Post on 09-Apr-2018
8/8/2019 Analyzing Equities
1/30
1
ANALYZING EQUITIES
PRESENTED BY:
ATO BARNES
SEM INTERNATIONAL ASSOCIATES
8/8/2019 Analyzing Equities
2/30
2
ANALYZING EQUITIES
The starting point for all fundamental analysis
Chapter 6
Economy, Industry, and Company Analysis
Analyzing the Economy
Profitability of all companies,depends on the overallperformance of the economy
The overall performance of the economy is measured by theGROSS DOMESTIC PRODUCT (GDP).
The GDP is the result of the interaction of governmentpolicies and external factors.
8/8/2019 Analyzing Equities
3/30
3
ANALYZING EQUITY
SECURITIESTwo categories of government policies:
(1)Fiscal:- establishes government revenue and
expenditure(2)Monetary: -determines the liquidity of the
economy through money supply. Also determineslevel of interest rates.
(3)Projections for government expenditure,inflation and GDP are always made in each yearsannual budget
8/8/2019 Analyzing Equities
4/30
4
Policy variables affect total spending (Y)which in Combination with the tax ratetcaffects corporate earnings. As investors changetheir expectations of corporate earnings,share prices respond, with high earnings
expectations leading to share price increasesand vice-versa.
Economic VariablesandShare Prices
Analyzing Equity Securities
(MichaelKeransModel)
8/8/2019 Analyzing Equities
5/30
5
Economic VariablesandShare Prices
2. The policy variables affect total spending whichin combination with the economy's potential
output Y* and past changes in prices determinecurrent changes in prices (P). Y and P determinecurrent changes in real output (X). Changes in Xand P generate expectations about inflation andreal growth which in turn affects interest rates.Interest rates have a negative effect on shareprices. As taxes rise, investors raise the rates ofreturn that they require, causing share prices tofall.
8/8/2019 Analyzing Equities
6/30
8/8/2019 Analyzing Equities
7/30
7
Industry Analysis
Evaluation of the industry in relation to majormacroeconomic variables
Implications of Cyclical ,Counter Cyclical,Interest Sensitive, and Non-interest Sensitiveindustries for the investor?
A qualitative analysis of industry characteristics.
Historical performance (Sales and profitability)
Competition (Porters 5 force Model) Government effects (regulations and taxes)
Structural changes of the industry
8/8/2019 Analyzing Equities
8/30
8
Summary ofIndustry Analysis
In the short-run (e.g. 1 year), industry analysisshould assist in identifying which industries will
produce high earnings, which industries will havehigh P/E ratios. The short-run analysis is usuallybased on expectations about macroeconomicvariables such as interest rates and GDP growth.
Long-run investors would usually be more interestedin the industry life cycle and the qualitative factorsthat affect the long-run strength of an industry.
Analyzing Equity Securities
8/8/2019 Analyzing Equities
9/30
9
Company Analysis
Company analysis identifies the strengths andweaknesses of a company.
Other things being equal, a strong companywould command a higher price-earnings ratiothan a weak company.
Therefore, it is necessary to evaluate the longterm prospects of a company in terms of sales
and profitability. A basic understanding of financial statements is
therefore, essential to company analysis.
Analyzing Equity Securities
8/8/2019 Analyzing Equities
10/30
10
TechnicalAnalysis
UnderlyingAssumptions Values, and thus, prices are determined by
supply and demand.
Supply and demand is driven by bothrational and irrational behaviour
Security prices move in trends that persistfor long periods of time.
While the cause for changes in supply anddemand are difficult to determine, theactual shifts in supply and demand can beobserved in market price behaviour.
8/8/2019 Analyzing Equities
11/30
11
Differences AmongFundamental,
Technical,andthe EfficientMarket
Analysts
Fundamental Analysts believe that a
securitys price is determined by the supply
and demand for the underlying security
based on its economic fundamentals such
as expected return and risk.
