Bachelor Degree in Banking and
Finance.
BFN 306: Security Analysis
and Portfolio Management
24 March 2023 1

PART1:
Security Analysis.
24 March 2023

Learning Outcomes
• After studying this part of the model, you should be
able to:
– Apply security analysis and portfolio management
principles in managing financial investment.
– Apply fundamental and technical analysis skills in
evaluating financial portfolio.
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Investment, Speculation, Gambling and
Investment Avenue
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• Investment is the allocation of monetary
resources to assets that are expected to yield
some returns over a period of time.
– It involves the commitment of resources which
have been saved with the expectation that some
benefits will accrue in future.
• Investment actually refers to the current
commitment of present resources mainly
money, in the hope of gaining future
benefits.
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INVESTMENT

• Investment increases future consumption
possibilities:
– By foregoing consumption today and
investing the savings, investors expect to
increase their future consumption
possibilities by increasing their wealth
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Why Do We Invest?
The Right Savings Formula
A. Income – Expenses = Savings ×
B. Income – Savings = Expenses √

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Why Do We Invest?
1. Retirement: By investing a portion of
your income you allow money to
grow and work for you when you
retire.
2. 3 parameters to assess suitability of
any investment avenue are –
i. Return potential
ii. Safety
iii.Liquidity
3. Various avenues where money can be
invested, are broadly classified into
‘Asset Class’. Equity and bonds are
the most popular class of assets.

• Equity Securities:
– Stocks
• Derivative
Securities:
– Options
– Future Contracts
Investment Avenue
• Money Market
Securities:
– Treasury Bill
– Negotiable CDs
• Fixed-Income
Securities:
– Bonds
– Asset-Backed Securities

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Why Do We Invest?
Capital growth Diversification
Tax benefits Returns
To Achieve:

• If we have savings and we do not invest, we
can’t earn anything on our savings.
• Second, the purchasing power of cash
diminishes in inflation
– This means that if savers do not invest
their savings, they will not only lose
possible return on their savings, but will
also lose value of their money due to
inflation
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WHAT IF WE DO NOT INVEST

• You will need funds in retirement
– To pay for food, clothing, and any other
living expenses
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WHAT IF WE DO NOT INVEST

• Speculation can be described as investment
related with short-term investment horizons and
involves purchasing the salable securities with
the hope that its price will increase rapidly,
providing them with a quick profit.
• Speculators try to buy low and sell high, their
primary concern is with anticipating and
profiting from market fluctuations.
• Source of income is associated with the change
in market price
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SPECULATION

• The stock brokers may be cited as an example.
Some brokers buy shares with a view to make quick
profit by selling within few days, when the prices of
such shares shoot up.
• Speculation involves trading a financial
instrument involving high risk, in expectation of
significant returns. The motive is to take
maximum advantage from fluctuations in the
market.
• Without having enough knowledge about the market
movements, speculators expose themselves to higher risks.
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SPECULATION

• Example – Speculator who buys 50 shares of
a company for $3000. Now the price of the
same shares becomes $4000 due to price
fluctuation. The person sells the shares and
earns profits of $1000.
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SPECULATION

• Gambling is different from investment and
speculation.
• Gambling purely depends on the intuition or
instincts of the investor.
• The chance of winning that gamble is
particularly very less
• A gamble is a very short term investment in a
game of chance.
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GAMBLING

• Example – The example of gambling are horse
racing, card game, lottery etc. This is a gamble as
this investment is not backed by any information or
analysis and the chances of winning are unknown.
• After experiencing a gain or profit, people are
willing to take more risk. This is called as “house-
money” effect.
• After experiencing a financial loss, people become
less willing to take a risk. This effect is recognized
as “snakebite” effect
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GAMBLING

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Concepts of Security Analysis

• Security – Is an asset with a financial value
• Investment can be made to intangible assets like
marketable securities or to real assets like gold,
real estate etc. More generally it refers to
investment in financial assets.
• Investment decision has two primary processes:
namely the analysis and management.
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SECURITY ANALYSIS

