ABSTRACT

Investment in equity is always considered to be very risky and considered a domain of

experts. There are several ways in which equity shares can be analysed, and investment in
equities can be made. The most important once are fundamental analysis and technical
analysis. Fundamental analysis is primarily an analysis tool that is used to fulfil long-term
investment objectives, and it relies on the study of economy, industry, and company. It uses
the past data of economy to see the economy attractiveness for future; it studies the
industry to see the growth prospect of industry and finally conducts a detailed company
analysis.

The company analysis is based on the profit and loss and balance sheet of previous years.
Several models such as dividend discount model discounted cash flow model, price earning
model, a book to price value model and residual income models are used to find out the
expected future price of a share, i.e., known as its intrinsic value.

An investor in a security market can give prediction about the future of share price of a
company on the basis of the study of forces affecting economic environment of the country.
Security analysis is typically divided into fundamental analysis, which relies upon the
examination of fundamental business factors such as financial statements, and technical
analysis, which focuses upon price trends and momentum .another form of security
analysis is technical analysis which uses graphs and diagrams for price prediction
securities. Simply the process of analysing return and risks of financial securities may term
as security analysis.

Earnings multiples remain the most commonly used measures of relative value. In this
report, I will discuss with a detailed examination of the price earnings ratio and then move
on to consider a variant that is often used for technology firms – the price earnings to
growth ratio (PEG).

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EQUITY ANALYSIS
INTRODUCTION
In addition, shareholder equity can represent the book value of a company. Equity can
sometimes be offered as payment-in-kind. It also represents the pro-rata ownership of a
company's shares.

Equity can be found on a company's balance sheet

and is one of the most common pieces of data Equity, typically referred to
as shareholders' equity (or owners'
employed by analysts to assess the financial health
equity for privately held companies),
of a company. represents the amount of money that
would be returned to a company’s
Equity analysis is the process of analyzing sectors shareholders if all of the assets were
and companies, to give advice to professional fund liquidated and all of the company's
debt was paid off in the case of
managers and private clients on which shares to
liquidation.
buy. Sell-side analysts work for brokers who sell
shares to the investors (mainly fund management
firms and private clients).

Equity is bought if the current share price is less

than the future intrinsic value and considered as
undervalued stock. If the share price is higher than the intrinsic value, the share is
considered overvalued and recommended as not a good investment.

Financial market economists have extensively examined the roles played by fundamental
analysis and technical analysis in processing the price information to conclude.

Discussion over the aspects of these two analyses will be shown further thoroughly.

Equity analysis, especially when done through balance sheet method, helps identify the risk
areas of the company. These may include questions such as whether the debt is too high.
Whether liquidity is too low? Etc. When such factors are identified, investors and analysts
can take precautions to avoid stocks which are a red signal for the portfolio.

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There are times when the market is bearish &
Investment bankers,
then there are times when the market is clearly
corporate analysts, and
bullish. Sometimes though, market signals may
investment analysts use
not be so clear and investors might be confused
equity analysis tools to assess
about the market direction. This is when equity
the impact of corporate events
valuation comes to rescue. The idea is to arrive at
including mergers,
the fair value of each stock and compare it with
acquisitions, divestitures,
the prevailing market rates. If the market is
spin-offs, management
overvaluing most stocks, then investors are
buyouts (MBOs), and
viewing market positively and the expectation
leveraged recapitalizations.
from the market is good. On the other hand, if the
Such events may affect a
market is undervaluing most stocks, then it is a
company’s future cash flows,
negative signal.
and thus the value of its
When relative analysis methods are used to equity. Especially in mergers
determine the value of a stock, it becomes easy and acquisitions, buyers often
for the analyst to compare stocks within the use the company’s own
sector and industry. For example, if the price to common stock as currency for
earnings ratio is used for valuing stock of the purchase. Investors need
company ABC, it becomes easy for the analyst to to know whether that stock’s
compare price-earnings ratio of company ABC to price is reasonable or not.
price-earnings ratio of its competitors. There is Furthermore, valuation is a
even benchmark price-earnings ratio available key factor in assessing the
for the sector. The analyst just has to compare fairness of a merger’s terms.
company ABC’s price-earnings ratio to that of the
sector benchmark. This further helps analysts
and investors make informed investing
decisions.

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STATEMENT OF PROBLEM
Equity analysis is a process of determining the fair market value of an equity security. In
our study we will be looking into various aspects of concern on what problems can be
caused by different variances in the analysis.

1. There are multiple methods of analyzing equity and each method has a different
perspective which creates a dilemma in selecting an analysis method.
2. Non-consideration of intangible assets as none of the equity analysis methods take
into account intangible assets of the company such as brand loyalty, customer
retention and ownership of intangible assets.
3. Error in assumptions which can raise a hindrance in the equity decision process.

OBJECTIVE OF THE STUDY

1. To acquire knowledge on various analysis of equity.
2. To understand the aspects of analysis i.e. Fundamental Analysis and Technical
Analysis.
3. To study the concept of Efficient Market and Dividend Capitalization Methods.
4. To acknowledge the price earnings in the economy.
5. To examine multiple approaches to equity valuation.
6. To learn the patterns and trends in the economy regarding equity perspective.
7. To suggest suitable observations regarding the thorough study on the equity
analysis.

SCOPE OF THE STUDY

1. It includes a review of its historical financial performance, forecast of its future
financial performance along with supporting arguments for the estimates and finally
a recommendation whether to buy or sell the stock. Sell-side firms usually produce
such detailed reports.
2. The assumption that the market price of a security can diverge from its intrinsic
value—as suggested by the rational efficient markets formulation of efficient market
theory—underpins active investing.

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FUNDAMENTAL ANALYSIS

INTRODUCTION
Fundamental analysis is a method of evaluating the intrinsic value of an asset and analysing
the factors that could influence its price in the future. This form of analysis is based on
external events and influences, as well as financial statements and industry trends.

Fundamental analysis is one of two major methods of market analysis, with the other being
technical analysis. While technical traders will derive all the information they need to trade
from charts, fundamental traders look at factors outside of the price movements of the
asset itself.

There are various tools and techniques that can be used for fundamental analysis, but they
have been categorised into two types of fundamental analysis: top-down analysis and
bottom-up analysis...The tools that traders might choose for their fundamental analysis
vary depending on which asset is being traded. For example, share traders might choose to
look at the figures in a company’s earnings report: revenue, earning per share (EPS),
projected growth or profit margins. While forex traders may choose to assess the figures
released by central banks that allow insight into the state of a country’s economy.

Fundamental analysis can be either quantitative or qualitative. As a result, it can be used to

analyse the sector, the industry, the company or the market.

 Quantitative fundamental analysis looks at a company’s viability as an investment

opportunity in terms of its numerical strengths – profit and loss statements, cash
flow statement and market share
 Qualitative fundamental analysis looks at factors which affect the character or
quality of the company. Examples would be brand recognition, senior management
or customer satisfaction

The fact that fundamental analysis can be both quantitative and qualitative is a huge
benefit, as it means that traders can base their decisions on more than what the numerical
data is showing.

