SECURITY ANALYSIS & PORTFOLIO MANAGEMENT

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Hitesh Shah

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Industry analysis
Industry

A group of firms produsing reasonably similar products which serve the same needs of common set of buyers.
E.g. Cement industry, cotton industry.

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Industry life cycle

Product has life cycle. They have identified four stages

in the life of a product,

Introduction

stages, stages,Decline stages

Growth

stages,

Maturity

Same way in industry is also said to have a life cycle. Pioneering stage The expansion stage The stagnation stage
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Decay stage

 The technological advances in one industry can effect

the growth of another industry. The jute industry began to decline when alternate and cheaper packing material came in to use.
The first step in industry analysis, therefore, is to

determine the stage of growth through which the industry is passing.

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Pioneering stage
In this stage a new industry where the technology as well as product are relatively new and have not reached a state of perfection. Many companies compete with each other vigorously. As large no. of companies attempt to capture their share of market, these arises high business mortality rates. Weak firms are eliminated and lesser number of firms survive in the pioneering stage.

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 Therefore investment in companies in an industry that

in an industry that is in the pioneering stage is highly risky.

Industries in the pioneering stage are called sunrise

industries.
Telecomunications,computersoftware,information

technology,etc.are examples of sunrise industries in India at present.

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Expansion stage
The second stage of expansion or growth. The industry

now includes only those companies that have survived in the pioneering stage. These companies continue to become stronger. Each companies finds a market for itself and develops its own strategies to sell and maintain its position in the market.
Investors can get high returns at low risk because

demand exceeds supply in this stage.

Companies will earn increasing amount of profit and

pay attractive dividends.

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Stagnation stage
The growth of the industry stabilizes. The ability of

industry to grow appears to have been lost. Sales may be increasing but at a slower rate than that experienced by competitive industries or by the overall economy.
Two important reasons for this transaction are change

in social habits and development of improved technology. Eg. B/W TVs during eighties.
An investor should dispose of his holdings in an

industry which begins to pass from the expansion stage to the stagnation stage because what is to follows 2/21/11

Decay stage
This occurs when the products of the industry are no

longer in demand. New products and new technologies have come to the market. Customers have changed their habits, style and liking. As a result the industry becomes obsolete and gradually cease to exist.
An investor should get out of the industry before the

onset of the decay stage.

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 An industry usually exhibits low profitability in the

pioneering stage, high profitability in the growth or expansion stage, medium but steady profitability in the stagnation or maturity stage and declining profitability in decay stage.
The classification of industries under this approach is

general pattern. There can be exceptions to this general pattern.

Careful analysis is needed to detect such exception.

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Industry characteristics
Demand and supply gap: excess supply reduces the

profitability of industry through a decline in the unit price realization.

on the contrary insufficient supply tends to improve

the profitability through higher unit price realization.

The gap between demand and supply in industry is

fairly a good indicator of its short-term and long term or mediumterm prospective.

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 Competitive conditions in the industry:

New entrants to an industry increase the capacity in an industry. These new entrants may face certain barriers to their entry. The barriers to entry may arise because of product differentiation, absolute cost advantage or economy of scale.
Permanence:

It is very important phenomenon related to the products and technology used by the industry. If an analyst feel that the need for a particular industry will vanish in short period or the rapid technological 2/21/11 changes would render the products obsolete within a

 Labour conditions:

Where the labour union are very powerful. If the labour in particular industry is rebellious and is inclined to resort to strikes frequently the prospects of that industry cannot become bright.
Attitude of the government:

The government may encourage the growth of certain industries and can assist such industries through favorable legislation. On the contrary the government may look with disfavor on certain other industries.
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In India this has been the experience of alcoholic

 Supply of raw materials: Some industries may have no difficulty in obtaining

the major raw materials as they may have to depend on a few manufacturers within the country or on imports from outside the country or
Cost structure:

It includes fixed cost and variable cost.

