location or an electronic trading platform. Though people are typically familiar with the image of the trading floor, many exchanges now use electronic trading. The Need to Invest Learn about the importance of savings. Identify avenues to invest the savings in a suitable investment vehicle. Compare historical returns generated by different assets and know what to expect from you. Regulators Find out who and how the regulators govern the financial markets and understand different types of financial market participants. Understand the need to regulate the markets. Financial Intermediaries An overview of the financial intermediaries in the Indian stock market and the services they offer. i. The IPO Markets – Part 1 Understand the origins of business and the funding environment of business. Learn about the different funding stages and learn how funding works. ii. The IPO Markets – Part 2 Learn the basics of the IPO market and the process of how to go about investing in IPO’s. This chapter also helps us understand the different IPO Jargons that are commonly used. The Stock Markets We explore the basics of stock trading and understand what makes the stock move on a minute-by-minute basis. We also explore the concept of return calculation. The Stock Markets Index An overview of the Indian Stock Market Indices, their construction, and practical uses in trading. Commonly Used Jargons Glossary of common stock market terms & associated concepts used in trading. We also explain in detail how to short a stock. The Trading Terminal An introduction to The Trading Terminal, its interface, various functionalities, and relevant concepts. Clearing and Settlement Process 51 CU IDOL SELF LEARNING MATERIAL (SLM)
The behind-the-scenes operations are involved in share buying & selling. Five Corporate Actions and Its Impact on Stock Prices Various corporate actions and the effect they have on the share prices and trading activity. Keys things you need to know before subscribing for corporate action. Key Events and Their Impact on Markets An introduction to the various macros economic factors that impact the performance of shares and stock markets. 5.2 TRADING SYSTEM Traders and investors can turn precise entry, exit, and money management rules into automated trading systems that allow computers to execute and monitor the trades. One of the biggest attractions of strategy automation is that it can take some of the emotion out of trading since trades are automatically placed once certain criteria are met. The trade entry and exit rules can be based on simple conditions such as a moving average crossover or they can be complicated strategies that require a comprehensive understanding of the programming language specific to the user's trading platform. They can also be based on the expertise of a qualified programmer. Automated trading systems typically require the use of software linked to a direct access broker, and any specific rules must be written in that platform's proprietary language. The TradeStation platform, for example, uses the easy language programming language. On the other hand, the NinjaTrader platform utilizes NinjaScript. The figure below shows an example of an automated strategy that triggered three trades during a trading session. 5.3 MARKET TIMING Share market timing is as follows: 9:15 am-3:30 pm on weekdays are the timings during which the BSE and NSE function. Muhurat Trading: normally the stock exchange is closed for the festival of Diwali, but it functions for one hour between 5:30 pm-6:40 pm as it is considered auspicious. 5.4 CIRCUIT BREAKER Circuit breakers are temporary measures that halt trading; they are intended to curb panic- selling on U.S. stock exchanges. Currently, U.S. regulations have three levels of a circuit breaker, set to halt trading when the S&P 500 Index drops 7%, 13%, and 20%. Circuit-breaker points represent the thresholds at which trading is halted market-wide for single-day declines in the S&P 500 Index. Circuit breakers halt trading on the nation's stock 52 CU IDOL SELF LEARNING MATERIAL (SLM)
markets during dramatic drops and are set at 7%, 13%, and 20% of the closing price for the previous day. 5.5 TRADEORDER A market order simply buys (or sells) shares at the prevailing market prices until the order is filled. A limit order specifies a certain price at which the order must be filled, although there is no guarantee that some or all the orders will trade if the limit is set too high or low. Making Sense of Day Trading Order Types Market Order. Westend61 / Getty Images. Buy Limit Order. A Buy Limit is an order to buy that is placed below the current price. Sell Limit Order. Buy Stop Order. Sell Stop Order. Buy Stop Limit. Sell Stop Limit. 5.5.1 Time The Securities and Exchange Commission (SEC) requires trades to be settled within a three- business daytime period, also known as T+3. When you buy stocks, the brokerage firm must receive your payment no later than three business days after the trade is executed. 5.5.2 Price The current price is the most recent selling price of a stock, currency, commodity, or precious metal that is traded on an exchange and is the most reliable indicator of that security's present value. If you do not have any broker of your own, you can visit the stock exchange office and they will give you a list of brokers and you may select one. An investor must pace the order with the broker by telephone, telegram, or personal visit. For example, Buy or Sell 100 Tesco shares at Rs. 252 or more. 5.5.3 Quantityconditions Quantity means the number of shares per order you selected. For example, you are going to buy SBIN at 420 prices, here you are required to decide what quantity you are going to be purchased. If you are placing an order to buy 20 shares of SBIN so here 20 shares would be the Quantity. 53 CU IDOL SELF LEARNING MATERIAL (SLM)
There are three main types of share market trends: short-term, intermediate-term, and long- term. 5.6 ORDERMATCHINGRULES For order matching rules, the best buy order is the one with the highest price, and the best sell order is the one with the lowest price. This is because the computer views all buy orders available from the point of view of a seller and all sell orders from the point of view of the buyers in the market. Matching orders is the process by which a securities exchange pairs one or more unsolicited buy orders to one or more sell orders to make trades. If one investor wants to buy a quantity of stock and another wants to sell the same quantity at the same price, their orders match, and a transaction is affected. 5.7 SUMMARY The concept behind how the stock market works is simple. The stock market lets buyers and sellers negotiate prices and make trades. The stock market works through a network of exchanges — you may have heard of the New York Stock Exchange or the Nasdaq. The stock market works through a network of exchanges — you may have heard of the New York Stock Exchange or the Nasdaq. Companies list shares of their stock on an exchange through a process called an initial public offering or IPO. Investors purchase those shares, which allows the company to raise money to grow its business. Investors can then buy and sell these stocks among themselves, and the exchange tracks the supply and demand of each listed stock. That supply and demand help determine the price for each security or the levels at which stock market participants — investors and traders — are willing to buy or sell. Buyers offer a “bid,” or the highest amount they’re willing to pay, which is usually lower than the amount sellers “ask” for in exchange. This difference is called the bid- ask spread. For a trade to occur, a buyer needs to increase his price, or a seller needs to decrease hers. This all may sound complicated, but computer algorithms generally do most the price- setting calculations. When buying stock, you’ll see the bid, ask, and bid-ask spread on your broker's website, but in many cases, the difference will be pennies, and won’t be of much concern for beginner and long-term investors. Investing in the stock market does come with risks, but with the right investment strategies, it can be done safely with minimal risk of long-term losses. Day trading, 54 CU IDOL SELF LEARNING MATERIAL (SLM)
which requires rapidly buying and selling stocks based on price swings, is extremely risky. Conversely, investing in the stock market for the long-term has proven to be an excellent way to build wealth over time. For example, the S&P 500 has a historical average annualized total return of about 10% before adjusting for inflation. However, rarely will the market provide that return on a year-to-year basis. Some years the stock market could end down significantly, others up tremendously. These large swings are due to market volatility, or periods when stock prices rise and fall unexpectedly. 5.8 KEYWORDS Stock Exchange: It is a place where shares of public listed companies are traded. ... A stock exchange facilitates stockbrokers to trade company stocks and other securities. A stock may be bought or sold only if it is listed on an exchange. Thus, it is the meeting place of the stock buyers and sellers. The stock market works in a nutshell: In a nutshell, a stock market is a marketplace for businesspeople. Goods are sold to the public in a public market. In the primary market, companies sell shares to investors to raise financing for their operating expenses. In the secondary market, investors buy and sell shares in companies to other investors. Stock market volatility: Volatility is the standard deviation of a stock's annualized returns over a given period and shows the range in which its price may increase or decrease. If the price of a stock fluctuates rapidly in a short period, hitting new highs and lows, it is said to have high volatility. Index funds and ETFs: The biggest takeaway is that both ETFs and index funds are great for long-term investing, but with ETFs, investors have the option to buy and sell throughout the day. And although they trade like stocks, ETFs are usually a less risky option in the long term than buying and selling stocks of individual companies. MKT and LMT: A market order generally will execute at or near the current bid (for a sell order) or ask (for a buy order) price. However, it is important for investors to remember that the last-traded price is not necessarily the price at which a market order will be executed. LMT, Place the order \"at the market\": Market orders are transactions meant to execute as quickly as possible at the current market price. ... Place the order \"at the limit\": Limit orders set the maximum or minimum price at which you are willing to buy or sell. 5.9 LEARNING ACTIVITY 55 CU IDOL SELF LEARNING MATERIAL (SLM)
1. Winning, losing, and breaking even may sound like gaming terms, but they also accurately describe the stock market. These simple and engaging games and activities will delight students as they present important information about the stock market. Why not approach the stock market curriculum with a fun gaming attitude? ___________________________________________________________________________ ___________________________________________________________________________ 2. When earnings per share increases, the market will perceive this positively and share prices will increase after buybacks are announced. This often comes down to simple supply and demand. When there is a less available supply of shares, then an upward demand will boost share prices. What made shares appealing for purchase? ___________________________________________________________________________ ___________________________________________________________________________ 5.10 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. How are orders matched in stock market? 2. How do exchanges match limit orders? 3. Can I sell delivery shares on same day? 4. What is the quantity when buying stocks? 5. What are the criteria for stock exchange? Long Questions 1. What are the types of stock market conditions? 2. What does ODTE mean in trading? 3. How long does it take to execute a stock trade? 4. How the stock market works in a nutshell? 5. What time does premarket open on the stock exchange? B. Multiple choice Questions 1. Identify the suitable option for the following: The first ULIP was launched in India in __________by the largest mutual fundUnit Trust of India: a. 1971 b. 1988 56 CU IDOL SELF LEARNING MATERIAL (SLM)