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Fundamental analysis takes the following components into account:

1. Company’s financial reports

2. Effectiveness of the management
3. Asset management
4. Demand for the product
5. Company’s press releases
6. Global industry review
7. Trade agreements
8. External policies of the government
9. News releases
10. Competitor analysis

If the analysis reveals that the current price of the stock differs from the market sentiments
and fundamental factors, then there is an opportunity for investment.

A company’s earnings are the most crucial data point that you should look at before
considering other components. A company’s earnings are its profits. Most companies
announce their earnings every quarter, and these financial statements are monitored by all
analysts. Earnings have a significant impact on share prices. If a company announces a rise
in profits, share prices are likely to go up. If the company falls short of the earnings
expectations, share prices are likely to be hammered. Good earnings of a company can also
earn you rich dividends.

TOP-DOWN VS. BOTTOM-UP FUNDAMENTAL ANALYSIS

Fundamental analysis can be either top-down or bottom-up. An investor who follows the
top-down approach starts the analysis with the consideration of the health of the overall
economy. By analyzing various macroeconomic factors such as interest rates, inflation, and
GDP levels, an investor tries to determine the overall direction of the economy and
identifies the industries and sectors of the economy offering the best investment
opportunities.

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Using a bottom-up investing approach, a money manager will closely examine the
fundamentals of a stock. They will look for companies that they believe will perform well
over time, based on such determinants as the company’s management team, low price to
earnings (P/E) ratios and earnings growth potential. If the company seems to be a strong
one, these investors believe that it will continue to perform well over time, regardless of
how the overall market may be doing.

Y
OMY ANYRY
ANY
INDUSTR /I NDUST
ECON
COMP
SECTOR/
COMP
SECTORS

Alternatively, there is the bottom-up approach. Instead of starting the analysis from the
larger scale, the bottom-up approach immediately dives into the analysis of individual
stocks. The rationale of investors who follow the bottom-up approach is that individual
stocks may perform much better than the overall industry.

For example, if the price of a commodity such as oil goes up and the company they are
considering investing in uses large quantities of oil to make their product, the investor will
consider how strong an effect the rise in oil prices will have on the company’s profits. So
their approach starts out very broad, looking at the macro economy, then at the sector and
then at the stocks themselves.

The bottom-up approach is primarily concentrated on various microeconomic factors such

as a company’s earnings and financial metrics. Analysts who use such an approach develop
a thorough assessment of each company to gain a better understanding of its operations.

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FUNDAMENTAL ANALYSIS- TOOLS
Although earnings are important, they don't tell you much by themselves. On their own,
earnings don't identify how the market values the stock. You'll need to incorporate more
fundamental analysis tools to begin building a picture of how the stock is valued.

You can find most of these ratios completed for you on finance-related websites, but they
aren't difficult to calculate on your own. If you want to wade in for yourself, keep in mind
that some of the most popular tools of fundamental analysis focus on earnings, growth, and
value in the market. These are some of the factors you'll want to identify and include:

EARNINGS PER SHARE OR EPS

EPS is the amount of profit that is assigned to each stock of the company. It is calculated by
dividing the total revenues or gain of the company by the total number of outstanding
shares. To put it in a formula:

Net Income of the company after tax

EPS=
Total outstanding shares

As EPS is a symbol of the health of the company, a higher EPS means higher returns for the
investor.

Apart from this, EPS can be subdivided into trailing, current and forward EPS. A trailing
EPS is the actual EPS of the recently completed fiscal. A current EPS is the project EPS of the
current fiscal. The forward EPS is a projection of the EPS for the upcoming fiscal.

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EPS of one company can be compared to another in the same industry to know in which
company to invest. However, a higher EPS may also lead to reduced earnings or increased
stock prices to get back to normal.

PRICE-TO-EARNINGS (P/E) RATIO

P/E is one of the essential tools of fundamental stock analysis. It reflects the company’s
payouts as compared to its stock price. With this, you can know if the share of stock pays
wells for the price you pay. A meagre P/E ratio may mean a lower price per share
compared to earnings. This signifies the stock is undervalued and shows potential to rise in
future. The opposite is the case for a higher P/E ratio.

Share Price
Price ¿ earnings=
EPS

P/E ratio can be categorised as:

 Trailing P/E ratio which means the P/E ratio of the past 12 months
 Forward P/E ratio which is the P/E ratio of the next 12 months

If the forward P/E ratio is higher than the trailing one, then there may be a decrease in
earnings. If the forward P/E ratio is lower than the trailing P/E ratio, then there could be an
increase in the profits of the company.

RETURN ON EQUITY
Return on Equity or RoE shows the efficiency of a company to generate profits on its
shareholder’s investment. It is calculated by dividing net earnings after tax by
shareholders’ equity. A higher ROE signifies a more efficient company. It means the
company can increase its profitability without any additional capital. However, a company
without many assets can also have a higher ROE. Therefore, not all companies with higher
ROE are suitable for investment. It is best to compare ROE of companies within the same
industry.

Net Income
Return on Equity=
Shareholder s ' Equity

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PRICE-TO-BOOK (P/B) RATIO
Also known as “stockholders equity”, the price to book ratio is the comparison of a stock’s
book value to its market value. Book value is the cost of each asset minus its cumulative
depreciation. The P/B ratio can be calculated by dividing the last closing price by the
previous quarter’s book value per share. It tells us what the company will be left with if it
repays all its liabilities and liquidates its assets. If the P/B ratio is less than one, then the
stock is undervalued. If the rate is more than one, then the stock is overvalued. The P/B
ratio is essential as it tells you if the company’s assets are comparable to the stock’s market
value.

Market Price per share

Price ¿ Book=
Book Value per share

BETA:
The Beta is the correlation of the stock price with its industry. You can calculate the Beta by
comparing the stock to the benchmark index. The Beta mostly oscillates between -1 and 1.
However, it can have a value above or below this mark. Any beta value above 0 signifies
the stock correlates with the benchmark index. Beta values below 0 mean shares are
inversely correlated. A higher beta means higher volatility signifying greater risk of assets.
The lower the Beta, lesser is the volatility.

PRICE-TO-SALES (P/S) RATIO:

Price-to-sales ratio compares a company’s stock price with its revenue. You can calculate
the P/S ratio by dividing market capitalisation by income or using the formula:

Stock price per share

Price ¿ Sales=
Revenue per share

A lower P/S ratio indicates undervaluation, while anything above average suggests
overvaluation.

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DIVIDEND PAYOUT RATIO
A dividend payout ratio tells us how much the company has earned and what portion of it
is being given out as a dividend. A company can choose to distribute its profit as a dividend
because there may be little room for growth. Dividend payout ratio accounts for the
amount of income that a company retains for future growth, debt payoff and cash reserve.

Dividends per share

Dividend payout=
Net Income

DIVIDEND YIELD RATIO

Dividend yield ratio is what the company pays to its shareholders as a dividend relative to
its share price. Expressed in percentage terms, the dividend yield ratio can be calculated by
dividing the annual dividend of stock by the current share price. The dividend yield ratio is
important for investors who are looking for earning dividends from a company.

