fundamental analysis basics

8/6/2019 Fundamental Analysis Basics

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Fundamental & Technical Analysis

By Anup K. Suchak


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Fundamental Analysis - Meaning

` The intrinsic value of an equity share depends on amultitude of factors. The earning of the company, the

growth rate and the risk exposure of the company have a

direct bearing on the price of the share.

` These factors in turn rely on a host of other factors likeeconomic environment in which they function, the

industry they belong to, and finally the companies own

performance.


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Meaning

` Fundamental analysis consists of an appraisal of theintrinsic value of shares through:-

` Economic Analysis

` Industry Analysis

` Company Analysis


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Economic Analysis

` When the level of economic activity is low, stock prices arelow, and when the level of economic activity is high, stockprices are high.

` The commonly analyzed macro economic factors are asfollows:`

Gross Domestic Products` Saving and investment

` Inflation

` Interest Rates

` Budget

` The tax Structure

` The balance of Payment

` Monsoon and agriculture

` Infrastructure facilities

` Demographic factors


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Industry Analysis

` Industries are classified into:` Growth Industry

` Cyclical Industry

` Defensive Industry

` Cyclical Growth Industry


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Industry life cycle

` Stages of Industry Life Cycle are:-` Pioneering Stage

` Rapid Growth Stage

` Maturity and Stabilization Stage

` Decline Stage


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Other factors to be analyzed

` Growth of the Industry

` Cost structure and profitability

` Nature of the product

` Nature of the competition

` Government Policy

` Labour

` Research and Development

` Pollution Standards` SWOT Analysis


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Company Analysis

` In the company analysis the investor assimilates theseveral bits of information related to the company and

evaluates the present and future value of the stock.

` The risk and return associated with the purchase of the

stock is analyzed to take better investment decision.


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Factors to determine future price

1. Competitive Edge of the company

a) The Market Share

b) Growth of Sales

c)Stability of Sales

d) Sales forecast

i. The investor can fit a trend line either linear or non linear whichever is

suitable

ii. Historical percentage of company sales to the industry sales can be

analyzed

iii. The sales growth can be compared with the macroeconomic variables

like GDP, Per Capital Income and Population Growth.

iv. Different components of demand for the companys product have to be

analyzed because the demand may arise from different sources.

v. The demand for the substitutes and competitors product should also be

analyzed using least square techniques


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2. Earnings of the Company

a) Change in Sales

b) Change in costs

c) Depreciation Method adoptedd) Depletion of resources in the case of oil, mining, forest

products, gas, etc.

e) Replacement cost of inventories

f) Inventory accounting methodg) Wages, salaries and fringe benefits

h) Income taxes and other taxes


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3. Capital Structure

a) Equity Capital

b) Preference Capital

c) Long term DebtsI. Earning limit of debt

II. Asset limit to debt


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4. Management:Analysis can be carried out in following ways:

a) The background of managerial personnel contributes much to thesuccess of the management i.e. managers age, educationalbackground, advancement within the company, levels of responsibilityachieved and the activities in the social sphere can be studied.

b) The past record of management.

c) The managements skill to have a market share ahead of others is aproof of managerial success.

d) The companys strength to expand.

e) Ability to maintain efficient production by proper utilization of the

plant and machinery.

f) The managements capacity to finance the company adequately.

g) Ability of management to work with employees and the Union isanother area of concern.

h) Adaptability to scientific management and quality control techniques.


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5. Operating Efficiency:

a) Low Break Even Point

b) Efficient use ofFixed Assets with raw materials, labour and

managementc) Growing firm should have low operating ratio to meet the

growing demand for its product.


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6. Operating Leverage: If the firms fixed cost is high in the

total cost, the firm is said to have a high degree of

operating leverage. The investor should understand the

operating leverage of the firm because the firm with ahigh operating leverage is affected highly by the cyclical

decline.


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Financial Analysis

` Analysis ofFinancial Statement includes:` Comparative Financial Statements

` Trend Analysis

` Common Size Statement

` Fund Flow Analysis

` Cash Flow Analysis

` Ratio Analysis


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TECHNICAL ANALYSIS

` The underlying assumption of technical analysis is that theprice of a stock depends on supply and demand in the

market.

` It has little co-relation with its intrinsic value.

` Here, charts are drawn to identify price movementpattern to predict future movement of the stock.


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Assumptions of Technical Analysis

` Market value is determined solely by the interaction of supplyand demand.