c. 1951 d. 2005 2. What means the number of stocks traded on a stock exchange on the day/s and within the period. a. Turnover b. Turnout c. Turndown d. Turnaround 3. Which of the following are types of auctions? a. Absolute Auction b. Multi-Parcel Auction c. Reserve Auction d. All of these 4. What does it known for buying or selling of futures contracts on a recognized exchange? a. Future market b. Futures trading c. Future contract d. Future selling 5. Which of the following cannot be predicted and foreseen? a. Rate of interest b. Liquidity crisis c. Opening bell d. Dividend Answers 57 1-a, 2-a, 3-d, 4-a, 5-b. 5.11 REFERENCES References CU IDOL SELF LEARNING MATERIAL (SLM)
Buffett, Warren E. Cunningham, Lawrence, A. (November 1, 2015). The Essays of Warren Buffett: Lessons for Corporate America. The Cunningham Group & Carolina Academic Press; 4th edition. Graham, Benjamin. Dodd, David. (September 25, 2008). Security Analysis. McGraw-Hill Education; 6th edition. Fisher, Philip, A. (August 29, 2003). Common Stocks and Uncommon Profits and Other Writings. Wiley; 2nd edition. Textbooks Hagstrom, Robert, G. (September 30, 2013). The Warren Buffett Way. Wiley; 3rd edition. Kratter, Matthew, R.(21 May 2019). A Beginner's Guide to the Stock Market: Everything You Need to Start Making Money Today. Independently Published. Douglas, Mark. (April 1, 2000). Trading in the Zone: Master the Market with Confidence, Discipline, and a Winning Attitude. Prentice Hall Press: Later Printing Used edition. Websites https://www.nerdwallet.com/article/investing/what-is-the-stock-market https://www.investopedia.com/articles/trading/11/automated-trading-systems.asp https://study.com/academy/popular/stock-market-lesson-plan.html 58 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 6 RISK AND RETURN STRUCTURE 6.0 Learning Objectives 6.1 Introduction 6.2 Return 6.2.1 NominalReturn 6.2.2 RealReturn 6.2.3 CumulativeWealthIndex 6.3 Risk 6.3.1 Standard Deviation 6.3.2 Beta 6.4 Summary 6.5 Keywords 6.6 Learning Activity 6.7 Unit End Questions 6.8 References 6.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Analyse calculation of risk on stock investment. Identify economic risk. The economy is constantly changing as the markets fluctuate. Describe compliance risk. Define Financial Risk. 6.1 INTRODUCTION All have higher risks and potentially higher returns than savings products. But there are no guarantees of profits when you buy stock, which makes stock one of the riskiest investments. If a company doesn't do well or falls out of favour with investors, its stock can fall in price, and investors could lose money. 59 CU IDOL SELF LEARNING MATERIAL (SLM)
Students should understand that every saving and investment product has different risks and returns. Differences include how readily investors can get their money when they need it, how fast their money will grow, and how safe their money will be. Savings Products Savings accounts, insured money market accounts, and CDs are viewed as very safe because they are federally insured. You can easily get money in savings if you need it for any reason. But there's a trade-off for security and ready availability. The interest rate on savings generally is lower compared with investments. Investment Products Stocks, bonds, and mutual funds are the most common investment products. All have higher risks and potentially higher returns than savings products. Over many decades, the investment that has provided the highest average rate of return has been stocking. But there are no guarantees of profits when you buy stock, which makes stock one of the riskiest investments. If a company doesn't do well or falls out of favor with investors, its stock can fall in price, and investors could lose money. Always remember the greater the potential return, the greater the risk. One protection against risk is time, and that's what young people have. On any day the stock market can go up or down. Sometimes it goes down for months or years. But over the years, investors who've adopted a \"buy and hold\" approach to investing tend to come out ahead of those who try to time the market. 6.2 RETURN A return, also known as a financial return, in its simplest terms, is the money made or lost on an investment over some period. A return can be expressed nominally as the change in dollar value of an investment over time. A return can also be expressed as a percentage derived from the ratio of profit to investment. Returns can also be presented as net results A positive return represents a profit while a negative return marks a loss. Returns are often annualized for comparison purposes, while a holding period return calculates the gain or loss during the entire period an investment was held. The real return accounts for the effects of inflation and other external factors, while the nominal return is only interested in price change. The total return for stocks includes price change as well as dividend and interest payments. Several return ratios exist for use in fundamental analysis. 6.2.1 NominalReturn 60 CU IDOL SELF LEARNING MATERIAL (SLM)
The nominal rate of return is the amount of money generated by an investment before factoring in expenses such as taxes, investment fees, and inflation. If an investment generated a 10% return, the nominal rate would equal 10%. After factoring in inflation during the investment period, the actual (\"real\") return would likely be lower. However, the nominal rate of return has its merits since it allows investors to compare the performance of an investment irrespective of the different tax rates that might be applied for each investment. 6.2.2 RealReturn Real return is what is earned on an investment after accounting for taxes and inflation. Real returns are lower than nominal returns, which do not subtract taxes and inflation. The average stock market return is about 10% per year for nearly the last century. The S&P 500 is often considered the benchmark measure for annual stock market returns. Though 10% is the average stock market return, returns in any year are far from average. 6.2.3 CumulativeWealthIndex The cumulative wealth index (CWI) is simply the return, expressed as a decimal multiple of the initial amount, earned by a certain initial amount of money over a period of years. The Capitalization-Weighted Index (cap-weighted index, CWI) is a type of stock market index in which each component of the index is weighted relative to its total market capitalization. Market Cap is equal to the current share price multiplied by the number of shares outstanding. 6.3 RISK Market risk is the risk of losing investments due to factors, such as political risk and macroeconomic risk, that affect the performance of the overall market. ... Other common types of systematic risk can include interest rate risk, inflation risk, currency risk, liquidity risk, country risk, and socio-political risk. 6.3.1 Standard Deviation Standard deviation is a statistical measurement in finance that, when applied to the annual rate of return of an investment, sheds light on that investment's historical volatility. For example, a volatile stock has a high standard deviation, while the deviation of a stable blue-chip stock is usually rather low. When stocks are following a normal distribution pattern, their individual values will place either one standard deviation below or above the mean at least 68% of the time. A stock's value will fall within two standard deviations, above or below, at least 95% of the time. 6.3.2 Beta 61 CU IDOL SELF LEARNING MATERIAL (SLM)
Beta is a measure of a stock's volatility in relation to the overall market. If a stock moves less than the market, the stock's beta is less than 1.0. High-beta stocks are supposed to be riskier but provide higher return potential; low-beta stocks pose less risk but also lower returns. Beta indicates how volatile a stock's price has been in comparison to the market. 6.4 SUMMARY In investing, risk and return are highly correlated. Increased potential returns on investment usually go together with increased risk. Different types of risks include project-specific risk, industry-specific risk, competitive risk, international risk, and market risk. Return refers to either gains and losses made from trading security. The return on investment is expressed as a percentage and considered a random variable that takes any value within a given range. Several factors influence the type of returns that investor can expect from trading in the markets. Diversification allows investors to reduce the overall risk associated with their portfolio but may limit potential returns. Making investments in only one market sector may, if that sector significantly outperforms the overall market, generate superior returns, but should the sector decline then you may experience lower returns than could have been achieved with a broadly diversified portfolio. Stocks, bonds, and mutual funds are the most common investment products. All have higher risks and potentially higher returns than savings products. Over many decades, the investment that has provided the highest average rate of return has been stocks. But there are no guarantees of profits when you buy stock, which makes stock one of the riskiest investments. If a company doesn't do well or falls out of favour with investors, its stock can fall in price, and investors could lose money. You can make money in two ways from owning stock. First, the price of the stock may rise if the company does well; the increase is called a capital gain or appreciation. Second, companies sometimes pay out a part of profits to stockholders, with a payment that's called a dividend. Bonds generally provide higher returns with higher risk than savings and lower returns than stocks. But the bond issuer’s promise to repay principal generally makes bonds less risky than stocks. Unlike stockholders, bondholders know how much money they expect to receive unless the bond issuer declares bankruptcy or goes out of business. In that event, bondholders may lose money. But if there is any money left, corporate bondholders will get it before stockholders. The risk of investing in mutual funds is determined by the underlying risks of the stocks, bonds, and other investments held by the fund. No mutual fund can guarantee its returns, and no mutual fund is risk-free. 62 CU IDOL SELF LEARNING MATERIAL (SLM)
Always remember the greater the potential return, the greater the risk. One protection against risk is time, and that's what young people have. On any day the stock market can go up or down. Sometimes it goes down for months or years. But over the years, investors who've adopted a \"buy and hold\" approach to investing tend to come out ahead of those who try to time the market. 6.5 KEYWORDS Risk Management: In financial terminology risk management is the process of identifying and assessing the risk and then developing strategies to manage and minimize the same while maximizing the returns. Risk is therefore central to stock markets or investing because without risk there can be no gains. Return on Investment: The average stock market return is about 10% per year for nearly the last century. The S&P 500 is often considered the benchmark measure for annual stock market returns. Though 10% is the average stock market return, returns in any year are far from average. Risk Profile: A risk profile is an evaluation of an individual's willingness and ability to take risks. A risk profile is important for determining a proper investment asset allocation for a portfolio. Organizations use a risk profile to mitigate potential risks and threats. Risk Calculator: The market risk is calculated by multiplying beta by the standard deviation of the Sensex which equals 4.39% (4.89% x 0.9). The third and final step is to calculate the unsystematic or internal risk by subtracting the market risk from the total risk. It comes out to be 13.58% (17.97% minus 4.39%). Risk Reward Ratio: This ratio approximates the reward that an investor may earn against the risk that they are willing to invest. It is presented in price form; for example, a risk/reward ratio of 1:5 means that an investor will risk $1 for the potential earning of $5. This is known as the expected return. 6.6 LEARNING ACTIVITY 1. Now that students understand the concept of risk, how would they invest their money and why? ___________________________________________________________________________ ___________________________________________________________________________ 2. If students already have selected a stock that they are following, have them chart how the stock has performed for the past two years, five years and 20 years. If an investor started with 100 shares, how much more -- or less -- money would he or she have now? 63 CU IDOL SELF LEARNING MATERIAL (SLM)