Annual Dividends per share

Dividend Yield=
Price per share

PROJECTED EARNINGS GROWTH (PEG) RATIO

Projected earnings growth indicates how much you have to pay for each unit of future
growth of earnings of the company. A lower projected earnings growth indicates a lesser
amount to be paid for each unit of future earnings growth. A stock with a smaller PEG ratio
is fundamentally stronger as it has higher projected growth in earnings.

P / E Ratio
PEG=
EPS Growth

DEBT TO EQUITY RATIO

We can examine whether a company is productive or not by understanding if it uses its
debt in a smart manner or not. Debt is not always a negative term.

Total liabilities
Debt ¿ Equity=
Total shareholder s' equity

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Investment- Approaches to Equity Analysis Page 12
FUNDAMENTAL ANALYSIS- FACTORS
The ultimate aim of doing fundamental analysis is to find a value that an investor can
compare with the security’s current price and on basis of his comparison he finally decides
whether to buy an underpriced security or to sell an overpriced security.

ECONOMIC ANALYSIS- IMPACT (30-35%)

Economic Analysis relates to the analysis of the economy. This related to study about the
economy in details and analysis whether economic conditions are favourable for the
companies to prosper or not.

1. Depression: is the worst of the four stages. During a depression, demand is low and
declining. Inflation is often high and so are interest rates.

2. Recovery stage: the economy begins to receive after a depression. Demand picks up
leading to more investments in the economy. Production, employment and profits are on
the increase.

3. Boom: The phase of the economic cycle is characterized by high demand. Investments
and production are maintained at a high level to satisfy the high demand. Companies
generally post higher profits.

4. Recession: The boom phase gradually slow down .the economy slowly begin to
experience a downturn in demand, production employment etc,

Some aspects in concern of economic analysis:

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Analysts always try to find out whether the economic development is conducive for the
growth of the company. An investor in a security market can give prediction about the
future of share price of a company on the basis of the study of forces affecting economic
environment of the country. For the Economic Analysis, the Macro Economic Factors are
studied to know about the condition of an economy or performance of the security market
of any country.

INDUSTRY ANALYSIS- IMPACT (15-20%)

Industry Analysis • Industry Analysis: An analysis of the performance, prospects and
problems of an industry is known as industry analysis. Industry analysis is required
because the return and risk of various industries are different. The performance of the
industry reflects the performance of the companies it consists. Industry analysis is used to
analyze the performance of the industries over the years. An industry is a group of firms
that have a similar technological structure of production and produce similar goods and
services.

Industries can be classified into:

 Growth industry: Has high rate of earnings and growth is independent of business
cycle. The expansion depends on technological change. Ex. IT, Pharma.

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  Cyclical industry: Growth and profitability of the industry move along with the
business cycle. During boom, industry enjoys growth and during depression they
suffer a setback. Ex. Real Estate, Capital Goods.
 Defensive industry: It is an industry which defies the business cycle. The stocks of
defensive industries can be held as they pay dividends on a regular basis. They
expand and earn income in depression also. They are counter cyclical in nature. Ex.
FMCG
 Cyclical growth industry: It is an industry that is cyclical and at the same time
growing. Changes in technology and introduction of new models can help the
industry resume its growth path. Ex. Automobile.

COMPANY ANALYSIS- IMPACT (30-35%)

The massive amount of numbers in a company's financial statements can be bewildering
and intimidating to many investors. On the other hand, if you know how to analyze them,
the financial statements are a gold mine of information.

Financial statements are the medium by which a company discloses information

concerning its financial performance. Followers of fundamental analysis use the
quantitative information gleaned from financial statements to make investment decisions.

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  Provide an overview of the company: major products/services, current positioning
and history, composition of sales, product life-cycle stages, R&D, past and planned
capital expenditures, board structure, analysis of management, employee benefits,
labour relations, insider ownership, legal actions, and other special
strengths/weaknesses.
 Explain relevant industry characteristics: life-cycle stage, business-cycle sensitivity,
product life cycles, brand loyalty, entry/exit barriers, industry supplier
considerations, number and concentration of companies within industry,
differentiation opportunities, technologies used, government regulation, labour
relations, and other industry problems/opportunities.
 Analyze demand for products/services: sources of demand, product differentiation,
past influences, and outlook.
 Analyze supply for products/services: sources of supply, industry capacity outlook,
import/export considerations, and proprietary products or trademarks.
 Explain pricing environment: past relationships of demand/supply/prices,
significance and outlook for raw material and labour costs, and anticipated future
trends.
 Present and interpret relevant financial ratios: activity ratios, liquidity ratios,
solvency ratios, profitability ratios, and financial statistics.

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TECHNICAL ANALYSIS
Technical analysis is a means of examining and predicting price movements in the financial
markets, by using historical price charts and market statistics. It is based on the idea that if
a trader can identify previous market patterns, they can form a fairly accurate prediction of
future price trajectories. Technical analysts also widely use market indicators of many
sorts, some of which are mathematical transformations of price, often including up and
down volume, advance/decline data and other inputs. These indicators are used to help
assess whether an asset is trending, and if it is, the probability of its direction and of
continuation. Technicians also look for relationships between price/volume indices and
market indicators. Examples include the moving average, relative strength index and
MACD. Other avenues of study include correlations between changes in Options (implied
volatility) and put/call ratios with price. Also important are sentiment indicators such as
Put/Call ratios, bull/bear ratios, short interest, Implied Volatility, etc.

There are many techniques in technical analysis. Adherents of different techniques (for
example: Candlestick analysis, the oldest form of technical analysis developed by a
Japanese grain trader; Harmonics; Dow Theory; and Elliott wave theory) may ignore the
other approaches, yet many traders combine elements from more than one technique.
Some technical analysts use subjective judgment to decide which pattern(s) a particular
instrument reflects at a given time and what the interpretation of that pattern should be.
Others employ a strictly mechanical or systematic approach to pattern identification and
interpretation.

ASSUMPTION
 Price Considers Everything: Price action is driven by a variety of factors, such as
the basic balance between supply and demand, the emotional state of traders, news,
rumours, and more, as well as external factors such as politics, weather, and others.
These factors will cause the price of an asset to rise or fall, depending on how the
market participants react to certain events and changes in the overall market
landscape.

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  Price Movement Delivers The Trend: Regular increases or decreases in a market
form a trend, and the price typically follows in that trend direction until something
significant occurs that changes the said trend. A dramatic news event, a major
disruption to supply and demand, and other factors often suggest a trend change is
possible. Once a trend change is confirmed, traders should look to alter their
technical analysis and trading strategies accordingly. The trend is your friend.
 History Repeats Itself: Markets are also cyclical, and history often repeats itself.
Many traders include time, and important dates into their technical analysis. There’s
a theory called the Halloween effect that urges traders to buy up an asset in
anticipation of an increase occurring during the winter months, while the term “sell
in May and go away” speaks to assets typically in decline during the wearer summer
months when market interest wanes. Markets also go through bear and bull cycles,
and much more.