Lower the fixed cost relative to the variable cost lower

would be the break even point. lower break even point provide the higher margin of safety.
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Company analysis
Porters model of five competitive factors Ratio analysis Financial statement analysis Other variables analysis Risk measurement

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Peters models of five competitive forces

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Threat of new entrants:

Determinants :
Economies of scale Brand identity Capital requirements Absolute cost advantages Government policy Product differences Switching cost 2/21/11

Threat of substitute product and services

Determinants:

Relative price performance of substitute Switching cost Customer propensity to substitute

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Bargaining power of suppliers

Determinants
Differentiation of inputs Switching cost of suppliers Presence of substitute input Supplier concentration Importance of volume to supplier

Cost relative to total purchases

Cost differential of input quality differentiation 2/21/11

Customer bargaining power

Determinants
Bargaining strength
Customer concentration Customer volume Customer switching costs Customer information Ability to backward integrate
2/21/11 Substitute products

Existing rivalry
Determinants
Company growth Intermittent over capacity Brand visibility Concentration Diversity of competitors

Fixed costs
Product differences 2/21/11

Financial statement analysis Balance sheet

Profit & loss a/c To provide reliable financial information about change

in net resources of enterprise that result from profit directed activity

It assist in estimating the earning potential of the

enterprise.
It provide information about the change in economic

resources and obligations.

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It also disclose, to the extent possible, other

 Is the firm in a position to meet its current

obligations?
What sources of long term finance are employed by

the firm and what relationship between them?

How efficiently does the firm use its assets?

Are the earning of the firm adequate

Investors consider the firm profitable and safe?

It does not give the exact answer of this questions but

it indicate what can be expected in future.

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 The content of the statements differ according to

the nature of business of the company. Broadly, the tools that are used for company analysis can be distinguished in terms of whether they are manufacturing companies, financial service companies, trading companies or multinational companies.
Manufacturing companies:-

Performance ratio Leverage ratio , liquidity ratio ,Turnover days of inventory , collection period.

Profitability ratio ROE, Return on total assets, net profit ratio and pay out ratio etc.
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 Trading companies

Balance sheet ratio Current ratio , quick ratio , debt equity

ratio. Profitability ratio ROI, net profit ratio , dividend pay out ratio etc. Value ratio Book value per share, EPS, Yield ratio.
Service companies.

Profitability ratio ROI, Return on capital, net profit ratio and dividend pay out ratio etc.
Liquidity ratio - Current ratio , quick ratio. Leverage ratio Debt equity ratio. Value ratio Book value per share, 2/21/11 EPS, Yield ratio.

Performance ratio Net int. margin/ total assets , Profit margin = Net profit/ Total Income. Assets Quality : GrossNPAs/ Gross advances, GrossNPAs/Total assets , Provision for loans & investments/Total Assets. Etc.

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Ratio analysis
Liquidity ratios concerned with the short term

solvency of the concern or its ability to meet financial obligation on their due dates.
Activity ratios concerning efficiency of management

of various assets by the concern.

Leverage ratios concerning stake of the owners in the

business in relation to outside borrowings or long term solvency.

Coverage ratios concerned with the ability of the

company to meet fixed commitments such as interest 2/21/11 on term loans and dividend on preference shares and

Other variables:
Companys market share Capacity utilization Modernization and expansion plan Order book position Availability of raw materials

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Degree of total leverage

DTL = contribution

Assessment of risk:
profit before tax(PBT) Operating leverage
DOL = contribution

earning before interest& tax(EBIT)

Financial leverage
DFL = profit before tax(PBT) 2/21/11

Technical analysis
The technical analysis believes that share prices are

determined by the demand and supply forces operating in the market.

That are influenced by a number of fundamental

factors as well as certain psychological or economical factors. some of them are not quantified.
the combined effect of all these factors is reflected on

the movement of the share prices.

By examining past shares price movements future

share prices can be accurately predicted.

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Dow theory
It was formulated by the Charles h. dow who was the

editor of the wall street general in U.S.A. During 19001902

Charles dow formulated a hypothesis that the stock

market does not move on random bases but his influence by three distinct cyclical trend that guide its direction.
The market has three movements and this movement

are simultaneous in nature.

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Primary movements

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1. Primary movement.

large range cycle that carries entire ups and down of market. this is the long term trended of market it usually last more than one year and may it last for several year. It can be either bullish market or bearish market.
2. Secondary Reactions:

these trends are intermediate, corrective reactions to the primary trend.

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these reactions typically last for one three months.

 Minor movement.

these are day to day fluctuations in the market . The minor movements are not significant and have a no analytical value as they are very short duration.

The price movements in the market can be identified

by means of line chart.

In these chart closing prices of shares or closing value

of market index may be floated against the corresponding trading days.

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helps in identifying primary secondary

 bull market is upward moving market 1. the prices would advance with the revival of

Bullish trend

confidence in the future of business.

2. price would advance due to improvement in

corporate earning
3. price advance due to inflation and speculation so in

line chart would execute formation of three peaks. Each peaks would be follow by a bottom formed by the secondary reaction. Each peaks would be higher than previous peaks. Each successive bottom would be higher than previous bottom . 2/21/11

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Bearish trend:
bearish market is downward moving market.