___________________________________________________________________________ ___________________________________________________________________________ 3. It is the uncertainty associated with the returns from an investment that introduces a risk into a project. The expected return is the uncertain future return that a firm expects to get from its project. What is meant by risk and return? ___________________________________________________________________________ ___________________________________________________________________________ 6.7 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What are the elements of risk? 2. What is the purpose of return 0? 3. Why is return important? 4. What do you mean by market risk? 5. Who is accountable for risk management? Long Questions 1. What are the 4 principles of risk management? 2. What are the five goals of risk management? 3. What is portfolio risk? 4. What is a risk profile? 5. How are stock market returns calculated? B. Multiple Choice Questions 1. What can Risk of two securities with different expected return can be compared with: a. Coefficient of variation b. Standard deviation of securities c. Variance of Securities d. None of these 2. How can a portfolio having two risky securities can be turned riskless? 64 a. The securities are completely positively correlated. b. If the correlation ranges between zero and one. c. The securities are completely negatively correlated. CU IDOL SELF LEARNING MATERIAL (SLM)
d. None of these. 3. What does Efficient frontier comprise of? a. Portfolios that have negatively correlated securities. b. Portfolios that have positively correlated securities. c. Inefficient portfolios. d. Efficient portfolios. 4. What does the point of tangency between risk-return indifferences curves and efficient frontier highlights? a. Optimal portfolio b. Efficient portfolio c. Sub-optimal portfolio d. None of these 5. Identify the right option: A portfolio comprises two securities and the expected return on them is 12% and 16% respectively. Determine return of portfolio if first security constitutes 40% of total portfolio. a. 12.4% b. 13.4% c. 14.4% d. 15.4% Answers 1-a, 2-c, 3-d, 4-a, 5-c. 6.8 REFERENCES References Vliet, Pim, van. Koning, Jan, de. (21 November 2016). High Returns from Low Risk: A Remarkable Stock Market Paradox. Wiley; 1st edition. Greenblatt, Joel. (21 April 2008). The Little Book That Beats the Market. Wiley; 1st edition. Paul, Prasenjit. (14 July 2015). How to Avoid Loss and Earn Consistently in the Stock Market: An Easy-to-understand and Practical Guide for Every Investor. Partridge Pub; 3rd Edition. 65 CU IDOL SELF LEARNING MATERIAL (SLM)
Textbooks Fisher, Ken.(9 January 2013). The Little Book of Market Myths: How to Profit by Avoiding the Investing Mistakes Everyone Else Makes. Wiley; 1st edition. Gujral, Ashwani. Khemariya, Prasanna. (21 June 2018). How to Make Money Trading with Charts. Vision Books; Third edition; Vision Books, New Delhi 110024, India. Yadav, Pooja. (21 July 2012). Risk & return behavior of stock markets. LAP Lambert Academic Publishing. Websites https://www.investor.gov/additional-resources/information/youth/teachers-classroom- resources/risk-and-return https://www.investor.gov/introduction-investing/investing-basics/glossary/real-return https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/risk-and- return/ 66 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 7 SECURITY ANALYSIS STRUCTURE 7.0 Learning Objectives 7.1 Introduction 7.2 ValuationPrinciples 7.3 FundamentalAnalysis 7.4 Summary 7.5 Keywords 7.6 Learning Activity 7.7 Unit End Questions 7.8 References 7.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Explain valuation principles. Apply fundamental analysis. List macro factors influencing valuation. 7.1 INTRODUCTION Security analysis refers to the method of analyzing the value of securities like shares and other instruments to assess the total value of a business which will be useful for investors to make decisions. There are three methods to analyse the value of securities–fundamental, technical, and quantitative analysis. The securities can broadly be classified into equity instruments (stocks), debt instruments (bonds), derivatives (options), or some hybrid (convertible bond). Considering the nature of securities, security analysis can broadly be performed using the following three methods: - Fundamental Analysis: This type of security analysis is an evaluation procedure of securities where the major goal is to calculate the intrinsic value of a stock. It studies the fundamental factors that effects stock’s intrinsic value like profitability statement & position statements of a company, managerial performance and outlook, present industrial conditions, and the overall economy. Technical Analysis 67 CU IDOL SELF LEARNING MATERIAL (SLM)
This type of security analysis is a price forecasting technique that considers only historical prices, trading volumes, and industry trends to predict the future performance of security. It studies stock charts by applying various indicators (like MACD, Bollinger Bands, etc.), assuming every fundamental input has been factored into the price. Quantitative Analysis This type of security analysis is a supporting methodology for both fundamental and technical analysis, which evaluates the historical performance of the stock through calculations of basic financial ratios e.g., Earnings Per Share (EPS), Return on Investments (ROI), or complex valuations like discounted cash flows (DCF). 7.2 VALUATIONPRINCIPLES The theory and principle of estimating the value of various securities is the heart of investing and leads to the construction of a portfolio consistent with your risk and return objectives. The understanding of these Valuation Principles is essential to successful investing. Figure 7.1: Valuation Principles On this page, we will kick off the discussion with a run-through of the financial statement Then, we will set the table by talking about some valuation basics. Finally, we will look at how macro factors influence valuation. Market Capitalization. Market capitalization is the simplest method of business valuation. Times revenue method. 68 CU IDOL SELF LEARNING MATERIAL (SLM)
Earnings multiplier. Discounted Cash Flow (DCF) Method. Book value. Liquidation value. Key Principles of Business Valuation The following are the key principles of business valuation that business owners who want to create value in their business must know. The value of a business is defined only at a specific point in time The value of a privately held business usually experiences change every single day. The earnings, cash position, working capital, and market conditions of a business are always changing. The valuation prepared by business owners a few months or years ago may not reflect the true current value of the business. The value of a business requires consistent and regular monitoring. This valuation principle helps business owners to understand the significance of the date of valuation in the process of business valuation. Value primarily varies in accordance with the capacity of a business to generate future cash flow A company’s valuation is essentially a function of its future cash flow except in rare situations where net asset liquidation leads to a higher value. The first key takeaway in the second principle is “future.” It implies that historical results of the company’s earnings before the date of valuation are useful in predicting the future results of the business under certain conditions. The second key in this principle is “cash flow.” It is because cash flow, which takes into account capital expenditures, working capital changes, and taxes, is the true determinant of business value. Business owners should aim at building a comprehensive estimate of future cash flows for their companies. Even though making estimates is a subjective undertaking, it is vital that the value of the business is validated. Reliable historical information will help in supporting the assumptions that the forecasts will use. The market commands what the proper rate of return for acquirers is? Market forces are usually in a state of flux, and they guide the rate of return that is needed by potential buyers in a particular marketplace. Some of the market forces include the type of industry, financial costs, and the general economic conditions. 69 CU IDOL SELF LEARNING MATERIAL (SLM)
Market rates of return offer significant benchmark indicators at a specific point in time. They influence the rates of return wanted by individual company buyers over the long term. Business owners need to be wary of the market forces in order to know the right time to exit that will maximize value. The value of a business may be impacted by underlying net tangible assets This principle of business valuation measures of the relationship between the operational value of a company and its net tangible value. Theoretically, a company with a higher underlying net tangible asset value has higher going concern value. It is due to the availability of more security to finance the acquisition and lower risk of investment since there are more assets to be liquidated in case of bankruptcy. Business owners need to build an asset base. For industries that are not capital intensive, the owners need to find means to support the valuation of their goodwill. Value is influenced by transferability of future cash flows How transferable the cash flows of the business are to a potential acquirer will impact the value of the company. Valuable businesses usually operate without the control of the owner. If the business owner exerts a huge control over the delivery of service, revenue growth, maintenance of customer relationships, etc., then the owner will secure the goodwill and not the business. Such a kind of personal goodwill provides very little or no commercial value and is not transferable. In such a case, the total value of the business to an acquirer may be limited to the value of the company’s tangible assets in case the business owner does not want to stay. Business owners need to build a strong management team so that the business can run efficiently even if they left the company for a long period of time. They can build a stronger and better management team through enhanced corporate alignment, training, and even through hiring. Value is impacted by liquidity This principal functions based on the theory of demand and supply. If the marketplace has many potential buyers, but there are a few quality acquisition targets, there will be a rise in valuation multiples and vice versa. In both open market and notional valuation contexts, more business interest liquidity translates into more business interest value. Business owners need to get the best potential purchasers to the negotiating table to maximize price. It can be achieved through a controlled auction process. Key Takeaways The above are fundamental business valuation principles that determine the value of a business. The value of any business is usually determined at a specific point in time and is 70 CU IDOL SELF LEARNING MATERIAL (SLM)
impacted by the company’s capacity to generate future cash flow, market forces, underlying net tangible assets, transferability of future cash flows, and liquidity. Although they are technical valuation concepts, the basics of the valuation principles need to understand by business owners to help them increase the valuation of their businesses. 7.3 FUNDAMENTALANALYSIS 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 concept of “Intrinsic Value” is the cornerstone of Fundamental Analysis. Fundamental analysis (FA) also defined as a method of measuring a security's intrinsic value by examining related economic and financial factors. The end goal is to arrive at a number that an investor can compare with a security's current price to see whether the security is undervalued or overvalued. 7.4 SUMMARY There are many objectives of Security Analysis. They are - Capital appreciation, Regular Income, the Safety of Capital, Hedge against Inflation, and Liquidity. It is a method of evaluating the intrinsic value of an asset and analyzing the factors that could influence its price in the future. Technical analysis studies the supply and demand for stock within the market. Investors who use technical analysis believe that a stock’s historical performance indicates how the stock will perform in the future. Little attention is given to the value of the company. The technical analysis places a heavy focus on the study of trends, charts, and patterns. A common method to analyzing a stock is studying its price-to-earnings ratio. You calculate the P/E ratio by dividing the stock’s market value per share by its earnings per share. To determine the value of a stock, investors compare a stock’s P/E ratio to those of its competitors and industry standards. Lower P/E ratios are seen as favorable by investors. A company’s earnings per share show how efficiently its revenue is flowing down to investors. An increasing EPS is taken as a good sign by investors. According to NASDAQ, the higher a company’s EPS, the more your shares are worth, because investors seek to purchase a company’s stock when earnings are high. The price-to-earnings-growth ratio takes the P/E ratio a step further by considering the growth of a company. To calculate the PEG, you divide the P/E ratio by the 12-month 71 CU IDOL SELF LEARNING MATERIAL (SLM)
