Security analysis

Security analysis

Security analysis refers to the analysis of trading securities from the point of their prices, returns and risks. All investments are risky and the expected return is related to the quantum of risk. All investors try to earn more return with low level of risk or without risk. For this purpose they are considering some objectives. These are:

Objectives

Regular income ' the income from the investment should be regular and consistent one. The high fluctuation is income stream is not suitable for the long-term growth.

Capital appreciation ' the investment must yield regular income as well as growth in value i.e, capital appreciation. It is the difference between the selling price and purchase price.

Safety of capital ' the capital invested in assets requires the safety. Safety is the important element which protects the loss of capital and return from the investments.

Liquidity ' liquidity is the ease of convertibility or marketability of assets.

Hedge against Inflation ' the inflation is the biggest problem we are facing today, hence the rate of return from the investment requires high yield to beat inflation rate.

These are the major objectives of an investor; to attain these objectives a careful and critical security analysis is necessary. The literature on security analysis can be consolidated to form three approaches to explaining the behavior of share prices and their valuation. These analysis are used to find out the answer for the question like, why share prices fluctuate, how they are determined, what to buy or sell and when to buy or sell.

Fundamental analysis

Fundamental analysis relates to an examination of the intrinsic worth of the company, to find out whether current market price is fair, overpriced or under priced. Intrinsic worth is the real worth of the company share price; it is calculated dividing the net assets by number of equity shares outstanding. Hence fundamentalists attempt to estimate the intrinsic worth of a share by analyzing the various economic, industry and company related factors. Analysis on fundamental factor is considered necessary while making investment in equity shares.

At any phase in the economy, there are some industries which are mounting while others are declining. The performance of companies will depend among other things upon the state of the industry as a whole and the economy. If the industry is prosperous, the companies, within the industries may also be prosperous although a few may be in a bad shape. The performance of a company depends not only of the industry and of the economy, but more importantly, on its own performance.

Macro-economic factors

It is concerned with macro-economic factors; these factors have much impact on the market price of the shares. These are growth rates of national income and industrial sectors, inflation and interest rate, foreign trade and exchange rates, savings and investment of the public, monsoon and agriculture performance, political stability etc. Hence this factor not only affects a particular script but affect the stock market as whole.

Industry-wide factors

The industry analysis should take into account the following factors among others as influencing the performance of the company, whose shares are to be analyzed. The factors like, business life cycle, raw material supply, demand and market tendency, labor supply, automation, future prospects etc. are considered here, before making investment in equity shares.

Company-specific factors

In company analysis the profit and loss account and balance sheet are analyzed before investing into a share of the company. Here the factors like sources and uses of funds, profitability, dividend payout ratio, price-earnings ratio, track record of the company and the promoters etc are considered.

Hence fundamentalist's objective is to relate the current market price of a security to its intrinsic value or theoretical value and to execute a buy or sell order accordingly in order to ensure superior gains from the market.

Technical analysis

The technical school of thought developed its own theory for determining the behavior of stock prices. The technicians do not believer fundamentalists thoughts. Technical analysis of the market is based n some basic tenets, namely, that all fundamental factors are discounted by the market and are reflected in prices. Secondly, these prices move in trends or waves which can be both upward and downward depending on the sentiment, psychology and emotions of operators or traders. Finally, the present trends are influenced by the past trends and the projection of future trends is possible by an analysis of past price trends. According to the technicians, prices are determined in the following manner.

Prices of securities are determined by the demand and supply of securities in the market. Demand and supply of securities are to be considered the main essence of changes in security prices. The collection of past market data used to find out the history of price movements and depict these on a chart. The chart helps to determine future prices.

Hence, the technical analysis reveals that the past behavior of stock prices gave an indication about the future of the stocks.

Efficient Market Hypothesis

The efficient market hypothesis is based on the flow of free and correct information and the market absorption of it. The theory of efficient market hypothesis describes the efficiency in three forms. These are weak form, semi-strong form and the strong form. In 1991 Eugene F Fama has re-titled these categories as tests for return predictability, event studies and test for private information.

The weak of efficient market hypothesis says that current prices of stocks reflect all information, which is already contained in the past. The weak for also holds that prices have no memory and yesterday has nothing to do with tomorrow. The semi-strong form of EMH asserts that the security prices incorporate all publicly available information such as information available from annual reports, dividends and earnings announcements etc. Lastly, the strong form of EMH maintains that current prices of stocks reflect all the information including the insider information.

Having awareness in these factors can help to earn more returns in the market.