` Supply and demand are governed by numerous factors, bothrational and irrational. Included in these factors are thoserelied upon by the fundamentalist, as well as opinions, moods,

guesses and blind necessities. The market weights all of thesefactors continually and automatically.

` Disregarding minor fluctuations in the market, security pricestends to move in trends which persist for an appreciablelength of time.

` Changes in trend are caused by the shifts in supply anddemand relationships. These shifts, no matter why they occur,can be detected sooner or later in the action of the marketitself.


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Distinction between Technical and

Fundamental Analysis

` Technical analysts try to predict short-term pricemovements whereas fundamental analysts try to establish

long-term values.

` The focus of technical analysis is mainly on internal

market data, particularly price and volume data whereasthe focus of fundamental analysis is on the factors relating

to economy, industry and the company.

` Speculator, who want to make quick money, mostly use

results of technical analysis, whereas investors, who investon long-term basis use the results of fundamental analysis.


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Dow Theory

` According to Charles Dow The market is alwaysconsidered as having three movements, all going at the

same time. The first is the narrow movement from day to

day. The second is the short swing, running from two

weeks to a month or more; and the third is the mainmovement,covering at least four years in its duration.

` The theory advocates that stock price behavior is 90%

psychological and 10% logical.

` It is the mood of the crowd which determines the way inwhich prices move and the move can be gauged by

analyzing the price and volume of transactions.


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Basic Tenets ofDow Theory

` The average discount everything except acts of god because theyreflect the combined market activities of thousands of investors andtraders.

` The market meaning the price of shares in general, swings in trendswhich may be major or primary, secondary and minor. The primary

trend may be the broad upward or downward movement which maylast for year or two. The secondary trends are correctivemovements, which may last for three weeks to three months. Theshort-term trend refers to the day to day price movement. It is alsocalled as oscillations or fluctuations. The primary trend may beinterrupted by the secondary trend.

` So long as each successive rally or price advance reaches a higherlevel than the one before it, and each secondary reaction, or pricedecline, stops at a higher level than the previous one, the primarytrend is up.This is call a bull market.


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Basic Tenets ofDow Theory

` When each intermediate decline carries prices tosuccessively lower levels and each intervening rally fails tobring them back up to the top level of the preceding rally,the primary trend is down and that is called bear market.

` The secondary trends are the intermediate declines ofcorrections which occur in bull market and theintermediate rallies or recoveries which occur in bearmarket.

` The minor trends are the brief fluctuations lasting usually

for six days but rarely for three weeks.` A trend should be assumed to continue in effect until

such time as its reversal has been definitely signaled.


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Dow TheoryChart


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Support and Resistance Level

` A support level exists at a price where considerabledemand for that stock is expected to prevent further fall

in the price level. Fall in the price may be halted for the

time being or it may result even in price reversal.

` In the support level, demand for the particular scrip isexpected.

` In the resistance level, supply of scrip would be greater

than the demand and further rise in price is prevented.

` The selling pressure is greater and the increase in price ishalted for the time being.


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Support and Resistance Level


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Indicators

` Technical indicators are used to find out the direction ofthe overall market. The overall market movements affect

the individual share price. Some of the indicators are:

` Volume of Trade

` The breadth of the market` Short Sales

` Odd lots trading

` MovingAverages

` Oscillators` Relative strength index

` Rate of Change


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Volume of Trade

` Dow gave special emphasis on volume. Volume expandsalong with the bull market and narrows down in the bear

market. Technical analysts use volume as an excellent

method of confirming the trend. The market is said to be

bullish when a small volume of trade and large volume oftrade follow the fall in price and the rise in price.

` A large volume with rise in price indicates a bull market

and a large volume with a fall in price indicates a bear

market.


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The Breadth of the Market

` The breadth of the market is the term often used to study theadvances and declines that have occurred in the stock market.

` The net difference between the number of stock advanced and

declined during the same period is the breadth of the market.

` Harvey A. Krow has computed advances and decline ratio. Hedivided the advances by declines.

` Ten day and 200 day moving average of the A/D ratios are also

computed. A ratio of 0.75 signals short term buying

opportunity.

` Except in the first phase of the bull market a rise above 1.25

indicates selling opportunities.


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Short Sales

` Short sales refers to the selling of shares that are notowned.

` The bears are the short seller who sell now in the hopeof purchasing at a lower price in the future to makeprofits.The short seller have to cover up their positions.