growth rate. You estimate the future growth rate by looking at the company’s historical growth rate. Investors typically consider a stock valuable if the PEG is lower than 1. Another method used to analyse a stock is determining a company’s price-to-book ratio. Investors typically use this method to find high-growth companies that are undervalued. The formula for the P/B ratio equals the market price of a company’s stock divided by its book value of equity. The book value of equity is derived by subtracting the book value of liabilities from the book value of assets. Investors view a low P/B ratio as a sign that the stock is potentially undervalued. Investors use return on equity to determine how well a company produces positive returns for its shareholders. Analyzing ROE can help you find companies that are profit generators. ROE is calculated by dividing net income by average shareholders’ equity. A continual increase in ROE is a good sign to investors. 7.5 KEYWORDS Security Valuation Technique: According to the fundamentalist approach to security valuation, the value of the security must be equal to the discounted value of the future income stream. The investor buys the securities when the market price is below this value. Security Analysis in Stock: Security analysis is the analysis of tradeable financial instruments called securities. It deals with finding the proper value of individual securities (i.e., stocks and bonds). These are usually classified into debt securities, equities, or some hybrid of the two. Security Valuation Formula: Here the principal operating is compound interest. Thus, if Vn is the terminal value at the period n, P is the initial value, g is a rate of compounding or return, n is the number of compounding periods, then Vn = P (1 + g) n. Valuation of Security:Valuing Stocks. A stock is partial ownership or equity stake in a business entitling the owner to dividends, a share of the profits generated by the company. The main factor which influences a company's stock price is the return on equity, or invested capital, to the shareholder. Objectives of Security Analysis: There are many objectives of Security Analysis. They are - Capital appreciation, Regular Income, the Safety of Capital, Hedge against Inflation, and Liquidity. It is a method of evaluating the intrinsic value of an asset and analyzing the factors that could influence its price in the future. Fundamental Analysis: Fundamental analysis (FA) is a method of measuring a security's intrinsic value by examining related economic and financial factors. 72 CU IDOL SELF LEARNING MATERIAL (SLM)
Fundamental analysts’ study anything that can affect the security's value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company's management. 7.6 LEARNING ACTIVITY 1. On completion of this course and the Essential reading and activities, you should be able to:Carefully analyse the financial performance of given securities and critically review equity research published by financial analysts. How do you analyse financial performance? ___________________________________________________________________________ ___________________________________________________________________________ 2. Competently apply valuation technologies required in corporate finance with minimum guidance. How do you evaluate securities? ___________________________________________________________________________ ___________________________________________________________________________ 7.7 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is Risk Management? 2. What is Security Analysis in the stock market? 3. What are the two major types of information necessary for security analysis? 4. What are the objectives of security analysis? 5. How would you explain that various indicators predict the prospect for investment in stocks? Long Questions 1. Summarize the concept of stock investment decision? 2. Do you think that knowing the status of the economy is useful in analyzing stock market movements? 3. What are the factors affecting economic analysis? 4. Explain: - “Fundamental analysis provides an analytical framework for rational investment decision–making”. 73 CU IDOL SELF LEARNING MATERIAL (SLM)
5. Explain the concept of EMH and discuss its implications for investment policy as it applies to fundamental and technical analysis. B. Multiple Choice Questions 1. Which are the financial investments that have no intrinsic value but drive their value from something else. a. Bonds b. Commercial Bills c. Desiratives d. Shares 2. What is a group of security is known as? a. Investment b. Portfolio c. Security d. Gambling 3. Which are the organized markets for buying & selling securities which include stock, bonds, options, futures? a. Desiratives b. Sensex c. Stock Exchange d. Market 4. Which pattern is a distinct formation on a stock chart that creates a trading signal or a sign of future price movements? a. Price Chart b. Chart c. Technical d. None of these 5. Which is the annual rate of return that a fundholder will earn under the assumption that the bond is held to maturity & the investment payments are invested. a. YTM b. NPV c. ARR 74 CU IDOL SELF LEARNING MATERIAL (SLM)
d. CY Answers 1-c, 2-b, 3-c. 4-b. 5-a. 7.8 REFERENCES References Graham, Benjamin. Dodd, David. (October 10, 2002). Security Analysis: Principles and Techniques. McGraw-Hill Education; 2nd edition. Fischer. (January 2016). Security Analysis and Portfolio Management. PEARSON INDIA. Donald, E. Fischer. Ronald, J. Jordan. Ashwini, K. Pradhan. (30 October 2018). Security Analysis Portfolio Management. Pearson Education. Textbooks Jensen, M.C. and R.S. Ruback ‘The market for corporate control: the scientific evidence’, Journal of Financial Economics 11 1983, pp.5–50. Jorion, P. and E. Talmor ‘Value relevance of financial and non-financial information in emerging industries: the changing role of web traffic data’, SSRN Working Paper, November 2001. Kothari, S.P. ‘Capital markets research in accounting’, Journal of Accounting and Economics 31 2001, section 4.3. Websites https://finance.zacks.com/seven-ways-analyze-stock-4845.html https://www.investopedia.com/terms/r/riskrewardratio.asp https://www.investopedia.com/terms/r/riskrewardratio.asp 75 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 8 ECONOMIC ANALYSIS STRUCTURE 8.0 Learning Objectives 8.1 Introduction 8.2 Macro Economic Activity and Security Markets 8.3 The CyclicalIndicatorApproachMonetary Variables 8.4The EconomyandStock Prices 8.5 Summary 8.6 Keywords 8.7 Learning Activity 8.8 Unit End Questions 8.9 References 8.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Define the stock market. Identify the indices of the stock market. Illustrate a mock stock portfolio. Explain how the stock market works. Define the impact does the stock market has on our overall economy. 8.1 INTRODUCTION Investors deciding to hold a portfolio of US stocks and bonds, perhaps within an employer- sponsored 401k plan, require an approach to the investment process. The top-down approach to investing begins with an analysis and forecast of the economy and stock market, followed by an industry analysis, and then a company analysis. Macro-economic factors, the business cycle, industry life cycles, and the competitive environment all have an impact on how industries, and firms within industries, perform. A study of industry sectors shows they cycle through peaks and troughs of the larger economy. For example, Reilly and Brown explain how financial stocks excel as the economy approaches a tough, consumer durables excel in the trough, and basic industries perform best at the cycle peak. 76 CU IDOL SELF LEARNING MATERIAL (SLM)
This paper assesses the current US economy and the stock market as of Fall 2016, and their expected future performance as a context for investor decisions. The growth rate of Gross Domestic Product (GDP) An economy's overall economic activity is summarized by a measure of aggregate output. As the production or output of goods and services generates income, any aggregate output measure is closely associated with an aggregate income measure. The United States now uses an aggregate output concept known as the gross domestic product or GDP. The GDP is a measure of all currently produced goods and services valued at market prices. One should notice several features of the GDP measure. First, only currently produced goods (produced during the relevant year) are included. This implies that if you buy a 150-year-old classic Tudor house, it does not count towards the GDP; but the service rendered by your real estate agent in the process of buying the house does. Secondly, only final goods and services are counted. To avoid double-counting, intermediate goods—goods used in the production of other goods and services—do not enter the GDP. For example, the steel used in the production of automobiles is not valued separately. Finally, all goods and services included in the GDP are evaluated at market prices. Thus, these prices reflect the prices consumers pay at the retail level, including indirect taxes such as local sales taxes. Savings and Investment The growth of an economy requires the proper number of investments which in turn is dependent upon the amount of domestic savings. The amount of savings is favorable related to investment in a country. The level of investment in the economy and the proportion of investment in the capital market is a major area of concern for investment analysts. Industry Growth Rate The GDP growth rate represents the average growth rate of the agricultural sector, industrial sector, and service sector. The current contribution of the industry sector in GDP in the year 2004-05 is 6.75 percent approximately. The publicly listed company plays a major role in the industrial sector. The stock market analysts focus on the overall growth of different industries contributing to economic development. The higher the growth rate of the industrial sector, other things being equal, the more favorable it is for the stock market. Price level and Inflation The inflation rate is defined as the rate of change in the price level. Most economies face positive rates of inflation year after year. The price level, in turn, is measured by a price index, which measures the level of prices of goods and services at a given time. The numbers of items included in a price index vary depending on the objective of the index. 8.2 MACRO ECONOMIC ACTIVITY AND SECURITY MARKETS 77 CU IDOL SELF LEARNING MATERIAL (SLM)