TYPES OF CHARTS
Technical analysts use a variety of charts based on the information they seek. They are:

Line Charts
A line chart is probably the most common type of chart. This chart tracks the closing prices
of the stock over a specific period. Each closing price point is represented by a dot. And all
the dots are connected by lines to get the graphical representation. While it is considered to
be quite simplistic (compared to other chart types), a line chart helps traders to spot trends
in the price movement.

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In the above chart, the X-axis represents the time period while the Y-axis represents the
stock price.

Bar Charts
A bar chart is quite similar to a line chart. However, it offers much more information. Instead of a
dot, each plot point in the graph is represented by a vertical line. This line has two horizontal lines
extending from both the sides.

It is represented as follows:

The top part of the vertical line represents the highest price at which the stock had traded
during the day. Similarly, the lower part represents the lowest traded price. The left
extension represents the price at which the stock opened while the right extension
represents the closing price for the day.

In addition to offering greater detail than a line chart, the bar chart also gives insight on
volatility. If the line is longer, it means that there was greater volatility in the trading of the
stock.

Candlestick Charts
Candlestick charts are very popular among technical analysts. They offer a great deal of
information in a very precise manner. As the name suggests, the price movements for each
day are represented in the shape of a candlestick. It is similar to a bar chart because it
represents the four data points: high, low, open and close.

While bar charts give volatility information only for a single trading day, candlestick charts
can offer this information for a much larger time period. In addition, the candlesticks come

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in different colors based on the price movements. A falling candlestick is generally
represented by a black or red body while a rising candlestick is represented by a white or
clear body.

In the above picture, it is clear how the values are represented in the form of a candlestick.

Heikin Ashi Chart

Heikin Ashi is another type of popular technical chart that originated in Japan is quite
similar to candlestick chart. With this chart, you can visualize the uptrend and downtrend
quite clearly. When there are continuous green HA handles without lower shadow, it’s a
reflection of a strong trend.

On the other hand, when there are continuous red handles without upper shadow, it
reflects a solid downtrend. As the HA bars are averaged, there’s no exact open and close
prices for a particular period.

Point & Figure Chart

One of the common types of chart in technical analysis, Point and Figure Chart using
vertical rows of X’s and O’s. When price of a share goes up, it’s indicated in the row of X’s.
On the other hand, when it goes down, the same is indicated by the vertical row of O’s.

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This chart for technical analysis is easy to plot and the patterns are easy to follow. A
disciplined method of identifying current and emerging trends, Point & Figure Chart can
help you in easy determination of entry and exit points.

BASIC TECHNICAL TOOLS

Using a few basic principles and tools, anyone can learn technical analysis and in no time
become an expert themselves. Familiarizing oneself with the meaning of the below terms
will be an important first step.

 Trend Lines: Trend lines are lines drawn on a price chart of an asset, just under or
over the asset’s local pivot highs or lows, to indicate that price is following a
particular direction. These lines exist based on the natural placement of buy or sell
orders by market participants, and the raising or lowering of stop loss levels, or
where natural profit-taking may occur.
A trend line typically is required to have multiple touches to be considered valid,
and traders are recommended to watch for a break and close above or below trend
lines, before taking any action.
 Support and Resistance Levels: Support and resistance levels can either be
horizontal, or diagonal. Trend lines often rise and fall, and represent diagonal
support or resistance. Horizontal resistance or support is often prices that represent
a historic level or are a significant rounded number.
Support is a level on price charts in which price has typically rebounded from in the
past and could provide yet another bounce if the price gets there and buyers step in.
Resistance is a level on price charts in which price has typically been rejected from,
representing an area of interest for sellers to begin taking profit.

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  Moving Averages: Moving averages are an indicator layered over price charts that
represents the average price of an asset across a certain time period. Moving
averages can be short- or long-term, across daily, weekly, or even longer
timeframes. Investors and traders typically use moving averages not only to find
levels that may act as support or resistance but to understand if a trend in an asset
class is changing.
When short term moving averages cross below or above a longer-term moving
average, the event is called either a death cross or golden cross, named for the
corresponding price action that typically follows. Death crosses are bearish, and
often indicate that the asset will soon fall into a downtrend, while golden crosses are
bullish and represent the wealth that investors are likely to generate from the trend
that follows such an occurrence.

 Trading Volume: Trading volume is another extremely important tool for traders
to use to determine interest in an asset. Volume typically precedes price action, and

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 keen-eyed technical analysts can often spot trend changes in the price of an asset by
watching trading volume. Trading volume also is used to confirm the validity of a
movement. Oftentimes, an asset will break down or up, but volume doesn’t follow,
suggesting buyers or sellers are hesitant and uncomfortable with taking an
actionable position. However, if the same movement occurs with strong volume,
chances are that much higher for the move to be valid, and not result in a fake out.
 Chart Patterns: One of the most helpful tools a trader can use when performing
technical analysis is to watch for certain patterns to appear on price charts before
taking a position. Using trend lines, technical analysis can draw triangles and other
geometric shapes on price charts. In addition to knowing which way a pattern might
break, oftentimes these patterns can also tip traders off as to the target of the
ultimate price movement that occurs, allowing traders to prepare in advance and
ensure take profit levels are determined ahead of time. Common bullish price
patterns include ascending triangles, falling wedges, inverse head and shoulders,
and more. Bearish price patterns include descending triangles, rising wedges,
double tops, and head and shoulders patterns.
 Fractals: Fractals are repeating patterns that play out on price charts, oftentimes on
increasingly lower timeframes. Fractals add validity and credence to the idea that
markets are cyclical, and each cycle is a direct impact of the emotional state of
traders. These emotions lead to repeating patterns on price charts that if spotted
well enough in advance, can tip a trader off as to how the price action may unfold.
 Indicators: In addition to volume, other helpful indicators have been developed to
add to a trader’s arsenal and offer even more changes to determine future price
movements before they occur. Commonly used indicators include the Stochastic
Oscillator, Bollinger Bands, the Acceleration Deceleration indicator, and the MACD –
the Moving Average Convergence Divergence indicator.

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DOW THEORY
The Dow Theory is a financial theory that says the market is in an upward trend if one of its
averages (i.e. industrials or transportation) advances above a previous important high and
is accompanied or followed by a similar advance in the other average. The theory is
predicated on the notion that the market discounts everything in a way consistent with the
efficient markets hypothesis.

In such a paradigm, different market indices must confirm each other in terms of price
action and volume patterns until trends reverse.

There are six main components to the Dow Theory.

1. The Market Discounts Everything

The Dow Theory operates on the efficient markets hypothesis (EMH), which states that
asset prices incorporate all available information. In other words, this approach is the
antithesis of behavioral economics.

Earnings potential, competitive advantage, management competence—all of these factors

and more are priced into the market, even if not every individual knows all or any of these
details. In more strict readings of this theory, even future events are discounted in the form
of risk.

2. There Are Three Primary Kinds of Market Trends

Markets experience primary trends which last a year or more, such as a bull or bear
market. Within these broader trends, they experience secondary trends, often working
against the primary trend, such as a pullback within a bull market or a rally within a bear
market; these secondary trends last from three weeks to three months.

