just as an army needs a general to lead it to victory, a company relies upon management
to steer it towards financial success. Some believe that management is the most important
aspect for investing in a company. It makes sense - even the best business model is
doomed if the leaders of the company fail to properly execute the plan.

5) Operational efficiency
How best the company is making use of its scarce resources is another factor that is
considered as a part of company analysis.

5) Financial performance.
 Financial performance is the most important aspect considered as a part of company
analysis. Best source of primary financial information is.
Balance Sheet
P&L account
Analysis of financial statement can be done by the following methods.
Comparative financial statement.
Trend analysis.
Common size statement ( % of each item)
FF / CF statement
Ratio aalysis

TECHNICAL ANALYSIS

Technical analysis is a method of forecasting price movements by looking at purely

market-generated data. Price data from a particular market is most commonly the type
of information analyzed by a technician, though most will also keep a close watch on
volume and open interest in futures contracts. The bottom line when utilizing any type
of analytical method, technical or otherwise, is to stick to the basics, which are
methodologies with a proven track record over a long period. After finding a trading
system that works for you, the more esoteric fields of study can then be incorporated
into your trading toolbox.
Almost every trader uses some form of technical analysis. Even the most reverent
follower of market fundamentals is likely to glance at price charts before executing a
trade. At their most basic level, these charts help traders determine ideal entry and exit
points for a trade. They provide a visual representation of the historical price action of
whatever is being studied. As such, traders can look at a chart and know if they are
buying at a fair price (based on the price history of a particular market), selling at a
cyclical top or perhaps throwing their capital into a choppy, sideways market. These are
just a few market conditions that charts identify for a trader. Depending on their level of
sophistication, charts can also help much more advanced studies of the markets.
On the surface, it might appear that technicians ignore the fundamentals of the market
while surrounding themselves with charts and data tables. However, a technical trader
will tell you that all of the fundamentals are already represented in the price. They are
not so much concerned that a natural disaster or an awful inflation number caused a
recent spike in prices as much as how that price action fits into a pattern or trend. And
much more to the point, how that pattern can be used to predict future prices.

It mainly studies the stock price movement of the security market. If there is a upward
trend in the price movement investor may purchase, and with the onset of fall he may sell
it.
With the help of several indicators, they analyse the relationship between price – volume
and supply-demand for the overall market and individual stock.
TECHNICAL ANALYSIS INVOLVES A STUDY OF MARKET GENERATED DATA
LIKE PRICE AND VOLUMES TO DETERMINE THE FUTURE DIRECTION OF
PRICE MOVEMENT.

Technical analysis (studying the price and trading history) stands in contrast to
fundamental analysis (studying the actual nature of the stock or commodity in question),
although some investors combine the two types of analysis in making investment
decisions.

Technical analysis is primarily (but not exclusively) conducted by studying charts of past
price and trading action. Many different methods and tools are used in technical analysis,
but they all rely on the assumption that price patterns and trends exist in markets, and that
they can be identified and exploited

Technical analysis is not, of course, 100% accurate, but attempts to give results that are,
simply, correct more often than they are wrong.
Indeed, the central strategy of many active traders is to trade often, terminating trades that
prove to be incorrect decisions and "letting run" trades that prove to be correct decisions.

DIFFERENCE BETWEEN TECHNICAL ANALYSIS AND FUNDAMENTAL

ANALYSIS

1 Tech – predict short term price movement

Fund – long term values
2 Tech –based on internal market data (price and volume)
Fund – based on fundamental factors
3 Tech – appeals mostly to short term traders
Fund – appeals long term investors

On the surface, it might appear that technicians ignore the fundamentals of the market
while surrounding themselves with charts and data tables. However, a technical trader
will tell you that all of the fundamentals are already represented in the price. They are not
so much concerned that a natural disaster or an awful inflation number caused a recent
spike in prices as much as how that price action fits into a pattern or trend. And much
more to the point, how that pattern can be used to predict future prices.

ASSUMPTIONS OF TECHNICAL ANALYSIS

1) The market value of scrip is determined by the interaction of supply and demand.
2) All market fundamentals are depicted in the actual market data. So the actual
market fundamentals and various factors, such as the differing opinions, hopes, fears, and
moods of market participants, need not be studied.
3) History repeats itself and therefore markets move in fairly predictable, or at least
quantifiable, patterns. These patterns, generated by price movement, are called signals.
The goal in technical analysis is to uncover the signals given off in a current market by
examining past market signals.