Macro-economic factors such as interest rates, inflation, unemployment, and economic growth often move stock markets. Macroeconomics studies economy-wide phenomena such as inflation, price levels, rate of economic growth, national income, gross domestic product (GDP), and changes in unemployment. Rising unemployment foreshadows lower economic growth, and falling unemployment tells stock investors that growth is on the way. Stock trading allows businesses to raise capital to pay off debt, launch new products and expand operations. Stock prices influence consumer and business confidence, which in turn affect the overall economy. The relationship also works the other way, in that economic conditions often impact stock markets. 8.3 THE CYCLICALINDICATOR APPROACHMONETARY VARIABLES The cyclical indicator approach, which is extensively used as a business cycle analysis tool, employs a series of variables that tend to anticipate, coincide with, or lag the movements of economic activity to indicate the phases of the business cycle. \"Cyclical indicators\" is the name given to the selected. Statistical series provide an indication of the direction in which the economy or sectors or industries are moving. Business cycle indicators (BCI) are a composite of leading, coincident, and lagging indexes created by the Conference Board and used to forecast, date, and confirm changes in the direction of the overall economy of a country. They are published monthly and can be used to measure the peaks and troughs of the business cycle. Key Takeaways Business cycle indicators (BCI) are composite indexes of leading, lagging, and coincident indicators used to analyse and predict trends and turning points in the economy. Various public and private organizations collect and analyse economic data and statistics to construct and track BCI. BCI must be used in conjunction with other statistics of an economy in order to understand the true nature of economic activity. Understanding Business Cycle Indicators (bci) Economies do not generally grow at a consistent linear or exponential rate, but instead experience periods of faster or slower growth as well as occasional episodes of outright decline in economic activity. These quasi-periodic fluctuations of economic activity, such as production and employment, are known as business cycles. There's usually a rise in activity 78 CU IDOL SELF LEARNING MATERIAL (SLM)
that reaches a high point, or peak, followed by a decline in output and employment until the economy reaches a bottom, known as a trough. Although past business cycles may show patterns that are likely to be repeated to some degree, the timing of peaks and troughs in business cycles aren't always predictable. Understanding, predicting, and overcoming the volatility of these cycles is a major focus of research by economists, public policymakers, and private investors. One prominent avenue of this research has been the measurement and dating of trends and turning points in economic data and statistics. From this research, numerous sets of indicators have been constructed. History of Business Cycle Indicators Wesley Mitchell and Arthur Burns at the National Bureau of Economic Research (NBER) were responsible for compiling the first set of BCI and using them to analyse economic boom and bust cycles during the 1930s.1 According to the NBER, there were a total of eleven business cycles between 1945 and 2009.2 The U.S. Department of Commerce began publishing BCI during the 1960s. The task of compiling and publishing the indicators was privatized in 1995, with the Conference Board being made responsible for the report.3 Interpreting Business Cycle Indicators Interpretation of BCI involves much more than simply reading graphs. An economy is much too complex to be summarized with just a few statistics. Thus, investors, traders, and corporations must realize that it is unreasonable to believe that any single indicator, or even set of indicators, always gives true signals and never fails to foresee a turning point in an economy. BCI are constructed by looking at a wide range of government and private sector data, which are statistically correlated with or logically related to national macroeconomic performance. In recent years, the impact of money supply, interest rate and inflation rate on economic growth has been at the centre of attention more so than other topics related to monetary economics due to its present direct effects in the world. The importance of economic growth as a main macroeconomic objectives of developing and developed countries, has been encompassed by monetary economists such as McKinnon (1973), Shaw (1973), Mathieson (1980), Odedokun (1996), Levine (1997) and Asogu (1998) who have all dedicated their studies in examining the influence money supply and interest rate on output, with mixed findings. As some authors conclude that the most important influence of economic growth is the variations in the quantity of money, other researchers state the nations that pay particular attention to examining behaviour of aggregate money supply rarely experience high levels of variations in their economic activities (Handler, 1997, Mansor, 2005, Townsend and Ueda, 79 CU IDOL SELF LEARNING MATERIAL (SLM)
2005, Owoye and Onafowora, 2007), as such are sceptical about the role of money or gross national income (Robinson, 1952, pp. 547-582). Monetary Variables Monetary policy comprises a combination of strategies and instruments used by the monetary authorities to control money supply in an economy consistent with a desired level of short- term interest rate, inflation and economic growth. In a changing economic environment, the choice of a monetary policy strategy is intertwined with the objectives of monetary policy which include ensuring price (inflation, exchange rate and interest rate) and financial stability. Thus, the conduct of monetary policy and the goal of price stability lie within the mandate of central banks (CBN, 2007). A majority of independent nations have their own currencies. At a global level, there are only four groups of countries that issue a common currency and conduct joint monetary policy (Gulde and Tsangarides, 2008). The four monetary unions are CEMAC, WAEMU, the Euro area, and the Eastern Caribbean Currency Union (ECCU). As it can be observed, two of these four monetary unions are located Africa, namely the Central African Economic and Monetary Community (CEMAC) and the West African Economic and Monetary Union (WAEMU). Even though CEMAC and WAEMU have their own distinct currency, they do have similarities, as Gulde and Tsangarides (2008) assert: “both unions peg their currencies to the euro at the same level, they share certain institutional features, and they are commonly referred to as the CFA franc zone”. The Central African Economic and Monetary Community (CEAMC) was established by a Treaty signed in 1972 and revised in March 1994 and 1996. It was ratified by six states: Cameroon, the Central African Republic, Chad, the Republic of Congo, Equatorial Guinea and Gabon. The Treaty was based on the monetary co-operation arrangements in effect under the common central bank since 1959 and on those of the Customs and Economic Union of Central Africa (UDEAC) established in 1966. This organisation has four main priorities: development of abilities to keep peace, security and stability; development of physical, economic and monetary integration; development of culture integration; and establishment of an autonomous financing mechanism for the Economic Community of Central African States (ECCAS). To achieve these objectives, the CEMAC adopted in 2001 a matrix of four macroeconomic convergence criteria: a zero or positive budget balance by 2002, a public debt/GDP ratio below 70%, overdue payments to be settled by 2004, and an inflation rate to be maintained below 3% per year (Strauss Kahn, 2003). To facilitate the conduct of the monetary policy in CEMAC and to achieve price stability, two monetary policy rules are incorporated in its statutes: the BEAC limits the stock of total advances to governments to 20 percent of the previous year’s fiscal revenues; and the BEAC designed to keep gross foreign reserves for each Central Bank above 20% of sight liabilities. The economic performance of CEMAC countries had experienced improvements following 80 CU IDOL SELF LEARNING MATERIAL (SLM)
the devaluation of the FCFA in 1994, although there were occasional droppings, according to Zafar and Kubota (2003): “Gabon’s fiscal crisis during the 1998 election year; Congo’s civil war of 1997-1999, several army mutinies in the Central African Republic in 1990 and 2002, and the impact of oil price volatility among others”. Price stability has been partially kept since the FCFA devaluation from 1994. The BEAC’s member governments comprehended the fact that devaluation could bring back competitiveness and macroeconomic stability only if the price level (including wages) did not proportionately increase (Zafar and Kubota, 2003). In March 1994, the Heads of States and Governments were left with no option than to devalue the CFA Franc at an exchange rate of 1FF = 100FCFA allowing the economies in the region to recover (ECA, 2008). Other efforts made by CEMAC member states to enhance economic growth include the adoption of the Growth and Employment Strategy Paper (GESP) whose objectives include raising the average annual growth rate to 5.5% over the 2010-20 periods and reducing the monetary poverty rate from 39.9% in 2007 to 28.7% in 2020. Despite these efforts, an assessment of CEMAC’s economic performance over the last several decades presents dismal economic growth. This therefore reveals that the root cause or causes of poor growth determinant(s) in the CEMAC Zone is still to be identified and solved. Therefore, this study aimed at providing answers to the following research question: how does money supply, inflation and interest rate systematically influence the economic growth of the CEMAC zone. This is done by examining the effect of money supply, inflation rate, and interest rate on the economic growth in the CEMAC region. The rest of this paper is organised as follows; section two explores the review of literature. The methodology employed is discussed in section three. Results are presented and discussed in section four while section five gives the recommendations and conclusion of the paper. 8.4THE ECONOMYANDSTOCKPRICES A rising stock market is usually aligned with a growing economy and leads to greater investor confidence. Investor confidence in stocks leads to more buying activity which can also help to push prices higher. When stocks rise, people invested in the equity markets gain wealth. The stock market will reflect the economic conditions of an economy. If an economy is growing, then the output will be increasing, and most firms should be experiencing increased profitability. This higher profit makes the company shares more attractive – because they can give bigger dividends to shareholders. A long period of economic growth will tend to benefit shares. However, share prices can fall for many reasons other than recession. An oft-repeated quote is that ‘stock markets have predicted ten of the past five recessions.’ What this means is that sometimes a fall in share prices is related to a recession. But sometimes share prices fall 81 CU IDOL SELF LEARNING MATERIAL (SLM)
and there is no correlation with the economy. It could be a correction of over-valued prices or a change in market sentiment. A long period of economic growth will tend to benefit shares. By contrast, if the stock market predicts a recession, then share prices will generally fall – in anticipation of lower profits. If the economy is forecast to enter a recession, then stock markets will generally fall. 8.5 SUMMARY The economic analysis involves assessing or examining topics or issues from an economist's perspective. The analysis aims to determine how effectively the economy or something within it is operating. For example, an economic analysis of a company focuses mainly on how much profit it is making. The economic analysis involves assessing or examining topics or issues from an economist’s perspective. Economic analysis is the study of economic systems. It may also be a study of a production process or an industry. The analysis aims to determine how effectively the economy or something within it is operating. For example, an economic analysis of a company focuses mainly on how much profit it is making. Along with its impressive economic growth, the stock markets in China (Shanghai, Shenzhen, and Hong Kong) have rapidly developed in recent years. The stock markets are an important part of China's economic growth and have become increasingly accessible. International investors. Naturally, understanding the economic forces and individual firm characteristics driving stock price movements in this market has become increasingly important. Economic history is the academic study of economies or economic events of the past. ... Scholars of the discipline may approach their analysis from the perspective of different schools of economic thought, such as mainstream economics, Marxian economics, the Chicago school of economics, and Keynesian economics. Investors deciding to hold a portfolio of US stocks and bonds, perhaps within an employer-sponsored 401k plan, require an approach to the investment process. The top-down approach to investing begins with an analysis and forecast of the economy and stock market, followed by industry analysis, and then company analysis. Macro-economic factors, the business cycle, industry life cycles, and the competitive environment all have an impact on how industries, and firms within industries, perform. A study of industry sectors shows they cycle through peaks and troughs of the larger economy. This paper assesses the current US economy and the stock market 82 CU IDOL SELF LEARNING MATERIAL (SLM)