3. Primary Trends Have Three Phases

A primary trend will pass through three phases, according to the Dow Theory. In a bull
market, these are the accumulation phase, the public participation (or big move) phase, and
the excess phase. In a bear market, they are called the distribution phase, the public
participation phase, and the panic (or despair) phase.

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4. Indices Must Confirm Each Other
In order for a trend to be established, Dow postulated indices or market averages must
confirm each other. This means that the signals that occur on one index must match or
correspond with the signals on the other. If one index, such as the Dow Jones Industrial
Average, is confirming a new primary uptrend, but another index remains in a primary
downward trend, traders should not assume that a new trend has begun.

If asset prices were rising but the railroads were suffering, the trend would likely not be
sustainable. The converse also applies: if railroads are profiting but the market is in a
downturn, there is no clear trend.

5. Volume Must Confirm the Trend

Volume should increase if the price is moving in the direction of the primary trend and
decrease if it is moving against it. Low volume signals a weakness in the trend. For
example, in a bull market, the volume should increase as the price is rising, and fall during
secondary pullbacks. If in this example the volume picks up during a pullback, it could be a
sign that the trend is reversing as more market participants turn bearish.

6. Trends Persist Until a Clear Reversal Occurs

Reversals in primary trends can be confused with secondary trends. It is difficult to
determine whether an upswing in a bear market is a reversal or a short-lived rally to be
followed by still lower lows, and the Dow Theory advocates caution, insisting that a
possible reversal be confirmed.

Criticisms to Dow Theory: Although Dow Theory forms the building blocks for modern-day
technical analysis, this theory is not without criticisms. One of the criticisms is that
following the theory will result in an investors acting after rather than before or at market
tops and bottoms. Dow Theory depicted the general trend of the market but not with the
intention of projecting the future trends or to diagnose the buy or sell signals. It is too
subjective and based on historical interpretation.

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BULL MARKET
A bull market is the condition of a financial market in which prices are rising or are
expected to rise. The term "bull market" is most often used to refer to the stock market but
can be applied to anything that is traded, such as bonds, real estate, currencies, and
commodities. Characteristics of Bull Market:

• Existence Period of Bull Market.

• Basis of Bull Market.

• Supply and Demand.

• Effects on Economy.

• Importance of Investor Psychology.

BEAR MARKET
A bear market is when a market experiences prolonged price declines. It typically describes
a condition in which securities prices fall 20% or more from recent highs amid widespread
pessimism and negative investor sentiment. THREE PSYCHOLOGICAL PHASES:

 Denial,
 Concern and,
 Capitulation. 

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FUNDAMENTAL ANALYSIS V/S TECHNICAL ANALYSIS
Rather than looking at the bigger picture, technical analysis is concerned with the historical
price movements of an asset. By looking at charts and using patterns to assess the behavior
of market participants, technical analysts hope to predict an asset’s future price
movements.

Technical analysis relies heavily on chart patterns and moving averages. As a result,
technical analysis requires an in-depth knowledge of – and sufficient aptitude at identifying
– chart patterns and what each pattern might mean for the future price movements of a
stock.

On the other hand, fundamental analysis requires less specialist knowledge of technical
indicators. Instead, fundamental analysts should have an in-depth knowledge of their
chosen market and sector so that they know how to quickly and accurately identify viable
companies based on news reports, financial statements or changes in company leadership.

Investment- Approaches to Equity Analysis Page 27

ELLIOTT WAVE THEORY
Wave theory formulated by Ralph Elliot, known as Elliot wave theory in 1934 by Elliot after
analyzing seventy five years of stock price movements and charts .from his studies he
concluded that the market movement was quit orderly and followed by a pattern of waves.

The Elliott Wave Theory is a form of technical analysis that looks for recurrent long-term
price patterns related to persistent changes in investor sentiment and psychology. The
theory identifies impulse waves that set up a pattern and corrective waves that oppose the
larger trend. Each set of waves is nested within a larger set of waves that adhere to the
same impulse or corrective pattern, which is described as a fractal approach to investing.

How the Elliott Wave Theory Works

The Elliott Wave Theory was developed by Ralph Nelson Elliott in the 1930s. After being
forced into retirement due to an illness, Elliott needed something to occupy his time and
began studying 75 years worth of yearly, monthly, weekly, daily, and self-made hourly and
30-minute charts across various indexes. The theory gained notoriety in 1935 when Elliott
made an uncanny prediction of a stock market bottom. It has since become a staple for
thousands of portfolio managers, traders, and private investors.1

Elliott described specific rules governing how to identify, predict and capitalize on these
wave patterns. These books, articles, and letters are covered in "R.N. Elliott's
Masterworks," which was published in 1994. Elliott Wave International is the largest
independent financial analysis and market forecasting firm in the world whose market
analysis and forecasting are based on Elliott’s model.

He was careful to note that these patterns do not provide any kind of certainty about future
price movement, but rather, serve in helping to order the probabilities for future market
action. They can be used in conjunction with other forms of technical analysis, including
technical indicators, to identify specific opportunities. Traders may have differing
interpretations of a market's Elliott Wave structure at a given time.

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How Elliott Waves Work
Some technical analysts try to profit from wave patterns in the stock market using the
Elliott Wave Theory. This hypothesis says that stock price movements can be predicted
because they move in repeating up-and-down patterns called waves that are created by
investor psychology or sentiment.

The theory identifies several different types of waves, including motive waves, impulse
waves, and corrective waves. It is subjective, meaning not all traders interpret the theory
the same way or agree that it is a successful trading strategy. Unlike most other price
formations, the whole idea of wave analysis itself does not equate to a regular blueprint
formation where you simply follow the instructions. Wave analysis offers insights into
trend dynamics and helps you understand price movements in a much deeper way.

The Elliott Wave principle consists of impulse and corrective waves at its core.

 Impulse Waves

Impulse waves consist of five sub-waves that make net movement in the same direction as
the trend of the next-largest degree. This pattern is the most common motive wave and the
easiest to spot in a market. Like all motive waves, it consists of five sub-waves—three of
them are also motive waves, and two are corrective waves. This is labeled as a 5-3-5-3-5
structure, which was shown above.

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It has three unbreakable rules that define its formation:

1. Wave two cannot retrace more than 100% of the first wave
2. The third wave can never be the shortest of waves one, three, and five
3. Wave four can't go beyond the third wave at any time

If one of these rules is violated, the structure is not an impulse wave. The trader would
need to re-label the suspected impulse wave.

 Corrective Waves

Corrective waves, which are sometimes called diagonal waves, consist of three—or a
combination of three—sub-waves that make net movement in the direction opposite to the
trend of the next-largest degree.2 Like all motive waves, its goal is to move the market in
the direction of the trend.

The corrective wave consists of five sub-waves. The difference is that the diagonal looks
like either an expanding or contracting wedge. The sub-waves of the diagonal may not have
a count of five, depending on what type of diagonal is being observed. As with the motive
wave, each sub-wave of the diagonal never fully retraces the previous sub-wave, and sub-
wave three of the diagonal may not be the shortest wave.