` Short positions of scrips are published in the businessnewspapers.

` When the demand for a particular share increases, theoutstanding short positions also increase and it indicates

future rise of prices.` At market tops, short selling is high and at market

bottoms, short selling is low.


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Odd Lot Trading

` Shares are generally sold in the lot of hundred. Sharessold in smaller lots, fewer than 100 are called odd lot.

` Odd lot purchases to odd lot sales ratio is the odd lot

index.

` High odd lot purchase forecasts fall in the market priceand low purchases/sales ratio are presumed to occur

towards the end of bear market.


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Moving Average

` The market indices do not rise or fall in a straight line.The upward and downward movements are interrupted

by counter movers. The underlying trend can be studied

by smoothening of the data. To smooth the data, the

moving average technique is used.` The moving averages are used to study the movement of

the market as well as the individual scrip price.

` The moving average indicates the underlying trend in the

scrip.


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Index and Stock Price Moving Average

` Individual stock price is compared with the stock marketindices. The moving average of the stock and the index

are plotted in the same sheet and trends are compared.

` If NSE or BSE index is above stocks moving average line,

the particular stock has bullish trend.` If the Sensex or Nifty is below the stocks moving average,

the bearish market can be expected for the particular

stock.


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Oscillators

` Oscillators indicate the market momentum or scripmomentum. Oscillator shows the share price movement

across a reference point from one extreme to another.

The momentum indicates:

` Overbought and oversold conditions of the scrip or themarket

` Signaling the possible trend reversal

` Rise or decline in the momentum


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Chartism

` On the chart, the y-axis (vertical axis) represents theprice scale and the x-axis (horizontal axis) represents the

time scale. Prices are plotted from left to right across the

x-axis with the most recent plot being the furthest right.


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Line Chart

Some investors and traders consider the closing level to be more important

than the open, high or low. By paying attention to only the close, intraday

swings can be ignored. Line charts are also used when open, high and low

data points are not available. Sometimes only closing data are available for

certain indices, thinly traded stocks and intraday prices.


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Bar chart High/Low/Close

Perhaps the most popular charting method is the bar chart. The high, low

and close are required to form the price plot for each period of a bar chart.

The high and low are represented by the top and bottom of the vertical barand the close is the short horizontal line crossing the vertical bar. On a

daily chart, each bar represents the high, low and close for a particular day.

Weekly charts would have a bar for each week based on Friday's close

and the high and low for that week.


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Open/High/Low/Close Bars

Bar charts can also be displayed using the open, high, low and close. The only

difference is the addition of the open price, which is displayed as a short

horizontal line extending to the left of the bar. Whether or not a bar chart

includes the open depends on the data available.


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Candle Stick Chart

White (clear) candlesticks form when the close is higher than the open and black

(solid) candlesticks form when the close is lower than the open. The white and

black portion formed from the open and close is called the body (white body or

black body). The lines above and below are called shadows and represent the

high and low.


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Point & Figure Chart


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V- Shaped Chart with Buy Signal


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V Shaped Chart with Sell Signal


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Double Top Chart


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Double Bottom Chart


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Head and Shoulder Chart Top


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Head and Shoulders Bottom Chart


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Cup and Handle Chart


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Triple Top Chart


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Triple Bottom Chart


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Ascending Triangle Chart

These patterns are normally seen in an uptrend and viewed as a continuation

pattern as buying demand gain more and more control, running up to the top

resistance line of the pattern. While you normally will see this pattern form in

an uptrend, if you do see it in a downtrend it should be paid attention to as it

can act as a powerful reversal signal.


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Descending Triangle Chart

These patterns are normally seen in a downtrend and viewed as a continuationpattern as the bears gain more and more control running down to the bottom

support line of the pattern. While you normally will see this pattern form in a

downtrend, if you do see it in an uptrend it should be paid attention to as it can

act as a powerful reversal signal.


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Symmetrical Triangle Chart

The symmetrical triangle is formed when the market makes lower highs and higherlows and is commonly associated with directionless markets as the contraction of the

market range indicates that neither the bulls nor the bears are in control. If this pattern

forms in an uptrend then it is considered a continuation pattern if the market breaks

out to the upside and a reversal pattern if the market breaks to the downside. Similarly

if the pattern forms in a downtrend it is considered a continuation pattern if the market

breaks out to the downside and a reversal pattern if the market breaks to the upside.


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Any Questions ???


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THANK YOU

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