4) Prices move in trends. Technicians typically do not believe that price fluctuations are
random and unpredictable. Prices can move in one of three directions, up, down or
sideways. Once a trend in any of these directions is established, it usually will continue
for some period.

History of Technical analysis

Dow Theory, a theory based on the collected writings of Dow Jones co-founder and
editor Charles Dow, inspired the use and development of technical analysis from the end
of the 19th century. Modern technical analysis considers Dow Theory its cornerstone.[5]
Technical tools and theories have been developed and enhanced in recent decades, with
an increasing emphasis on computer-assisted techniques.

Technical Indicators
Following are some of the technical indicators analysed as a part of technical
analysis.

Trend indicators
Strength indicators
Volatility indicators
Cycle indicators
Support/resistance indicators
Momentum indicators

Trend indicators
Trend is a term used to describe the persistence of price movement in one direction over
time. Trends move in three directions: up, down and sideways. Trend indicators smooth
variable price data to create a composite of market direction. (Example: Moving
Averages, Trend lines)

Strength indicators
Market strength describes the intensity of market opinion with reference to a price by
examining the market positions taken by various market participants. Volume or open
interest are the basic ingredients of this indicator. Their signals are coincident or leading
the market.

Volatility indicators
Volatility is a general term used to describe the magnitude, or size, of day-to-day price
fluctuations independent of their direction. Generally, changes in volatility tend to lead
changes in prices.

Cycle indicators
A cycle is a term to indicate repeating patterns of market movement, specific to recurrent
events, such as seasons, elections, etc. Many markets have a tendency to move in cyclical
patterns. Cycle indicators determine the timing of a particular market patterns. (Example:
Elliott Wave)

Support/resistance indicators
Support and resistance describes the price levels where markets repeatedly rise or fall and
then reverse. This phenomenon is attributed to basic supply and demand.

Momentum indicators
Momentum is a general term used to describe the speed at which prices move over a
given time period. Momentum indicators determine the strength or weakness of a trend as
it progresses over time. Momentum is highest at the beginning of a trend and lowest at
trend turning points. Any divergence of directions in price and momentum is a warning of
weakness; if price extremes occur with weak momentum, it signals an end of movement
in that direction. If momentum is trending strongly and prices are flat, it signals a
potential change in price direction.

CHARTING TECHNIQUES
Charting techniques are are integral part of technical analysis.There are a variety of
charts that show price action. The most common are bar charts, line chart and dow
theory. Each bar will represent one period of time and that period can be anything from
one minute to one month to several years. These charts will show distinct price patterns
that develop over time.
Basic concept underlying chart analysis

Persistence of trend
Relationship between volume and trend
Resistance and support level

CHARTING TECHNIQUES

Technical analysis uses variety of charting techniques. Most important among them are

Dow theory
Bar and line chart
Point and figure chart
Moving average line
Relative strength line

1) Dow theory.
Dow theory refers to three movements
 Daily fluctuations
Secondary movements or corrections
Primary trend representing bull or bear phase.

2) Bar and line chart

this is commonly used charting tool. It depicts daily price range along with closing
price and volumes.

3) Point and figure chart

Only significant price changes are recorded. Price and time scale is incorporated.

4)Moving average chart

Moving avg is calculated by taking into account most recent n observations

6) Relative strength index.

It is based on the assumption that prices of some securities rise rapidly during bull phase
but fall slowly during bear phase in relation to market as a whole.these securities posses
greater relative strength and hence outperform the market.
Efficient market hypothesis

EFFICIENT MARKET HYPOTHESIS

The efficient market hypothesis (EMH) concludes that technical analysis cannot be
effective. If all relevant information is reflected quickly in a security's price through the
actions of traders who have that information, no method, including technical analysis, can
"beat the market". News events and new fundamental developments which influence
prices occur randomly and are unknowable in advance. EMH advocates have produced
many studies that reject the efficacy of technical analysis.

EMH advocates reply that although individual market participants do not always act
rationally (or have complete information), their aggregate decisions complement each
other, resulting in a rational outcome, (i.e. irrational optimists, wishing to buy stock and
bid the price higher, are counter-balanced by irrational pessimists trying to sell their
stock, until the price reaches equilibrium). Likewise, complete information is reflected in
the price because all market participants bring their own individual, but incomplete,
knowledge together in the market.