These impulse and corrective waves are nested in a self-similar fractal to create larger
patterns. For example, a one-year chart may be in the midst of a corrective wave, but a 30-
day chart may show a developing impulse wave. A trader with this Elliott wave
interpretation may thus have a long-term bearish outlook with a short-term bullish
outlook.

The classification of a wave at any particular degree can vary, though practitioners
generally agree on the standard order of degrees (approximate durations given):

 Grand super cycle: multi-century

 Super cycle: multi-decade (about 40–70 years)
 Cycle: one year to several years (or even several decades under an Elliott
Extension)

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  Primary: a few months to a couple of years
 Intermediate: weeks to months
 Minor: weeks
 Minute: days
 Minuette: hours
 Subminuette: minutes

EFFICIENT MARKET HYPOTHESIS

The efficient market hypothesis (EMH), alternatively known as the efficient market theory,
is a hypothesis that states that share prices reflect all information and consistent alpha
generation is impossible.

According to the EMH, stocks always trade at their fair value on exchanges, making it
impossible for investors to purchase undervalued stocks or sell stocks for inflated prices.
Therefore, it should be impossible to outperform the overall market through expert stock
selection or market timing, and the only way an
investor can obtain higher returns is by purchasing
There are three major versions of
the hypothesis: “weak", "semi riskier investments. Although it is a cornerstone of
-strong", and "strong" modern financial theory, the EMH is highly
controversial and often disputed. Believers argue it
is pointless to search for undervalued stocks or to
try to predict trends in the market through either fundamental or technical analysis.

Theoretically, neither technical nor fundamental analysis can produce risk-adjusted excess
returns (alpha) consistently, and only inside information can result in outsized risk-
adjusted returns. While academics point to a large body of evidence in support of EMH, an
equal amount of dissension also exists. For example, investors such as Warren Buffett have
consistently beaten the market over long periods, which by definition is impossible
according to the EMH.

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Detractors of the EMH also point to events such as the 1987 stock market crash, when the
Dow Jones Industrial Average (DJIA) fell by over 20 percent in a single day, and asset
bubbles as evidence that stock prices can seriously deviate from their fair values.

 Weak-form efficiency

In weak-form efficiency, future prices cannot be predicted by analyzing prices from the
past. Excess returns cannot be earned in the long run by using investment strategies based
on historical share prices or other historical data. Technical analysis techniques will not be
able to consistently produce excess returns, though some forms of fundamental analysis
may still provide excess returns. Share prices exhibit no serial dependencies, meaning that
there are no "patterns" to asset prices. This implies that future price movements are
determined entirely by information not contained in the price series. Hence, prices must
follow a random walk. This 'soft' EMH does not require that prices remain at or near
equilibrium, but only that market participants not be able to systematically profit from
market 'inefficiencies'. However, while EMH predicts that all price movement (in the
absence of change in fundamental information) is random (i.e., non -trending), many
studies have shown a marked tendency for the stock markets to trend over time periods of
weeks or longer and that, moreover, there is a positive correlation between degree of
trending and length of time period studied (but note that over long time periods, the
trending is sinusoidal in appearance). Various explanations for such large and apparently
nonrandom price movements have been promulgated.

The problem of algorithmically constructing prices which reflect all available information
has been studied extensively in the field of computer science. For example, the complexity
of finding the arbitrage opportunities in pair betting markets has been shown to be NP-
hard.

 Semi-strong-form efficiency

In semi-strong-form efficiency, it is implied that share prices adjust to publicly available

new information very rapidly and in an unbiased fashion, such that no excess returns can
be earned by trading on that information. Semi-strong-form efficiency implies that neither

Investment- Approaches to Equity Analysis Page 32

fundamental analysis nor technical analysis techniques will be able to reliably produce
excess returns. To test for semi- strong-form efficiency, the adjustments to previously
unknown news must be of a reasonable size and must be instantaneous. To test for this,
consistent upward or downward adjustments after the initial change must be looked for. If
there are any such adjustments it would suggest that investors had interpreted the
information in a biased fashion and hence in an inefficient manner.

 Strong-form efficiency

In strong -form efficiency, share prices reflect all information, public and private, and no
one can earn excess returns. If there are legal barriers to private information becoming
public, as with insider trading laws, strong-form efficiency is impossible, except in the case
where the laws are universally ignored. To test for strong-form efficiency, a market needs
to exist where investors cannot consistently earn excess returns over a long period of time.
Even if some money managers are consistently observed to beat the market, no refutation
even of strong-form efficiency follows: with hundreds of thousands of fund managers
worldwide, even a normal distribution of returns (as efficiency predicts) should be
expected to produce a few dozen "star" performers.

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DIVIDEND DISCOUNT MODELS
Dividend Discount Model, also known as DDM, in which stock price is calculated based on
the probable dividends that will be paid and they will be discounted at the expected yearly
rate. In simple words, it is a way of valuing a company based on the theory that a stock is
worth the discounted sum of all of its future dividend payments. In other words, it is used
to evaluate stocks based on the net present value of future dividends.

The financial theory states that the value of a stock is worth all of the future cash flows
expected to be generated by the firm discounted by an appropriate risk-adjusted rate. We
can use dividends as a measure of the cash flows returned to the shareholder.

Some examples of regular dividend-paying companies are McDonald’s, Procter & Gamble,
Kimberly Clark, PepsiCo, 3M, Coca-Cola, Johnson & Johnson, AT&T, Wal-Mart, etc. We can
use the Dividend Discount Model to value these companies.

However, this situation is a bit theoretical, as investors normally invest in stocks for
dividends as well as capital appreciation. Capital appreciation is when you sell the stock at
a higher price then you buy for. In such a case, there are two cash flows –

1. Future Dividend Payments

2. Future Selling Price

Investment- Approaches to Equity Analysis Page 34

Now that we have understood the very foundation of the Dividend Discount Model let us
move forward and learn about three types of Dividend Discount Models.

 Zero Growth Dividend Discount Model – This model assumes that all the dividends
that are paid by the stock remain one and the same forever until infinite.
Annual Dividends
Stoc k ' s intrinsic value=
Required Rate of Return
 Constant Growth Dividend Discount Model – This dividend discount model assumes
that dividends grow at a fixed percentage annually. They are not variable and are
constant throughout.

Where,
a) D1= Value of dividend to be received next year
b) D0= Value of dividend received this year
c) g= Growth of dividend
d) Ke= Discount rate
 Variable Growth Dividend Discount Model or Non-Constant Growth – This model
may divide the growth into two or three phases. The first one will be a fast initial
phase, then a slower transition phase; a then ultimately ends with a lower rate for
the infinite period.

The value of a share of stock should be equal to the present value of all the future cash
flows you expect to receive from that share. Since common stock never matures, today's

The basic model: The basic premise of stock valuation is that in a market with rational markets,
the value of the stock today is the present value of all future cash flows that will accrue to that
investor in the stock. In other words, you get (in a present value sense) what you pay for. Using
time value of money principles, we can determine the price of a stock today based on the
discounted value of future cash flows.