as of Fall 2016, and their anticipated future performance as context for investor decisions. While most economic measures show a broad and gradual domestic recovery has been underway for many years now, there are other indicators that may be of concern. Economic analysis is the study of economic systems. It may also be a study of a production process or an industry. The analysis aims to determine how effectively the economy or something within it is operating. They measure, in monetary terms, what the benefits of a project are to the economy or community. To do it properly, you will need time and money, whether you do it yourself or contract it out. Do not underestimate the rigor required to carry out the economic analysis. This can result in poor economic analysis and undermine the credibility of your evidence. The final step to this analysis process would be to take apart the financial statements and come up with a means of valuation. Below is a list of potential inputs into a financial analysis. 8.6 KEYWORDS Economic Forecast: First and foremost, in a top-down approach would be an overall evaluation of the general economy. The economy is like the tide and the various industry groups and individual companies are like boats. When the economy expands, most industry groups and companies benefit and grow. Fundamental Evaluation: Fundamental analysis is the examination of the underlying forces that affect the well-being of the economy, industry groups, and companies. As with most analyses, the goal is to derive a forecast and profit from future price movements. At the company level, fundamental analysis may involve an examination of financial data, management, business concept, and competition. Stock prices and economic growth: According to common theory, the price of a share equals the sum of all future dividend payments discounted to its present value. Higher stock prices reflect an increase in the discounted expected earnings, providing potentially useful information about future economic growth. Monetary Variables: The three monetary variables (exchange rates, money supply, and lending rates) selected for this study are crucial to explaining the link in the monetary-real sector nexus. The exchange rate is defined as a price relation of a country's currency to another country. Cyclical indicators: It has been used for many years as tools to understand the aggregate U.S. economy. ... For example, the series “average weekly hours of 83 CU IDOL SELF LEARNING MATERIAL (SLM)
manufacturing workers” is a cyclical indicator that generally leads the aggregate economy in business cycles. First and foremost, in a top-down approach would be an overall evaluation of the general economy. The economy is like the tide and the various industry groups and individual companies are like boats. When the economy expands, most industry groups and companies benefit and grow. Fundamental Evaluation: Fundamental analysis is the examination of the underlying forces that affect the well-being of the economy, industry groups, and companies. As with most analyses, the goal is to derive a forecast and profit from future price movements. At the company level, fundamental analysis may involve an examination of financial data, management, business concept, and competition. 8.7 LEARNING ACTIVITY 1. Cyclical indicators have been used for many years as tools to understand the aggregate U.S. economy. Which approach uses cyclical indicators? ___________________________________________________________________________ ___________________________________________________________________________ 2. Understanding the relationship between macroeconomic variables and the stock market is important because macroeconomic variables have a systematic effect on stock market returns.How does macroeconomics affect the stock market? ___________________________________________________________________________ ___________________________________________________________________________ 8.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What Do You Understand By economic analysis of Securities Market? 2. What Are the Different Types of Securities Markets? 3. What Do You Mean by Derivatives? 4. What Do You Understand by Stock Market Indices? 5. Which are the Major Stock Market Indices? Long Questions 1. What are the problems and theses proposed in the field of: Fundamental and technical analysis carried out for the purpose of making invest. decisions? 2. In economics, does technical analysis have any scientific basis? 84 CU IDOL SELF LEARNING MATERIAL (SLM)
3. Can the perennial plants be converted to annual plants? What are the prospects and constraints, along with advantages and disadvantages? 4. What can be done when GARCH Coefficients are negative? 5. Which is the primary reason that traditional economics cannot explain reality? Lack of a realistic theory or the mistakes of the traditional theory? B. Multiple choice Questions 1. Which of the following would not be considered as capital market security? a. A corporate bond. b. A common stock. c. A 6-month Treasury bill. d. A mutual fund shares. 2. What is the other name for coupon rate? a. Market interest rate. b. Current yield. c. Stated interest rate. d. Yield to maturity. 3. How are Dividends paid? a. Monthly. b. Quarterly. c. Semi-annually. d. Yearly. 4. What is he referring to if an investor states that Intel is overvalued at 65 times? a. Earnings per share. b. Dividend yield. c. Book value. d. P/e ratio. 5. What does it mean if a preferred stock issue is cumulative? 85 a. Dividends are paid at the end of the year. b. Dividends is legally binding on the corporation. c. Unpaid dividends will be paid in the future. CU IDOL SELF LEARNING MATERIAL (SLM)
d. Unpaid dividends are never repaid. Answers 1-c, 2-a, 3-d, 4-b, 5-c. 8.9 REFERENCES References Eschenbach, G. P, Lavelle, Jerome. G, Newnan, Donald. (January 2010). Engineering Economic Analysis 10Th Edition. Oxford. WHITE, JOHN, A. E, CASE, KENNETH. (January 2012). Principles Of Engineering Economic Analysis 5Th Ed. Wiley IndiaPvt Ltd. SYDSAETER.HAMMOND, PETER, J. (January 1995). Mathematics For Economic Analysis 1St Ed. Pearson Education India. Textbooks Beavis, Brian. Dobbs, Ian. (February 1990). Optimisation And Stability Theory for Economic Analysis. CAMBRIDGE UNIVERSITY PRESS. Agarwal, H, S. (1 December 2009). A Textbook of Economic Analysis. ANE Books. Sharma, Seema. (1 January 2018). Statistics for Business and Economics. Wiley. Websites https://www.economicshelp.org/blog/541/economics/relationship-between-stock- market-and-economy/ https://people.stern.nyu.edu/nroubini/bci/bciintroduction.htm https://study.com/academy/popular/stock-market-lesson-plan.html 86 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 9 INDUSTRY ANALYSES STRUCTURE 9.0 Learning Objectives 9.1 Introduction 9.2 IntroductionBusinessCycle andIndustrySectors 9.3 EvaluatingtheIndustryLife Cycle 9.4 Summary 9.5 Keywords 9.6 Learning Activity 9.7 Unit End Questions 9.8 References 9.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Explain uses of industry analysis and the relation of industry analysis to company analysis. Compare methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system. Explain the factors that affect the sensitivity of a company to the business cycle and the uses and limitations of industry and company descriptors such as “growth,” “defensive,” and “cyclical”. Explain how a company’s industry classification can be used to identify a potential “peer group” for equity valuation. Describe the elements that need to be covered in a thorough industry analysis. 9.1 INTRODUCTION Fundamental analysis is most often used when determining the quality of long-term investments in a wide array of securities and markets, while technical analysis is used more in the review of short-term investment decisions such as the active trading of stocks. Investing in a stock is never a standalone decision. Say you want to invest in HDFC Bank Ltd., it is important to analyse HDFC Bank, its loan book, its NPAs, and other banking-specific factors. However, your research should not stop there. You need to look at how the banking sector 87 CU IDOL SELF LEARNING MATERIAL (SLM)
performed in the past few years, what it looks like soon, how risky it is, and if the sector’s risk level aligns with your risk level and then repeats this exercise for every stock. Industry analysis is thus an important step in fundamental analysis and can help you pick a stock that matches your risk profile and investment objectives. Before placing big bucks on any company, understanding the industry is extremely important. Say you are investing in a pharmaceutical company, there are a few things you will have to keep in mind. For example, drug regulations and patenting, demand situation of medicines, FDA regulations, and more. Such factors tell investors which are the threats that the pharma industry faces, which factors go in favour, and the competitive landscape of the industry. Thorough industry analysis will help you to understand such unique aspects of any industry. There are many ways in which you can do this. However, we have zeroed down on two of the best methods to help you analyse an industry: Porter’s Five Forces to Analyse Stocks SWOT Analysis It is important to know about the position of a company's art peers from the same industry. You cannot rank a manufacturing company against a pharmaceutical company for comparison. 9.2 INTRODUCTIONBUSINESSCYCLEANDINDUSTRYSECTORS Business cycles are a type of fluctuation found in the aggregate economic activity of nations… a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions… this sequence of changes is recurrent but not periodic.\" That description, from the 1946 magnum opus by Arthur F. Burns and Wesley C. Mitchell, Measuring Business Cycles, remains definitive today. In essence, business cycles are marked by the alternation of the phases of expansion and contraction in aggregate economic activity, and the co-movement among economic variables in each phase of the cycle. Aggregate economic activity is represented by not only real (i.e., inflation-adjusted) GDP—a measure of aggregate output—but also the aggregate measures of industrial production, employment, income, and sales, which are the key coincident economic indicators used for the official determination of U.S. business cycle peak and trough dates. There are different investment approaches to identify sector winners and losers, such as price momentum strategies, top-down approaches based on specific macroeconomic indicators and bottom-up approaches to identify sectors with improving fundamentals. One widely used approach is business cycle analysis. Since economic cycles usually exhibit characteristics that 88 CU IDOL SELF LEARNING MATERIAL (SLM)
impact sectors or industries differently, investors may identify sectors that are favoured by the current economic phase. A standalone business cycle-based sector rotation is difficult to implement, as differences exist in the economic conditions of each cycle over time and transformative technology continues to alter business model and economic impact. However, understanding cycle dependency on sectors is important to sector portfolio construction, particularly for a top- down approach. A recession is a specific sort of vicious cycle, with cascading declines in output, employment, income, and sales that feedback in a further drop in output, spreading rapidly from industry to industry and region to region. This domino effect is key to the diffusion of recessionary weakness across the economy, driving the co-movement among these coincident economic indicators and the persistence of the recession. On the flip side, a business cycle recovery begins when that recessionary vicious cycle reverses and becomes a virtuous cycle, with rising output triggering job gains, rising incomes, and increasing sales that feed back into a further rise in output. The recovery can persist and result in a sustained economic expansion only if it becomes self-feeding, which is ensured by this domino effect driving the diffusion of the revival across the economy. To make a quantitative and systematic assessment of how different sectors performed through various business cycles, we used the Conference Board Leading Economic Indicator Index (LEI) to segregate business cycles and evaluated sector performance over multiple business cycles between 1960 and 2018. This provided a good sample size to evaluate sector performance consistency for different cycles. Stages of the Business Cycle In the diagram above, the straight line in the middle is the steady growth line. The business cycle moves about the line. Below is a more detailed description of each stage in the business cycle: i. Expansion The first stage in the business cycle is expansion. In this stage, there is an increase in positive economic indicators such as employment, income, output, wages, profits, demand, and supply of goods and services. Debtors are generally paying their debts on time, the velocity of the money supply is high, and investment is high. This process continues if economic conditions are favorable for expansion. ii. Peak The economy then reaches a saturation point, or peak, which is the second stage of the business cycle. The maximum limit of growth is attained. The economic indicators do not grow further and are at their highest. Prices are at their peak. This stage marks the reversal 89 CU IDOL SELF LEARNING MATERIAL (SLM)