Fundamentalists believe they can forecastvalue changes by analyzing earnings data
and publicly available data.
8/8/2019 Analyzing Equities
12/30
12
Differences AmongFundamental,
Technical,andthe EfficientMarket
Analysts
The major challenges to technical analysisis the efficient market hypothesis.
Efficient analysts feel all availableinformation is impounded in the currentsecurity price. That past technicalrelationship may not be repeated. That
technical rules require too much subjectiveinterpretation, and decision variableschanges over time.
8/8/2019 Analyzing Equities
13/30
13
Differences AmongFundamental,
Technical,andthe EfficientMarket
Analysts The difference between fundamental analysts,
technical analyst and efficient market analysts is
the speed at which these analyst believe news isimpounded into prices.
Fundamentalists, through research, look forchanges in the basis of value, which eventuallyleads to changes in the supply and demand for the
shares. Technicians look for evidence of changesin supply and demand through market signals andindicators. Efficient market followers say all thislooking is a hopeless and profitless exercise since
prices will change instantaneously to informationchan es.
8/8/2019 Analyzing Equities
14/30
14
AdvantagesofTechnicalAnalyst
Its quick and easy
It does not involve messing with data and
adjusting for accounting problems
It incorporates psychological as well as
economic reasons behind price changes
It tells when to buy; not why investors are
buying
8/8/2019 Analyzing Equities
15/30
15
Challengesto TechnicalTrading
Rules
The vast majority of studies have found
that prices do not move in trends based on
statistical tests of autocorrelation and runs.
That is, past price patterns may not be
repeated in the future.
If technical trading rules worked, themarket would self-destruct. This is called
self-fulfilling prophecy.
8/8/2019 Analyzing Equities
16/30
16
Challengesto TechnicalTrading
Rules
If a technical trading proved to be
successful, others would copy it. As more
traders implement the strategy, its value
will be neutralized.
Interpreting the rules is too subjective and
the decision variables change over time.
8/8/2019 Analyzing Equities
17/30
17
TechnicalRules
Technicians tend to take one of two views when
analyzing general market rules:
The contrarian view contrary-opinion techniciansfeel that everybody else is stupid, so they had better do
the opposite of what investors are doing.
Follow the smart money view technicians feel that
smart investors know what they are doing, so thattechnicians had better jump on the bandwagon while
there is still time.
8/8/2019 Analyzing Equities
18/30
18
TechnicalRules
A review of the contrarian viewpoint
Since contrarians feel that majority of
investors are always wrong, they wait to see
what the investing public is doing and do the
opposite. This approach comes from
greed/panic view of the investment process. A
wise contrary-opinion technician does the
opposite of what the general public does.
8/8/2019 Analyzing Equities
19/30
TECHNICAL ANALYSIS(contd)
1. The DOW Theory
Primary Moves: broad based market movement lasting for several years.
BULL marketupward primary move, in which successive market rallies
tend to penetrate previous highs:BEAR marketdownward primary move, in
which successive market rallies fail to penetrate previous highs, and declines
penetrate previous lows. Secondary Moves: occurs within primary moves. Represents interruptions
lasting for several weeks or months. Leads to technical corrections when
market is adjusting to previous excesses.
Day-to-Day Moves: occur randomly around the primary and secondary moves.
Analyzing Equity Securities
ANALYSIS OFAGGREGATE MARKET
2. Technical Indicators for Aggregate Market
1. Advance-Decline Line
2. New Highs and Lows
3. Volume : A high volume is considered bullish
4. Cumulative Offers to Bid
5. Contrarian Opinion: Odd-Lot Index=Odd Lot Sales/Odd Lot Purchases
8/8/2019 Analyzing Equities
20/30
TECHNICAL ANALYSIS(contd)
Volume
Odd-Lot Index
Cumulative Offers-to-Bids Technical indicators, graphs, charts, for individual shares
Head and Shoulders patterns: These are time series graphs ofmarket
indextoshareprice ratiothat indicate endofrallies.