Investment- Approaches to Equity Analysis Page 35

value is the present value of an infinite stream of cash flows. And also, common stock
dividends are not fixed, as in the case of preferred stock

Dividend Valuation Model

If dividends are constant forever, the value of a share of stock is the present value of the
dividends per share per period, in perpetuity. Let D1 represent the constant dividend per
share of common stock expected next period and each period thereafter, forever, P0
represent the price of a share of stock today, and r the required rate of return on common
stock.1 The current price of a share of common stock, P0, is:

D1
P 0=
r

The required rate of return is the compensation for the time value of money tied up in their
investment and the uncertainty of the future cash flows from these investments. The
greater the uncertainty, the greater the required rate of return.

If dividends grow at a constant rate, the value of a share of stock is the present value of a
growing cash flow. Let D0 indicate this period's dividend. If dividends grow at a constant
rate, g, forever, the present value of the common stock is the present value of all future
dividends, which – in the unique case of dividends growing at the constant rate g –
becomes what is commonly referred to as the dividend valuation model (DVM):

D 0 ( 1+ g )
P 0=
r−g

This model is also referred to as the Gordon model. This model is a one of a general class of
models referred to as the dividend discount model (DDM).

Suppose dividends on a stock today are Rs.1.20 per share and dividends are expected to
decrease each year at a rate of 2% per year, forever. If the required rate of return is 10%,
what is the value of a share of stock?

Investment- Approaches to Equity Analysis Page 36

 1.2 [ 1−0.02 ]
P 0= =9.80
[ 0.10−0.02 ]

Investment- Approaches to Equity Analysis Page 37

PRICE EARNING MULTIPLE APPROACH
The earnings multiple reflects the risk attached to future earnings. The lower the deemed
risk, the higher the earnings multiple. The higher the considered risk, the lower the
earnings multiple. The earnings multiple also reflects the expected growth in future
earnings. The higher the projected earnings growth, the higher the earnings multiple.

In adopting an earnings multiple, the business value assumes that the earnings base will be
earn in perpetuity. The application of earnings multiple is the same as capitalizing earnings.
The earnings multiple reflects the inverse of the capitalization rate.

APPLICATION OF AN EARNING MULTIPLE

An earnings multiple approach, requires the use of the appropriate earnings multiple. The
business valuer applies an historical EBIT or EBITDA to historical earnings and applies a
forward EBIT or EBITDA multiple to forward earnings.

Different multiples value different things. An EBIT or EBITDA multiple provides an

enterprise valuation, the value of the business. A P/E multiple provides an equity valuation.

The traded market price of a listed stock, together with historical earnings or forecast
earnings, can be used to calculate an earnings multiple. When valuing a private business, a
listed company earnings multiple has to be adjusted to reflect factors such as the lack of
liquidity in a private business and specific risk, which cannot be diversified away by private
investors.

PRICE EARNING RATIO

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its
current share price relative to its per-share earnings (EPS). The price-to-earnings ratio is
also sometimes known as the price multiple or the earnings multiple.

P/E ratios are used by investors and analysts to determine the relative value of a
company's shares in an apples-to-apples comparison. It can also be used to compare a

Investment- Approaches to Equity Analysis Page 38

company against its own historical record or to compare aggregate markets against one
another or over time.

A high P/E ratio could mean that a company's stock is over-valued, or else that investors
are expecting high growth rates in the future. Companies that have no earnings or that are
losing money do not have a P/E ratio since there is nothing to put in the denominator.

Two kinds of P/E ratios - forward and trailing P/E - are used in practice.

Market Value per share

Price ¿ earning=
Earnings per share

To determine the P/E value, one simply must divide the current stock price by the earnings
per share (EPS). The current stock price (P) can be gleaned by plugging a stock’s ticker
symbol into any finance website, and although this concrete value reflects what investors
must currently pay for a stock, the EPS is a slightly more nebulous figure.

When the PE ratios of technology firms are compared, it is difficult to ensure that the
earnings per share are uniformly estimated across the firms for the following reasons:

 Technology firms often grow by acquiring other firms, and they do not account for
with acquisitions the same way. Some do only stock-based acquisitions and use only
pooling, others use a mixture of pooling and purchase accounting, still others use
purchase accounting and write of all or a portion of the goodwill as in-process R&D.
These different approaches lead to different measures of earnings per share and
different PE ratios.
 Using diluted earnings per share in estimating PE ratios might bring the shares that
are covered by management options into the multiple, but they treat options that
are deep in-the-money or only slightly in-the-money as equivalent.
 The expensing of R&D gives firms a way of shifting earnings from period to period,
and penalizes those firms that are spending more on research and development.

Technology firms that account for acquisitions with pooling and do not invest in R&D can
have much lower PE ratios than technology firms that use purchase accounting in
acquisitions and invest substantial amounts in R&D.

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DETERMINANTS OF THE P/E RATIO
The fundamentals that determine multiples were extracted using a discounted cash flow
model – an equity model like the dividend discount model for equity multiples and a firm
value model for firm multiples. The price earnings ratio, being an equity multiple, can be
analyzed using an equity valuation model. In this section, the fundamentals that determine
the price earnings ratio for a high growth firm are analyzed.

A Discounted Cash flow Model perspective on PE ratios

P0 ( Payout Ratio ) ( 1+g n )
=PE=
EPS 0 k −g

If the PE ratio is stated in terms of expected earnings in the next time period, this can be
simplified:

P0 Payout Ratio
=Forward PE=
EPS 1 k e −gn

The price-earnings ratio for a high growth firm can also be related to fundamentals. In the
special case of the two-stage dividend discount model, this relationship can be made
explicit fairly simply. When a firm is expected to be in high growth for the next n years and
stable growth thereafter, the dividend discount model can be written as follows:

( 1+ g )n

P 0=
(
EPS0∗Payout Ratio∗ ( 1+ g ) 1−
( 1+k e , hg)
n
) +
n
EPS 0 ( Payout Ratio ) ( 1+ g ) (1+ g n)
n
k e ,hg−g ( k e , st −gn ) ( 1+ k e ,hg )
Where,

EPS0 = Earnings per share in year 0 (Current year)

g = Growth rate in the first n years

ke, hg = Cost of equity in high growth period

ke,st = Cost of equity in stable growth period

Payout = Payout ratio in the first n years

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 gn = Growth rate after n years forever (Stable growth rate)

Payout Ratio = Payout ratio after n years for the stable firm

Divide both sides of the equation by EPS0.

Here again, we can substitute in the fundamental equation for payout ratios.

g (1+ g)n g
P0
=
(
1−
ROEhg )
( 1+ g ) (1−
(1+ k e ,hg )n

+
( ROE st ) n
) 1− n ( 1+ g ) (1+ gn )

EPS 0 k e, hg−g (k e ,st −gn)(1+ k e ,hg )n

Where ROEhg is the return on equity in the high growth period and ROE st is the return on
equity in stable growth: The left hand side of the equation is the price earnings ratio. It is
determined by:

(a) Payout ratio (and return on equity) during the high growth period and in the stable
period: The PE ratio increases as the payout ratio increases, for any given growth rate. An
alternative way of stating the same proposition is that the PE ratio increases as the return
on equity increases and decreases as the return on equity decreases.