These also having three phases.

1) Prices begin to fall due to abandonment of hopes 2)Investor begin to sell there shares. In second phase

company start reporting lower profit and lower dividends. These causes further fall in prices due to increase selling pressure.
3) Price fall still further due to distress selling. Bearish market would be indicated by the formation of
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lower bottoms

 Dow theory laid emphasis on volume of transactions

also.
Theory also make certain assumptions which have

been referred as hypothesis of the theory. 1. The market discounts everything.

2.
3.

Price moves in trends.

History tends to repeat itself.

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1. The Market Discounts Everything

A major criticism of technical analysis is that it only considers price movement, ignoring the fundamental factors of the company.

However, technical analysis assumes that, at any given time, a stock's price reflects everything that has or could affect the company - including fundamental factors.

Technical analysts believe that the company's fundamentals, along with broader economic factors and market psychology, are all priced into the stock, 2/21/11

2. Price Moves in Trends

In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this assumption.

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3. History Tends To Repeat Itself

Another important idea in technical analysis is that

history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time.
Technical analysis uses chart patterns to analyze

market movements and understand trends.

Although many of these charts have been used for

more than 100 years, they are still believed to be relevant because they illustrate patterns in price 2/21/11

Trends and trend reversal

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Trend and reversals

Raising trend (Bullish trend)

Falling trend (Bearish trend)

Reversal trend

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Reversal
A change in the direction of a price trend. On a price

chart, reversals undergo a recognizable change in the price structure.

An uptrend, which is a series of higher highs and

higher lows, reverses into a downtrend by changing to a series of lower highs and lower lows.
A downtrend, which is a series of lower highs and

lower lows, reverses into an uptrend by changing to a series of higher highs and higher lows.
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Also referred to as a "trend reversal", "rally" or

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 The Importance of Trend

It is important to be able to understand and identify trends so that you can trade with rather than against them.
Two important sayings in technical analysis are "the

trend is your friend" and "don't buck the trend,

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Charts:
A chart is simply a graphical representation of a

series of prices over a set time frame.

Chart Properties

There are several things that you should be aware of when looking at a chart, as these factors can affect the information that is provided.
They include the time scale, the price scale and

the price point properties used.

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Line Chart
The most basic of the four charts is the line chart because it represents only the closing prices over a set period of time. The line is formed by connecting the closing prices over the time frame. Line charts do not provide visual information of the trading range for the individual points such as the high, low and opening prices. However, the closing price is often considered to be the most important price in stock data compared to the high and low for the day and this is why it is the only value used in line charts.

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Bar Charts
The bar chart expands on the line chart by adding several more key pieces of information

to each data point.

The chart is made up of a series of vertical lines that represent each data point. This

vertical line represents the high and low for the trading period, along with the closing price. The close and open are represented on the vertical line by a horizontal dash.
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 The opening price on a bar chart is illustrated by the

dash that is located on the left side of the vertical bar. Conversely, the close is represented by the dash on the right.
Generally, if the left dash (open) is lower than the right

dash (close) then the bar will be shaded black, representing an up period for the stock, which means it has gained value.
A bar that is colored red signals that the stock has

gone down in value over that period. When this is the case, the dash on the right (close) is lower than the dash on the left (open).
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The candlestick chart

The candlestick charting pattern is one that any experienced trader must know. As Japanese rice traders discovered centuries ago, investors' emotions surrounding the trading of an asset have a major impact on that asset's movement. Candlesticks help traders to gauge the emotions surrounding a stock, and thus make better predictions about where that stock might be headed.

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In the chart you see the "long black body" or "long black line". The long black line represents a bearish period in the marketplace. During the trading session, the price of the stock was up and down in a wide range and it opened near the high and closed near the low of the day. By representing a bullish period, the "long white body", or "long white line"-(in the EBAY chart below, the white is actually gray because of the white background) is the exact opposite of the long black line. Prices were all over the map during the day, but the stock opened near the low of the day and closed near the high.
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Spinning tops are very small bodies and can be either black or white. This pattern shows a very tight trading range between the open and the close, and it is considered somewhat neutral. Doji lines illustrate periods in which the opening and closing prices for the period are very close or exactly the same. You will also notice that, when you start to look deep into candlestick patterns, the length of the shadows can vary.

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point and figure chart

The point and figure chart is not well known or used

by the average investor but it has had a long history of use dating back to the first technical traders. This type of chart reflects price movements and is not as concerned about time and volume in the formulation of the points.
When first looking at a point and figure chart, you will

notice a series of Xs and Os. The Xs represent upward price trends and the Os represent downward price trends. There are also numbers and letters in the chart; these represent months, and give investors an idea of 2/21/11 the date.