point in the trend of economic growth. Consumers tend to restructure their budgets at this point. iii. Recession The recession is the stage that follows the peak phase. The demand for goods and services starts declining rapidly and steadily in this phase. Producers do not notice the decrease in demand instantly and go on producing, which creates a situation of excess supply in the market. Prices tend to fall. All positive economic indicators such as income, output, wages, etc., consequently start to fall. iv. Depression There is a commensurate rise in unemployment. The growth in the economy continues to decline, and as this fall below the steady growth line, the stage is called depression. v. Trough In the depression stage, the economy’s growth rate becomes negative. There is further decline until the prices of factors, as well as the demand and supply of goods and services, contract to reach their lowest point. The economy eventually reaches the trough. It is the negative saturation point for an economy. There is extensive depletion of national income and expenditure. vi. Recovery After the trough, the economy moves to the stage of recovery. In this phase, there is a turnaround in the economy, and it begins to recover from the negative growth rate. Demand starts to pick up due to low prices and, consequently, supply begins to increase. The population develops a positive attitude towards investment and employment and production starts increasing. Employment begins to rise and, due to accumulated cash balances with the bankers, lending also shows positive signals. In this phase, depreciated capital is replaced, leading to new investments in the production process. Recovery continues until the economy returns to steady growth levels. This completes one full business cycle of boom and contraction. The extreme points are the peak and the trough. 9.3 EVALUATINGTHEINDUSTRYLIFECYCLE The number of stages in this industry life cycle analysis will vary based on how much detail you wish. A five-phase model would include which can be Pioneering development Rapid accelerating growth Fully developed growth Stabilization and market maturity Deceleration involving growth and decrease. Besides being valuable when estimating revenue, this analysis of your industry’s life cycle also can provide some insights into income and earnings 90 CU IDOL SELF LEARNING MATERIAL (SLM)
expansion, although these profit measures will not necessarily parallel the actual sales growth. The profit perimeter series typically peaks very early from the total cycle after which it levels off and declines as competitors are attracted by the early success of the industry. Evaluating the Industry Life Cycle An insightful analysis when predicting industry sales and trends in profitability is to view the industry over time and divide its development into stages like those that humans progress through as they move from birth to adolescence to adulthood to middle age to old age. The number of stages in this industry life cycle analysis can vary based on how much detail you want. A five-stage model would include I. Pioneering development II. Rapid accelerating growth III. Mature growth IV. Stabilization and market maturity V. Deceleration of growth and decline. Besides being useful when estimating sales, this analysis of an industry’s life cycle also can provide some insights into profit margins and earnings growth, although these profit measures do not necessarily parallel the sales growth. The profit margin series typically peaks very early in the total cycle and then levels off and declines as competition is attracted by the early success of the industry. To illustrate the contribution of life cycle stages to sales estimates, we briefly describe these stages and their effects on sales growth and profits: I. Pioneering development. During this start-up stage, the industry expenses modest sales growth and very small or negative profit margins and profits. The market for the industry’s product or service during this time is small, and the firms involved incur major development costs. II. Rapid accelerating, growth. During this rapid growth stage, a market develops for the product or service and demand becomes substantial. The limited number of firms in the industry faces little competition, and individual firms can experience substantial backlogs. The profit, margins are very high. The industry builds its productive capacity as sales grow at an increasing rate as the industry attempts to meet excess demand, High sales growth and high profit margins that increase as firms become more efficient cause industry and firm profits to explode. During this phase, profits can grow at over 100 percent a year ass result of the low earnings base and the rapid growth of sales and net profit margins. 91 CU IDOL SELF LEARNING MATERIAL (SLM)
III. Mature growth. The success in ‘Stage 2 has satisfied most of the demand for the industry goods or service. Thus, future sales growth may be above normal, but it no longer accelerates. 1’or example, if the overall economy is growing at 8 percent, sales for this industry might grow at an above normal rate of 15 percent to 20 percent a year. Also, the rapid growth of sales and the high profit margins attract competitors to the industry, which causes an increase in supply and lower prices, which means that the profit margins begin to normal levels. IV. Stabilization and market maturity. During this stage, which is probably the longest phase, the industry growth rate declines to the growth rate of the aggregate economy or its industry segment? During this stage, investors can estimate growth easily because sales correlate highly with an economic series. Although sales grow in line with the economy, profit growth varies by industry because the competitive structure varies by industry and by individual firms within the industry because the ability to control costs differs among companies. Competition produces tight profit margins, and the rates of return on capital (e.g., return on assets, return on equity)” eventually become equal to or slightly below (he competitive level). V. Deceleration of growth and decline. At this stage of maturity, the industry’s sales growth declines because of shifts in demand or growth of substitutes. Profit margins continue to be squeezed and some firms experience low 2roflts or even losses. Finns that remain profitable may show very low rates of return on capital. Finally, investors begin thinking about alternative uses for the capital tied up in this industry. Although these are general descriptions of the alternative life cycle stages, they ‘should help you identify the stage your industry is in, which should help you estimate its potential sales growth. Obviously, everyone is looking for an industry in the early phases of Stage 2 and hopes to avoid industries in Stage 4 or Stage 5. Comparing the sales and earnings growth of an industry to similar growth in the economy should help you identify the industry’s stage within the industrial life cycle. 9.4 SUMMARY Company analysis and industry analysis are closely interrelated. Company and industry analysis together can provide insight into sources of industry revenue growth and competitors’ market shares and thus the future of an individual company’s top- line growth and bottom-line profitability. A limitation of current classification systems is that the narrowest classification unit assigned to a company generally cannot be assumed to constitute its peer group for the purposes of detailed fundamental comparisons or valuation. A peer group is a group of companies engaged in similar business activities whose economics and valuation are influenced by closely related factors. 92 CU IDOL SELF LEARNING MATERIAL (SLM)
Steps in constructing a preliminary list of peer companies: i. Examine commercial classification systems if available. These systems often provide a useful starting point for identifying companies operating in the same industry. ii. Review the subject company’s annual report for a discussion of the competitive environment. Companies frequently cite specific competitors. iii. Review competitors’ annual reports to identify other potential comparable. iv. Review industry trade publications to identify additional peer companies. v. Confirm that each comparable or peer company derives a significant portion of its revenue and operating profit from a similar business activity as the subject company. Not all industries are created equal. Some are highly competitive, with many companies struggling to earn returns more than their cost of capital, and other industries have attractive characteristics that enable most industry participants to generate healthy profits. Differing competitive environments are determined by the structural attributes of the industry. For this important reason, industry analysis is a vital complement to company analysis. The analyst needs to understand the context in which a company operates to fully understand the opportunities and threats that a company faces. The framework for strategic analysis known as “Porter’s five forces” can provide a useful starting point. Porter maintains that the profitability of companies in an industry is determined by five forces: 1) The threat of new entrants, which in turn is determined by economies of scale, brand loyalty, absolute cost advantages, customer switching costs, and government regulation; 2) the bargaining power of suppliers, which is a function of the feasibility of product substitution, the concentration of the buyer and supplier groups, and switching costs and entry costs in each case; 3) the bargaining power of buyers, which is a function of switching costs among customers and the ability of customers to produce their own product; 4) the threat of substitutes; and 5) the intensity of rivalry among existing competitors, which in turn is a function of industry competitive structure, demand conditions, cost conditions, and the height of exit barriers. The concept of barriers to entry refers to the ease with which new competitors can challenge incumbents and can be an important factor in determining the competitive environment of an industry. If new competitors can easily enter the industry, the industry is likely to be highly competitive because incumbents that attempt to raise prices will be undercut by newcomers. As a result, industries with low barriers to entry tend to have low pricing power. Conversely, if incumbents are protected by 93 CU IDOL SELF LEARNING MATERIAL (SLM)