• Security analysis is an investment decision
process involving valuation and analysis of
individual securities.
• Security 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.
• Two approaches for security analysis
 Fundamental analysis
 Technical analysis
Security Analysis
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• In accounting and finance, Fundamental analysis is
an evaluation procedure of securities where the
major goal is to estimate the intrinsic value of a
stock.
• It studies the fundamental factors that effects stocks
intrinsic value like profitability statement & position
statements of a company, managerial performance
and future outlook, present industrial conditions, and
the overall economy.
– Fundamental analysis uses internal and external
variables to anticipate price movements.
• Thus, fundamental analysis values the stock using
financial variables in order to determine company’s
Fundamental Analysis:

 The ultimate goal of fundamental analysis is to
quantify the intrinsic value of a security.
 The estimated security’s intrinsic value can then be
compared to its current market price to help with
investment decisions.
 The current price of a stock may not reflect the
actual value of the stock.
 The stock may be overvalued or undervalued in the
market.
Fundamental analysis:
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 Fundamental analysis helps investors to study the
health of the company, and thus leading to the actual
value of the stock.
 The main purpose of this method is to identify
companies that that are fundamentally strong in
order to invest in them for the long term.
 It is not enough just to find a successful business, it
is necessary to find companies that worth more than
other investors estimate.
Fundament Analysis:
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• Fundamental analysis consists of three main
parts namely:
1. Economic analysis - fundamental analysis might
focus on economic data to assess the present
and future growth of the economy.
2. Industry analysis – examination of supply and
demand forces for the products offered
3. Company analysis- involves the examination of
financial data, management, business concept
and competition.
Components of Fundament Analysis:
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• This analysis helps to evaluate investment opportunities
such as when to buy and sell securities.
• Using fundamental variables, an intrinsic value of a firm
(Vo) can be estimated and compared with the prevailing
market prices (Po) to aid in investment decisions
• An intrinsic value - the most common approach for
valuation of common stocks using fundamental analysis
– In this method, an investor or analyst studies
the future prospects for a company and
estimates the likely dividends to be paid (the
only payments an investor receives directly
from a firm).
• The goal of fundamental analysis is to derive a
Fundament analysis at Company
Level
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• The intrinsic value (IV) is the “true” value, it tells
what a stock will do in the future.
• The market value (MV) is the consensus value of
all market participants
If Vo > Po, purchase because the stock is
undervalued
If Vo < Po, sell because the stock is overvalued
If Vo = Po, the stock is correctly priced
Fundamental Analysis at Company
Level …
Intrinsic Value and Market Price
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• V0 = Intrinsic value; Dt= Dividend at time t; k =
required rate of return
• The DDM says the stock price should equal the
present value of all expected future dividends into
perpetuity.
Fundamental Analysis at Company
Level …
Dividend Discount Models (DDM)
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   
...
1
1
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k
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k
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k
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V

• g = dividend growth rate which is constant in
perpetuity
• A stock just paid an annual dividend of $3/share.
The dividend is expected to grow at 8% indefinitely,
and the market capitalization rate (from CAPM) is
14%.
Fundamental Analysis at Company
Level …
Constant Growth DDM
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g
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• Growth rate (g) of dividends can be
estimated using the formula
• Where:
g = growth rate in dividends
ROE = Return on Equity for the firm
b = plowback or retention ratio
(1- dividend payout ratio)
Fundamental Analysis at Company
Level …
Growth rate of dividends
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b
ROE
g x


Fundamental Analysis at Company
Level …
Growth rate of dividends
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• Consider the expected dividends for Honda:
2010 $.50 2012 $ .83
2011 $.66 2013 $1.00
• Since the dividend payout ratio is 30% and ROE is
11%, the “steady-state” growth rate is 7.7%.
• Honda’s beta is 0.95 and the risk-free rate is 3.5%. If
the market risk premium is 8%, then k is:
• k=3.5% + 0.95(8%) = 11.1%

Fundamental Analysis at Company
Level …
Growth rate of dividends
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• Therefore:
• Finally,
• In 2009, one share of Honda Motor Company Stock
    68
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V