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Chart pattern
Support pattern

Resistance pattern
Reversal pattern Continuation pattern

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 A support level is the price at which buyers are

Support pattern

expected to enter the market in sufficient numbers to take control from sellers.
The market has a memory. When price falls to a new

Low and then rallies, buyers who missed out on the first trough will be inclined to buy if price returns to that level. Afraid of missing out for a second time, they may enter the market in sufficient numbers to take control from sellers. The result is a rally, reinforcing perceptions that price is unlikely to fall further and creating a support level.
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 A resistance level is the price level at which sellers are

Resistance pattern

expected to enter the market in sufficient numbers to take control from buyers.
When price makes a new High and then retreats,

sellers who missed the previous peak will be inclined to sell when price returns to that level. Afraid of missing out a second time, they may enter the market in numbers sufficient to overwhelm buyers. The resulting correction will reinforce market perceptions that price is unlikely to move higher and establish a resistance level.
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 Some support and resistance levels are more important

Strength of Support/Resistance

than others. The significance of the support level is identifiable by:

the number of times that the level has been respected; the amount of volume that has been traded near the

level;
whether the level is old or new - recent levels have

greater significance;

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Reversal pattern
Support levels, once penetrated, frequently become

resistance levels and vice versa.

The market logic is fairly simple: buyers who purchase

near a support level, only to see price fall, are likely to sell in order to recover their losses, when price rallies to near their break-even point. The support level then becomes a resistance level.
Likewise, stockholders who sell when price approaches

a resistance level will be disappointed if price penetrates the level and continues to rise. They will be inclined to buy if price returns to near the support 2/21/11 level, fearing that they may miss out a second time.

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 The most common of these are:

Head and shoulders top and bottom Double top and bottom Rounding top and bottom Broadening formation Rising and falling wedge

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Head and shoulders top

The Head and Shoulders Top is one of the most

common, and reliable, forms of reversal pattern. The shape consists of a left shoulder followed by a head and then a right shoulder.

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 The left shoulder is formed after an extensive

increase in price, usually supported by high volume. The shoulder rounds as the price dips slightly, usually on lower volume. This dip is the start of the neck line and the head is about to form.
The head is formed with heavy volume on the rising

part of the head and less volume on the falling part. Prices then fall to somewhere near the same level as the low of the left shoulder. It does not have to be at exactly the same level and could be slightly higher or lower, but definitely below the top of the left shoulder.
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 The right shoulder is formed by a rally in the price to

a level roughly equal with that of the left shoulder. Again it can be slightly higher or lower but definitely below the high achieved by the head.
Once the right shoulder has started to form you can

draw in a "neckline" across the bottoms created between the left shoulder and head and the head and right shoulder. When the price falls from the right shoulder and breaks through the neckline the Head and Shoulders Top formation has been confirmed and it is your signal to consider selling the share.
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Head and shoulders bottom

A Head and Shoulders Bottom is the inverse of a Head

and Shoulders Top, and it signifies a reversal from a downtrend to an uptrend

The main difference between this and the Head and

Shoulders Top is in the volume pattern associated with the share price movements.
The volume should pick up as the prices increase from

the bottom of the head and then increase even more on the rally which follows the right shoulder. If the neckline is broken but volume is low.
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Double top
Double Tops appear on a chart in the shape of the

letter "M" and are quite common.

A peak price is reached before a small decline, which

causes the valley between the Double Tops, and then the price rallies again to a peak roughly equal to the level of the first. The price then falls away on a new downtrend.
Correctly predicting a Double Top can be tricky.

This is because a simple uptrend, with each new wave of buying interspersed with minor reactions and profit taking, will appear as if it is making a Double Top formation. However, as you can see in the chart below, 2/21/11

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 Once you reach the point shown by the end of the line

on the chart above, you cannot be sure if the Double Top formation will be confirmed and the price will drop away, or if the price will again rally and the uptrend will stay in force. In roughly 90% of cases you will find that the Double Top is, indeed, a fake and the uptrend will stay in force.
Volume is important in determining whether a true

Double Top formation is being created or if it is going to be a fake. Look at the volumes associated with both of the peaks.
If the volume associated with the first peak is greater
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than that associated with the second peak, this

 If the volume accompanying the second rise is the

same as that accompanying the first, or even greater, it is likely that the uptrend will continue.
The time span taken to create the Double Top

formation can also help determine the likely progression of the price data.
If the two tops are fairly close together in terms of

time, it may well be a consolidation period, a pause for breath, before the rally continues.
If the peaks are separated over a longer period and

the valley between the two peaks is deep it is more 2/21/11 likely to turn into a genuine Double Top.

