Investment

Investment is the employment of funds with the aim of achieving additional income or growth in value. There is a commitment of present funds. There is an expectation of some return or benefits from such commitment in future, and There is always some risk involved in respect of return and the principal amount invested.

Investment & Speculation

Investment In safe securities For long term holding For capital appreciation Analysis of fundamentals Speculation In risky issues For a quick return For profit Rumors, tips etc

fundamental analysis
Fundamental analysis involves a detailed study of a companys financial position, often in the form of financial ratios and is used to provide general support for a long term, which would help in taking an investment decision. there are two basic approaches one can use: bottom up analysis top down analysis

Top down approach

ECONOMY

INDUSTRY

COMPANY

Various types of stocks

Blue chip stocks Value stocks Growth stocks Income stocks Penny stocks Other stocks

Benjamin Graham (May 8,1894- September 21,1976) is popularly known as the father of financial analysis . He revolutionized the investment theory by introducing the concept of security analysis, fundamental analysis and value investing theories. He has converted speculating into investing by devising sound principles for analyzing a companys fundamentals and its future prospects

Fundamental analysis is based on the premise that any security (and the market as a whole) has an intrinsic value, or the true value as estimated by an investor. By assessing these fundamental determinants of the value of a security, an estimate of its intrinsic value can be determined. This estimated intrinsic value can then be compared to the current market price of the security

stock intrinsic value- stock market value = margin of safety.

MARGIN OF SAFETY

Intrinsic value
Value investors typically calculate intrinsic value by focusing on earnings, cash flow and other indicators of the companys wealth creation potential. (Graham).

V = Intrinsic Value EPS = Trailing Twelve Months Earnings Per Share 8.5 = P/E base for a no-growth company g = reasonably expected 7 to 10 year growth rate The term intrinsic value means the discounted value of the cash that can be taken out of a business during its remaining life. In other words, a companys intrinsic value is equal to the value today of all the money it will deliver in the future. (Buffet, 1996).

Important variables
Dividend Yield Price-Earnings Ratio - P/E Ratio Debt equity ratio Book value Net current assets Current ratio

RULES BY BENJAMIN GRAHAM

1. PE of the stock has to be less than the inverse of the yield on the AAA corporate bonds 2. PE of the stock has to be less than 40 percent of the average PE over the past five years 3. Dividend Yield > Two-thirds of the AAA Corporate Bond Yield 4. Price < Two-thirds of Book Value 5. Price < Two-thirds of Net Current Asset Value 6. Debt-Equity Ratio has to be less than one 7. Current Assets > Twice Current Liabilities 8. Debt < Twice Net Current Assets 9. Historical Growth in EPS (over last 10 years) > 7% 10. No more than two years of declining earnings over the previous 10 years

price-to-earnings (P/E) ratios, debt-to-equity ratios, dividend records, net current assets, book values, and earnings growth.

Case study
Rolta india (as on 1-04-2009)
Borrowings Current liabilities Current assets Debt equity ratio Closing prices Price earnings ratio Book value 693 cr 200 cr 778 cr 0.53 61.25 2.59 97 cr

Rolta India

Market return

Case study
Allahabad bank (as on 1-04-2009)
Borrowings Current liabilities Current assets Debt equity ratio Closing prices Price earnings ratio Book value 3848 cr 2962 cr 8085 cr 0.77 39.5 2.3 111 cr

Allahabad Bank

MAGIC FORMULA BY JOEL GREENBLATT

The magic formula ranks companies based on two factors: Return on capital EBIT/(Net Working Capital + Net Fixed Assets) Earnings yield Earnings yield was measured by calculating the ratio of pre-tax operating earnings (EBIT) to enterprise value (market value of equity + net interest-bearing debt).

YEAR 1988 1989

Magic Formula 27.1% 44.6

Market Average 24.8% 18

1990
1991

1.7
70.6

-16.1
45.6

1992
1993

32.4
17.2

11.4
15.9

1994
1995 1996 1997 1998 1999 2001 2002 2003 2004

22
34 17.3 40.4 25.5 53 69.6 -4 79.9 19.3 22.9%

-4.5
29.1 14.9 16.8 -2 36.1 11.5 -24.2 68.8 17.8 11.7%

Growth investing
Growth stocks have been defined as having relatively high prices in relation to fundamental factors like earnings per share, cash flow per share, book value per share and dividends per share..growth investors are more apt to subscribe to the efficient market hypothesis which maintains that the current market price of the stock reflects all the currently knowable information about a company and, so, is the most reasonable price for that stock at that given point in time.

Industry analysis
It is a type of business research that focuses on the status of the industry or an industrial sector which involves a review of an industrys recent performance, its current status and outlook for the future, its relative strength and weakness within an economic environment. determining which industries are likely to fare best in the anticipated economic environment.

Industry life cycle

Tools for industry analysis

Cross sectional industry performance Industry performance over time Differences in industry risk Prediction about market behavior Competition over industry lifecycle

Porters model

ECONOMIC ANALYSIS
Aims at determining if the economic environment is conducive and is capable of encouraging the growth of business sector, especially the capital market. When the economy expands, most industry groups and companies are expected to benefit and grow. When the economy declines, most sectors and companies usually face survival problems.

TOOLS FOR ECONOMIC ANALYSIS

Gross domestic product Monetary policy and liquidity Inflation Interest rates International influences Fiscal policy

Gross domestic product

It is the total amount of the goods and services produced in a country in a year. It is calculated by adding the market value of all the final goods and services produced in a year.

 Monetary policy and liquidity: tight monetary policy of the central banks leads to availability of lesser excess funds with banks to lend, the sources of capital become scarce with business houses and the economic activity may slow down or decline Inflation: it can be defined as trend of rising prices caused by demand exceeding supply. if prices rise steadily, after a number of years, the consumers will be able to buy only fewer goods and services assuming income level does not change with inflation. It also results in extra costs to businesses (they are generally unable to pass all the cost increases through to the consumer), thereby squeezing their profit margins and leading to real declines in profitability.

 Interest rates: it is the price of credit. It is the percentage fee received or paid by individuals or organizations when they lend or borrow money. the increase in interest rates lead to reduced borrowing and an economic slowdown, which leads to fall in share prices. Fiscal policy: policy of the government which involves the collection and spending of revenue. International influences: it includes: exchange rate balance of payments trade barriers quotas currency restrictions

Behaviour of economic indicators and their suggestive impact on the share market
s.n o. 1. 2. 3. Economic indicator Gross domestic product Inflation Unemployment situation Growth decline Constant prices inflationary/ deflationary Increase decline Impact on share market Positive Negative Positive negative Negative Positive

4.
5. 6.

Individual savings
Interest rate Exchange rate

Increase decline
High Low Favorable(strong against foreign currency) unfavorable High Low Positive negative

Positive Negative
Negative Positive Positive negative Negative Positive Positive Negative

7. 8.

Domestic corporate tax rate Balance of trade