INVESTMENT ANALYSIS AND

PORTFOLIO MANAGEMENT
Jeet R.Shah
M.Com, CFP CM ,Ph.D
 Overview
2

 Meaning :-
1. Investment
2. Portfolio
3. Capital Market
 Investment Attributes
 Approaches to Investment Decision Making

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 Investment
3

 Income - Expenses = Savings ??????

 he tradeoff of present consumption for a higher level of
future consumption is the reason for saving.What you do with
the savings to make them increase over a time is Investment.
 Thus it is the purchase of any asset with the potential to
yield future financial benefit to the purchaser.

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 BENJAMIN GRAHAM
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 Prof at Columbia Business School

 Graham is considered the dean of financial analysis.
 He was awarded that distinction because “before him there
was no [financial analysis] profession and after him they began
to call it that.”
 Graham’s two most celebrated works are Security Analysis,
coauthored with David Dodd, and originally published in
1934; and The Intelligent Investor, originally published in 1949.
 lack of a universal definition for investment that would
distinguish it from speculation

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 BENJAMIN GRAHAM
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“An investment operation is one which, upon thorough

analysis, promises safety of principal and a
satisfactory return. Operations not meeting these
requirements are speculative.”

1.Its the act of buying and selling a security

2.RIL in March 2000 and RIL today
3.Cannot say that a good company is a good
investment.
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 BENJAMIN GRAHAM
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“An investment operation is one which, upon thorough

analysis, promises safety of principal and a
satisfactory return. Operations not meeting these
requirements are speculative.”

“the careful study of available facts with the

attempt to draw conclusions there from
based on established principles and sound
logic.”

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 BENJAMIN GRAHAM
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“An investment operation is one which, upon thorough

analysis, promises safety of principal and a
satisfactory return. Operations not meeting these
requirements are speculative.”

1.Investing is a probabilistic activity. There are winners

and losers.
2.There are no sure things.

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 BENJAMIN GRAHAM
8

“An investment operation is one which, upon thorough

analysis, promises safety of principal and a
satisfactory return. Operations not meeting these
requirements are speculative.”

Sequence is IMP

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 BENJAMIN GRAHAM
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Investment V/S Speculation

Investment has a MOS and Speculation doesn’t

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 BENJAMIN GRAHAM
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 “We insist on a margin of safety in our purchase price. If we

calculate the value of a common stock to be only slightly higher
than its price, we're not interested in buying. We believe this
margin-of-safety principle, so strongly emphasized by Ben
Graham, to be the cornerstone of investment success.”
-WB

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 BENJAMIN GRAHAM
11

 The Idea of “Margin of Safety” is based on the idea of Redundancy

in Engineering
 “Duplication of critical components of a system with the intention of
increasing reliability of the system, usually in the case of a backup or
failsafe...
 “In many safety-critical systems, such as fly-by-wire aircraft, some
parts of the control system may be triplicated. An error in one
component may then be out-voted by the other two.
 “In a triply redundant system, the system has three sub components, all
three of which must fail before the system fails. Since each one rarely
fails, and the sub components are expected to fail independently, the
probability of all three failing is calculated to be extremely small.”

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 Margin of Safety - Bonds
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 In Graham’s view, establishing a margin-of-safety concept for bonds

was not too difficult.
 It wasn’t necessary, he said, to accurately determine the company’s
future income, but only to note the difference between earnings and
fixed charges.
 If that margin was large enough, the investor would be protected
from an unexpected decline in the company’s income.
 If, for example, an analyst reviewed the operating history of a
company and discovered that, on average, for the past five years
the company was able to earn annually five times its fixed charges,
then that company’s bonds possessed a margin of safety.

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 Margin of Safety - Stocks
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 spread between the price of a stock and the intrinsic

value of a company should be large enough.
 IV = “that value which is determined by the facts.”
 These facts included a company’s assets, its earnings
and dividends, and any future definite prospects.
 PV
 IV does not equal to CMP

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 Margin of Safety - Stocks
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 There are two rules of investing, said Graham. The first rule is
don’t lose.
 The second rule is don’t forget rule number one.
 This “don’t lose” philosophy steered Graham toward two
approaches for selecting common stocks that, when applied,
adhered to the margin of safety.
1. The first approach was buying a company for less than two-
thirds of its net asset value, and
2. The second was focusing on stocks with low price-to-earnings
(P/E) ratios.

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 Margin of Safety - Stocks
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 Graham’s conviction rested on certain assumptions.

 First, he believed that the market frequently mispriced stocks,
usually because of the human emotions of fear and greed.
 His second assumption was based on the statistical
phenomenon known as “reversion to the mean,” although he
did not use that term. More eloquently, he quoted the poet
Horace: “Many shall be restored that now are fallen, and
many shall fall that now are in honor.”
 However stated, by statistician or poet, Graham believed that
an investor could profit from the corrective forces of an
inefficient market.