Support and Resistance patterns/level This is a time series graph of
marketindexthat indicates newandendingrallies.
Analyzing Equity Securities
ANALYSIS OF INDIVIDUAL SHARES
8/8/2019 Analyzing Equities
21/30
21
TECHNICAL ANALYSIS(contd)
Demerits of Technical Analysis:
1. Failed to outperform simple buy and holdstrategy
2. Tools of technical analysis (graphs, charts,
indicators) can be misinterpreted
3. Rule could be self-destructive if many analysts
use it.
Analyzing Equity Securities
8/8/2019 Analyzing Equities
22/30
22
PERFORMANCE
EVALUATION
Concerns assessing the performance of a portfolio and
hence a portfolio manager
A performance measurement system should address twoconcerns:
How did the manager perform after adjusting for the
risk associated with the active portfolio strategyemployed?
How did the manager achieve the reported return?Was the stated strategy followed?
Introduction
8/8/2019 Analyzing Equities
23/30
23
Benchmarksfor EvaluatingPerformance
Market Indices
GSE All-Share Index
Databank Stock Index
Performance Evaluation
8/8/2019 Analyzing Equities
24/30
24
Generic-InvestmentStyle
IndicesGeneric-Investment Style Indices
Measures performance of various investmentstyles, and compared with published styleindexes
Style classification: large value, large growth,small value, small growth
P/B ratio used to classify stocks as value or
growth stocksGrowth oriented managers concerned aboutearnings growth; value oriented managersconcerned about price movement
Value stocks are cheap stocks (low P/B ratio)
8/8/2019 Analyzing Equities
25/30
25
NormalPortfolio
Normal Portfolios
Customized benchmark that includes all of
the securities from which a managernormally chooses, weighted as themanager would weight them.
8/8/2019 Analyzing Equities
26/30
26
Single IndexMeasuresofPortfolio
Performance
1. The Reward-to-Variability Ratio (the SharpeIndex)
Performance Evaluation
A good measure of performance considers bothrisk and return. Two common measures ofportfolio performance that considers both riskand return are:
p
fp RRSIW
!
8/8/2019 Analyzing Equities
27/30
27
Treynor Index
2. The Reward-to-Volatility Measure (the TreynorIndex)
p
fp RRTIF!
Recall: Standard deviation or variance measurestotal risk, but beta measures systematic risk
Note: BothSI and TI measure excess returnovertherisk-free rate torisk
8/8/2019 Analyzing Equities
28/30
28
Single IndexMeasuresofPortfolio Performance
(contd)Illustration:- Calculation of Sharpe and Treynor Indices
Performance Evaluation
PERIOD A B MARKET INDEX RISK FREE RATE
1 10.4 15.4 17 8.6
2 -15.3 -15.7 -19 10.3
3 20 23.4 12.3 11.5
4 26.1 23.2 20 11.9
5 32.1 28.5 20 12
6 -30.7 -28.6 25 11.2
7 26 25.6 17.4 12.5
8 15.9 18 21.5 13
9 21.5 24.7 23.9 13.1
10 -24.1 12 -9.8 9.5
MEAN 8.2 12.7 12.8 11.14
STD DEV 21.7 18.3 14.2 1.4
BETA 0.79 0.42 1
PORTFOLIO
8/8/2019 Analyzing Equities
29/30
29
Equity Performance AttributionModels
Performance Evaluation
1. Timing short term factor trends2. Market timing3. Security analysis
These models seek to explain the sources of equityportfolio return in terms of three actions of portfoliomanagers, viz:
8/8/2019 Analyzing Equities
30/30
30
Equity Performance AttributionModels
The equity performance attribution attribution analysisis done with the view to determining:
1. The sources of return2. Whether the short-term factor timing is
statistically significant3. Whether the market timing is statistically
significant4. Whether the security analysis is statistically
significant