 Double bottom
A double bottom is the opposite of a double top and

appears as a letter "W" on a chart.

The formation of a double bottom and the indicators

of the reversal are much the same as for a double top, but the volume patterns are different. A true double bottom will show more volume on the second rally up than on the first rally.
If it's the other way round - low volume on the second

rally - you may not be looking at a double top at all, but at a continuing downtrend.
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Rounding tops and bottoms

A Rounding Top forms an "n" shape on a chart, and a

Rounded Bottom a "u" shape.

It can be difficult to separate a Rounded Bottom from a

consolidation pattern (i.e. one where the price continues to decrease or stay level), but the clue, as always, is in volume.
In a true Rounded Bottom, the volume decreases as

the price decreases, which signifies an easing of selling pressure. As the price movement becomes neutral and goes sideways you will see that there is 2/21/11 very little trading activity and volumes are very low.

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Broadening formations
The theory behind this reversal pattern is when you

get five small reversals they are usually followed by a more substantial change.
So in the example below, you have:

Reversal 1: change from rise to fall Reversal 2: change from fall to rise Reversal 3: change from rise to fall
2/21/11 Reversal 4: change from fall to rise

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 In a Broadening Top, reversal 3 must occur at a higher

level than reversal 1, and reversal 5 must be higher than reversal 3. Reversal 4 must occur at a lower level than reversal 2.

The underlying idea behind this reversal pattern is

that the market is almost out of control and lacking support from well-informed investors. The smart money is bearish on the stock, but it keeps on getting bounced upwards by other investors. Volume is also erratic during this period and does not help with the interpretation of the charts.
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Wedge formations
If you draw trend lines along both the bottom and

top of a share price chart, you will sometimes get a trend channel and you'll sometimes get a wedge shape similar to the one below.
According to the theory, if the wedge is pointing

upwards, as in our example, the share price will fall when the price line cuts across the lower line of the wedge.
If the wedge is pointing downwards (a falling wedge),

the share price will rise when the price line cuts across the upper line of the wedge. 2/21/11

 If the wedge is level - in other words not pointing up

or down - then this is a 'consolidation' pattern and you can expect the trends to continue. (i.e. no reversal)
Notice that wedge formations take place over a period

of 3-4 weeks. This is because they occur as reversals of intermediate and minor trends. They will not be seen, except in unusual circumstances, as reversals to a major market trend.

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Continuation patterns indicate that the price action described by the pattern is merely a pause in the prevailing trend and that upon breaking out of the pattern the price trend will continue in the same direction. We will look at the following patterns that imply trend reversals: Flags, Rectangles, Triangles, and Wedges.

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Flag

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Rectangle

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Triangles
Triangles are continuation formations. Three flavors:
Ascending Descending Symmetrical

Typically, triangles should break out about half to threequarters of the way through the formation.

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Flags

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Elliott Wave Theory

Elliott Wave Theory interprets market actions in terms

of recurrent price structures obedient to the Fibonacci sequence.

Basically, Market cycles are composed of two major

types of Wave : Impulse Wave and Corrective Wave. For every impulse wave, it can be sub-divided into 5 wave structure (1-2-3-4-5), while for corrective wave, it can be sub-divided into 3 - wave structures (a-b-c).

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 Surfer's Waves within Wave

An important feature of Elliott Wave is that they are

fractal in nature. 'Fractal' means market structure are built from similar patterns on a larger or smaller scales. Therefore, we can count the wave on a long-term yearly market chart as well as short-term hourly market chart.

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 This theory is based on the principle that action is

followed by reaction.
This theory used for predicting the future price

changes and deciding the timing of investment.

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indicators
Mathematical indicators

Market indicators

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Mathematical indicators
Moving average

1.simple moving average

2.exponential moving average

Factor =

2 n1

EMA=(clo. Price- previous EMA)* factor previous EMA

Oscillators
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Rate of change indicators(ROC)

 Rate of change indicators

ROC= current price

price n period ago-1

Relative strength index

RS= average gain per day

average loss per day

RSI=100-[100/(1 RS)]
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Market indicators
Breath of the market

Short interest
Odd-lot index Mutual fund cash ratio

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Conclusion
Information is pretty

thin stuff, unless mixed with experience.

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