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 MOS - WB
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 Margin of Safety in Business Models

 Pricing power
 Low cost advantage
 Margin of Safety in Capital Structures
 Aversion to debt
 Margin of Safety in Managerial Practices
Margin of Safety in Accounting
“Optimism has no place in accounting.”
- Charlie Munger
Bad accounting encourages bad behavior

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 Two Key Aspects
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1. Time .
2. Risk.
 Sacrifice takes place now and is certain .
 The benefit is expected in the future and is uncertain.
 In some investment Time element is dominant –Govt Bonds.
 In some investment Risk element is dominant –Stock Options.
 In some investment both Time and Risk are dominant –Equity
Shares.

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 Two concepts
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1. Economic Investment :
 Addition to the Capital Stock of the society.
 Capital Stock of the society are the goods which are used in
the production of other goods.
2. Financial Investment :
 This is an allocation of monetary resources to the assets
that are expected to yield some gain or return over a
period of time.
 It means an exchange of financial claims such as shares.

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 Portfolio
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 A portable case for holding paper, Drawings,etc

 All the investments of an individual

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 Financial Market
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 A Financial Market is a market for the creation and

exchange of financial assets.
 Functions :-
1. Facilitates Price Discovery
2. Provides Liquidity
3. Reduces cost of transacting.

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 Classification
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 Nature Of claim –  Timing of Delivery –

a. Debt Market a. Cash / Spot Market
b. Equity Market
b. Forward or Futures
 Maturity Of Claim –
a. Money Market  Organisational Structure –
b.Capital Market a. Exchange Traded
b. Over the Counter
 Seasoning Of Claim –
a. Primary Market
b. Secondary Market

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 Investment Attributes
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1. Rate Of Return
2. Risk
3. Marketability
4. Tax Shelter
5. Convenience

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Evaluation Of Various Investment Avenues
Return Risk Marketa Tax Conveni
bility / Shelter ence
Liquidity
Current Capital
Yield Appreciati
on
Equity Low High High Fairly High High
Shares High
Non- High Negligible Low Average Nil High
convertible
Debentures

Equity Low High High High High Very High

Schemes
Debt Moderate Low Low High No tax on Very High
Schemes Dividends

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Evaluation Of Various Investment Avenues
Return Risk Marketa Tax Conveni
bility / Shelter ence
Liquidity
Current Capital
Yield Appreciati
on
Bank Moderate Nil Negligible High Nil Very High
Deposits
PPF Nil Moderate Nil Average Sec 80C Very High
benefit
LIP Nil Moderate Nil Average Sec 80C Very High
benefit
Real Moderate Moderate Negligible Low High Fair
Estate
Gold & Nil Moderate Average Average Nil Average
Silver

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 Approaches to
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Investment Decision Making
 Fundamental Approach
 Psychological / Technical Approach
 Academic Approach
 Eclectic Approach
 Cybernetic Analysis

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 Fundamental Approach
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 It is a method of forecasting the future price

movements of a financial instrument based on
economic ,social , political and other relevant factors
and the statistics that will affect the basic supply and
demand of whatever underlines the financial
instrument.
 It is an answer to the question of what to buy and
why to buy.

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 Technical Approach
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 In his book “Technical Analysis Explained” , Martin Ping explains :

“The TA approach to investing
- is essentially a reflection of the idea that prices move in trends
-which are determined by the changing attitudes of investors
towards a variety of economic,monetary, political & psychological
forces.
- The art of TA – for it is an art – is to identify trend changes at an
early stage &
-to maintain an investment posture until the weight of the evidence
indicates that the trend has been reversed.”

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 Academic Approach
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 Tenets
1. Market Price approx equals to Intrinsic Value
2. Stock price behaviour corresponds to a random
walk
3. There is a positive relationship between risk and
return

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 Eclectic Approach
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 Neither FA nor TA should be used in isolation.

 It is better to use The Eclectic Approach.

This means-
 Conduct FA to establish certain value “anchors.”

 Do TA to assess the state of the market psychology .

 Combine FA and TA to determine which securities are worth-

buying, holding and disposing off.
 Respect Market Price and do not show excessive zeal in
“beating the market”
 Accept that for higher return there are higher risk.

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 Cybernetic Analysis
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 Jerry Felson offers an alternative to the efficient market theory in his book,
Cybernetic Approach to Stock Market Analysis (Exposition Press, 1975) in
order to bypass its perceived limitations and deficiencies.
 According to Felson, the extreme complexity of the stock market and the
environment in which it operates as well as inadequate investment tools
hamper the investor from earning above-average investment returns.
 Using cybernetics concepts (the science and control of communication, and
mathematical analysis of the flow of information) and artificial intelligence
(advanced cybernetics) techniques, Felson proposes developing judgmental
decision-making processes by weighing evidence and formalizing
investment analysis.
 In plain language, the cybernetics approach automates the investment
decision-making process through the use of pattern recognition, learning
system theory, and other methods, removing the imperfect human factor
and theoretically improving investment returns.


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 Cybernetic Analysis
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 Felson stresses that no investment analysis can be very

successful unless it conforms to the law of requisite
variety.
 In other words, the investment decision system must
be as complex and as variable as the system (stock
market) which it is trying to interpret.
 According to Felson, this is where other investment
systems fail.

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