(b) Riskiness (through the discount rate k e): The PE ratio becomes lower as riskiness
increases.

(c) Expected growth rate in earnings, in both the high growth and stable phases: The PE
increases as the growth rate increases, in either period.

This formula is general enough to be applied to any firm, even one that is not paying
dividends right now. In fact, the ratio of FCFE to earnings can be substituted for the payout
ratio for firms that pay significantly less in dividends than they can afford to.

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FACTS AND FINDINGS
Equity analysis refers to the method of analyzing the value of securities like shares and
other instruments to assess the total value of business which will be useful for investors to
make decisions. There are three methods to analyze the value of securities – fundamental,
technical, and quantitative analysis.

Equity/security analysis helps people achieve their ultimate goal, as discussed below:

 Capital Gain: Capital Gain or appreciation is the difference between the sale price
and purchase price.

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  Yield: It is the return received in the form of interest or dividend.

Return = Capital Gain + Yield

 Risk: It is the probability of losing the principal capital invested. Security analysis
avoids risks and ensures the safety of capital, also creates opportunities to
outperform the market.

 Safety of Capital: The capital invested with proper analysis; avoids chances to lose
both interest and capital. Invest in less risky debt instruments like bonds.

 Inflation: Inflation kills one’s purchasing power. Inflation over time causes you to
buy a smaller percentage of good for every dollar you own. Proper investments
provide you hedge against inflation. Prefer common stocks or commodities over
bonds.

 Risk-Return relationship: The higher the potential return of an investment, the

higher will be the risk. But the higher risk doesn’t guarantee higher returns.

 Diversification: “just don’t put all your eggs in one basket,” i.e., do not invest your
whole capital in a single asset or asset class but allocate your capital in a variety
of financial instruments and create a pool of assets called a portfolio. The goal is to
reduce the risk of volatility in a particular asset.

The weakness of this method is lack of precision and un-dependable nature of any
calculation of economic future. A valuation may be very skillfully done in the light of all
pertinent data and the soundest judgment of future probabilities; yet the market may delay
adjusting itself to the indicated value for so long a period that new conditions may
supervene and bring with them a new value. Thus even though the price ultimately
converges with that new value, the old valuation may have proved undependable.

These limitations should be acknowledged by the analyst and must use good judgment in
distinguishing between securities and situations that are better suited and those that are
worse suited to value analysis. Its working assumption is that the past record affords at
least a rough guide to the future. The more questionable this assumption, the less valuable

Investment- Approaches to Equity Analysis Page 43

is the analysis. Hence this technique is more useful when applied to a business of
inherently stable character than to one subject to wide variations and more useful when
carried on under fairly normal general conditions than in times of great uncertainty and
radical change.

There are three general areas in which value analysis will operate successfully

 Inherently stable securities – conservatively capitalized public utilities and strongly

entrenched industrials.
 Cases of extreme disparity between price and indicated value. Here the analyst
relies upon a large initial margin of safety to absorb and offset the uncertainties of
the future. Here diversification is especially valuable.
 Comparative analysis to determine if one if preferable to the other.

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CONCLUSION AND SUGGESTIONS
Equity/Security analysis is the analysis of tradable 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. Tradable
credit derivatives are also securities. Commodities or futures contracts are not securities.
They are distinguished from securities by the fact that their performance is not dependent
on the management or activities of an outside or third party. It ensures the aspects:

 To value financial instruments like equity, debt, and warrants of a company.

 To use publicly available information. The use of insider information is unethical
and illegal.
 Security analysts must act with integrity, competence, and diligence while
conducting the investment profession.
 To use various analytical tools, this includes fundamental, technical, and
quantitative approaches.
 Security analysts should place the interest of clients above their personal interests.

Equity analysis has three functions. The first is the descriptive function, which presents
relevant facts in an understandable manner and compares different securities. The second
is the selective function, which
judges whether an investor should Stock analysis is a method for investors and traders
buy, sell or hold onto a security. to make buying and selling decisions. By studying
and evaluating past and current data, investors and
Finally, the critical function
traders attempt to gain an edge in the markets by
monitors corporate policies, making informed decisions.
management and company
Looking at the balance sheet still, a stock analyst
structure on an ongoing basis so
may want to know the current debt levels taken on
that changes can be made if by a company.
necessary.

A major recommendation to enhance the reliability of analysts' ratings is to have their

record of recommendations available to investors. The public availability of their previous

Investment- Approaches to Equity Analysis Page 45

recommendations would motivate analysts to improve their track record to improve their
credibility. Some rules by the self-regulatory authorities do require the listing of an
analyst's recommendation for companies that they are currently covering, but companies
no longer covered by the analysts can be excluded.

A major consideration to keep in mind when reviewing recommendations is that stock

analysts are no more able to predict future market conditions than other market
participants. (If they could, they would all be enormously wealthy!) Target prices are based
on the assumption that the current market conditions will continue

In security analysis the prime stress is laid upon protection against untoward events. We
obtain this protection by insisting upon margins of safety. The underlying idea is that even
if the security turns out to be less attractive than it appeared, the commitment might still
prove a satisfactory one. The recurrent but highly irregular stock-market cycles are of
prime interest to the analyst, because their low ranges and high ranges almost always mark
areas of undervaluation and overvaluation for both standard and secondary common
stocks in general. In intermediate areas of the general market or during its minor
downturns, there are significant price fluctuations in many secondary stock issues when
standard stocks remain in a neutral range.

Investment- Approaches to Equity Analysis Page 46

BIBLIOGRAPHY

 WEBSITES:
 https://en.wikipedia.org/wiki/Fundamental_analysis
 https://economictimes.indiatimes.com/company/equity-analsis-(india)-
private-limited/U67120MH1995PTC092449
 https://en.wikipedia.org/wiki/Price%E2%80%93earnings_ratio

 ONLINE JOURNALS:-
 Cooper, Stephen. "Performance measurement for equity analysis and
valuation." Accounting in Europe 4, no. 1 (2007): 1-49.
https://www.tandfonline.com/toc/cdan20/current
 https://onlinelibrary.wiley.com/doi/abs/10.1111/1475-679X.00042
 Ohlson, J. A. (2001). Earnings, book values, and dividends in equity
valuation: An empirical perspective. Contemporary accounting
research, 18(1), 107-120.

 BOOKS:-
 R.P. Rustogi, Fundamentals of Investment, Sultan Chand & Sons, New
Delhi.
 C.P. Jones, Investments Analysis and Management, Wiley, 8th ed.
 Christensen, P.O. and Feltham, G.A., 2009. Equity valuation. Now
Publishers Inc
 Graham, B., & Dodd, D. (2004). Security analysis: The classic 1951
edition (p. 770). New York, NY: McGraw-Hill.

Investment- Approaches to Equity Analysis Page 47