barriers to entry, they may enjoy a more benign competitive environment that gives them greater pricing power over their customers because they do not have to worry about being undercut by upstarts. Industry concentration is often, although not always, a sign that an industry may have pricing power and rational competition. Industry fragmentation is a much stronger signal, however, that the industry is competitive and pricing power is limited. The effect of industry capacity on pricing is clear: Tight capacity gives participants more pricing power because demand for products or services exceeds supply; overcapacity leads to price cutting and a highly competitive environment as excess supply chases demand. The analyst should think about not only current capacity conditions but also future changes in capacity levels—how long it takes for supply and demand to come into balance and what effect that process has on industry pricing power and returns. Examining the market share stability of an industry over time is like thinking about barriers to entry and the frequency with which new players enter an industry. Stable market shares typically indicate less competitive industries, whereas unstable market shares often indicate highly competitive industries with limited pricing power. An industry’s position in its life cycle often has a large impact on its competitive dynamics, so it is important to keep this positioning in mind when performing strategic analysis of an industry. Industries, like individual companies, tend to evolve over time and usually experience significant changes in the rate of growth and levels of profitability along the way. Just as an investment in an individual company requires careful monitoring, industry analysis is a continuous process that must be repeated over time to identify changes that may be occurring. Price competition and thinking like a customer are important factors that are often overlooked when analyzing an industry. Whatever factors most influence customer purchasing decisions are also likely to be the focus of competitive rivalry in the industry. Broadly, industries for which price is a large factor in customer purchase decisions tend to be more competitive than industries in which customers value other attributes more highly. Company analysis takes place after the analyst has gained an understanding of the company’s external environment and includes answering questions about how the company will respond to the threats and opportunities presented by the external environment. This intended response is the individual company’s competitive strategy. The analyst should seek to determine whether the strategy is primarily defensive or offensive in its nature and how the company intends to implement it. 94 CU IDOL SELF LEARNING MATERIAL (SLM)
Spreadsheet modelling of financial statements to analyse and forecast revenues, operating and net income, and cash flows has become one of the most widely used tools in company analysis. Spreadsheet modelling can be used to quantify the effects of the changes in certain swing factors on the various financial statements. The analyst should be aware that the output of the model will depend significantly on the assumptions that are made. 9.5 KEYWORDS Market Analysis: A market analysis is a quantitative and qualitative assessment of a market. It investigates the size of the market both in volume and in value, the various customer segments and buying patterns, the competition, and the economic environment in terms of barriers to entry and regulation. Industry Analysis: Industry analysis is a tool that facilitates a company's understanding of its position relative to other companies that produce similar products or services. Understanding the forces at work in the overall industry is an important component of effective strategic planning. Systematic Analysis Methods: Qualitative research fieldwork produces clouds of data. We must ensure that no idea is lost, and that comprehensive understanding is produced. While much has been written about research methods and even individual analysis techniques, not much has been written about systematic methods of analysis. Systematic Analysis: Systemic analysis is a way of thinking. It is a way of putting together the pieces of information we must create an understanding of the whole of what is happening in our society (wherever that is) as well as communities and societies around the world. Metastock Analysis: MetaStock is a charting software tool for traders to analyse the markets. It uses technical analysis to help traders take the guesswork out of trading by offering a methodical, systematic approach to selecting which securities to trade and when. 9.6 LEARNING ACTIVITY 1. Business cycles are a type of fluctuation found in the aggregate economic activity of nations cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions. What are the 5 phases of the business cycle? ___________________________________________________________________________ ___________________________________________________________________________ 95 CU IDOL SELF LEARNING MATERIAL (SLM)
2. The Deep Learning Market is expected to register a CAGR of 42.56% over the forecast period from 2020 to 2025. Deep learning, a subfield of machine learning (ML), has led to breakthroughs in several artificial intelligence tasks, including speech recognition and image recognition. How is deep learning used in the industry? ___________________________________________________________________________ ___________________________________________________________________________ 9.7 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is the history of the industry? 2. What affects the growth of the industry? 3. Who are the leaders in the industry? 4. Are there any government regulations related to this specific industry? 5. What is the Standard Industry Classification – SCI? Long Questions 1. What is estimated size of the industry in money and products sold? 2. What are the trends in sales over recent years? 3. What is sensitivity of the industry? 4. What type of marketing strategy is usually used? 5. What are management trends in the industry? B. Multiple choice Questions 1. What does Strategic group analysis refer to? a. Identifying similarities and differences between groups of people who buy and use your firm's goods and services. b. Identifying strategies for groups of multinational firms. 1 c. Identifying strategies for similar groups of firms. d. Identifying firms with similar strategies or competing on similar bases. 2. What kind of organizational structure is this: XYZ Co has four sales teams: London & the Southeast, Wales & the Midlands, Northern England, and Scotland? a. Geographic organisation 96 CU IDOL SELF LEARNING MATERIAL (SLM)
b. Market organisation c. Network organisation d. Product organization 3. Identify the right option for the following: Strategic management is an important part of any business which helps with _________ formulation and business decisions. a. Strategy b. Tactics c. Procedure d. Marketing 4. What is Strategy? a. Completely Proactive & Completely Reactive b. Partly Proactive & Partly Reactive c. Neither Proactive nor Reactive d. Proactive Only 5. Which of the following is not part of the microenvironment? a. Technology b. Shareholders c. Competitors d. Publics Answers 1-a, 2-a, 3-a, 4-b, 5-a 9.8 REFERENCES References Weir, Deborah. (22 November 2005). Timing the Market: How to Profit in the Stock Market Using the Yield Curve, Technical Analysis, and Cultural Indicators. Wiley; 1st edition. Palat, Raghu. (1 January 2015). Fundamental Analysis for Investors: How to Make Consistent, Long-term Profits in the Stock Market. Vision Books; 4th edition. 97 CU IDOL SELF LEARNING MATERIAL (SLM)
Sharma, Robin. (15 September 2021). The Everyday Hero Manifesto. Mumbai, Maharashtra. Jaico Publishing House; 1st edition. Textbooks Sivalingam, Ravi. (13 March 2018). Strategic Management. Industry Analysis, Strategic Drift and Re-Strategizing. Grin Verlag. (CNBC TV18), TV18 Broadcast LTD. (5 October 2018). Everything You Wanted to Know About Stock Market Investing. TV18 Broadcast LTD (CNBC TV18). Gala, Khushboo. Gala, Ankit. (1 January 2019). Fundamental Analysis Shares: Become an Intelligent Investor. Buzzing stock Publishing House; 1st edition. Websites https://www.entrepreneurshipinabox.com/653/industry-analysis-answering-40- questions/ https://www.mordorintelligence.com/industry-reports/deep-learning https://study.com/academy/practice/quiz-worksheet-industry-analysis-for-business- plans.html 98 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 10 COMPANY ANALYSIS STRUCTURE 10.0 Learning Objectives 10.1 Introduction 10.2 AnalysisofGrowth andValueCompanies 10.3 RealtimeOnline ShareTradingStrategies 10.4 Relevance 10.5 Steps 10.6Summary 10.7Keywords 10.8Learning Activity 10.9Unit End Questions 10.10References 10.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Explainreal time online share trading strategies. Analyze growth and value of companies. Describe how to deliver better services and products. 10.1 INTRODUCTION Industry analysis is the analysis of a specific branch of manufacturing, service, or trade. Understanding the industry in which a company operates provides an essential framework for the analysis of the individual company—that is, company analysis. Equity analysis and credit analysis are often conducted by analysts who concentrate on one or several industries, which results in synergies and efficiencies in gathering and interpreting information. Industry Classification Products and/or Services Supplied Business-Cycle Sensitivities Statistical Similarities: Compare and contrast the methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system. Pages Modern classification schemes are most based on grouping 99 CU IDOL SELF LEARNING MATERIAL (SLM)
companies by similar products and/or services. According to this perspective, an industry is defined as a group of companies offering similar products and/or services. For example, major companies in the global heavy truck industry include Volvo, Daimler AG, Paccar, and Navistar, all of which make large commercial vehicles for the on-highway truck market. Similarly, some of the large players in the global automobile industry are Toyota, General Motors, Volkswagen, Ford, Honda, Nissan, PSA Peugeot Citroën, and Hyundai, all of which produce light vehicles that are close substitutes for one another. Companies are sometimes grouped based on their relative sensitivity to the business cycle. This method often results in two broad groupings of companies―cyclical and noncyclical. A cyclical company is one whose profits are strongly correlated with the strength of the overall economy. Such companies experience wider-than-average fluctuations in demand—high demand during periods of economic expansion and low demand during periods of economic contraction— and/or are subject to greater-than-average profit variability related to high operating leverage (i.e., high fixed costs). Concerning demand, cyclical products and services are often relatively expensive and/or represent purchases that can be delayed if necessary (e.g., because of declining disposable income). Examples of cyclical industries are autos, housing, basic materials, industrials, and technology. A noncyclical company is one whose performance is largely independent of the business cycle. Noncyclical companies produce goods or services for which demand remains relatively stable throughout the business cycle. Examples of noncyclical industries are food and beverage, household and personal care products, health care, and utilities. Statistical approaches to grouping companies are typically based on the correlations of past securities’ returns. For example, using the technique known as cluster analysis, companies are separated (based on historical correlations of stock returns) into groups in which correlations are relatively high but between which correlations are relatively low. This method of aggregation often results in nonintuitive groups of companies, and the composition of the groups may vary significantly by time and region of the world. Growth Companies Cyclical Industries Defensive Industries Growth Industrials: Explain the factors that affect the sensitivity of a company to the business cycle and the uses and limitations of industry and company descriptors such as “growth,” “defensive,” and “cyclical. “Pages the usefulness of industry and company labels such as “cyclical,” “growth,” and “defensive” is limited. Cyclical industries as well as growth industries often have growth companies within them. A cyclical industry itself, although exposed to the effects of fluctuations in overall economic activity, may grow at an above-average rate for periods spanning multiple business cycles. Furthermore, when fluctuations in economic activity are large, as in the deep recession of 2008−2009, few companies escape the effects of the cyclical weakness in overall economic activity. The defensive label is also problematic. Industries may include both companies that are growth and companies that are defensive in character, making the choice 100 CU IDOL SELF LEARNING MATERIAL (SLM)
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