INTEGRAL PART OF FUNDAMENTAL
ANALYSIS
• it helps the analyst understand a firm’s current
condition
• where it is headed
• what factors affect it
• how the factors affect it
includes a study of the three major
statements:
• the balance sheet
• the income statement
• the statement of cash flows
Financial analysis:
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• Balance sheet:
o Shows the financial position of the firm at a
particular point in time. Is a summary of a firm’s
financial position on a given date that shows total
assets = total liabilities + owners’ equity.
• The income statement: Indicates company's ability
in generating profit/loss for a period under
consideration
• Cash flow statement: Showing the firm's cash
movement for a certain period
Financial Statement categories
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• Ratio analysis is a method that can be used to
assess a company’s performance over a period
of time or to compare the performance of two
companies.
• In comparing the performance of two companies
you must consider the nature of each
company’s business because the ratios of a
supermarket will be significantly different from
those of an engineering company.
Ratio analysis
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• A ratio on its own is meaningless unless:
o Interpretation is made
o It is compared with other ratios in the same
set of financial statements
o It is compared with the same ratio in previous
financial statements ( trend analysis)
o It is compared with a standard of
performance. The standard measure may be
an industry average or a target set by the
management.
Importance of Ratios
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i. LIQUIDITY- measures the ability of the firm to
meet its due or maturing short term obligations
– some liquidity ratios:
ocurrent ratio
oquick ratio
ii. PROFITABILITY-These ratios measure the
performance of firms in terms of profit
generation/productivity.
Types of Ratios:
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• Some profitability ratios
– Gross Margin
oGross profit / Sales
– Operating Margin
oOperating income / Sales
– ROA
oNet income / Total assets
– ROE
oNet income / Owner’s equity
Types of Ratios…
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iii. GEARING/ LEVERAGE RATIOS
• These ratios indicate the degree to which the
activities of a firm are supported by creditors'
funds as opposed to owners.
– some examples:
odebt to equity ratio
olong-term debt/total capital ratio
Types of Ratios…
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iv. ASSET UTILIZATION/ACTIVITY/EFFICIENCY
RATIOS
• They measure how efficient is a firm in utilizing
short-term assets to generate income.
• If a business does not use its assets effectively,
investors in the business would rather take their
money and place it somewhere else.
– Some ratios include:
o inventory or stock turnover
o average debtors collection period
o creditors’ payment period
o total asset turnover
Types of Ratios…
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v. MARKET/INVESTMENT RATIOS
• These are the ratios which indicate the
relationship of the firm's share price to dividends
and earnings.
• Market value ratios are indicators of what
investors think of the firm's past performance
and future prospects. They include; dividend
yields, P/E ratio, dividend cover, dividend pay
out ratio, Earnings yield and P/B ratio
Types of Ratios…
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Technical Analysis - Logic
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Supply and
demand
determine
prices
Changes in
supply and
demand
cause
changes in
prices
Prices can
be projected
with charts
and other
technical
tools

• Is a security analysis discipline for forecasting the
direction of prices through the study of past
market data, primarily price and volume.
• Technicians say that market's price reflects all
relevant information, so analysis looks at the
history of a security's trading pattern rather than
external drivers such as economic, fundamental
and news events.
• It involves plotting share prices on a chart and
interpreting the pattern.
• Technical analysts do not attempt to measure a
security's intrinsic value but instead use stock
charts to identify patterns and trends that may
Technical Analysis
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• Rules for when to buy and sell stocks are then
established on the basis of the patterns/trend that
emerge.
• Trends “are your friend” and sentiment changes
predate and predict trend changes.
Technical analysis…
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• Technical analysts believe that prices trend
directionally, i.e., up, down, or sideways (flat) or
some combination.
• Charts are essential component of the technical
analyst’s toolkit.
• Charts provide information about past price behavior
and provide a basis for inferring likely future price
behavior.
• A variety of charts can be useful in studying the
markets.
• The selection of the chart to use in technical analysis
is determined by the intended purpose of the
analysis.
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Technical Analysis – Charts

• Four main types of charts are available for investors
and traders to use depending on the information
they are seeking and their individual skill levels.
• These charts are:
- Line chart
- Bar Chart
- Candlestick Chart, and
- Point and Figure Chart
Technical analysis – Types of Charts
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l
• The basic and simplest form of the four charts
• Line charts represent only the closing prices over a
set period of time.
• The line is formed by connecting the closing prices
over the time frame.
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Line Charts …

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Line Charts …

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Line Charts

• While this type of chart doesn’t provide
much insight into intraday price
movements, many investors consider the
closing price to be more important than the
open, high, or low price within a given
period.
• These charts also make it easier to spot
trends since there’s less ‘noise’ happening
compared to other chart types.
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Line Charts (Summary)

Bar Charts
• Consists of bars which are vertical line and
Horizontal dash
– The vertical lines
• consists of Low Price (L) at the bottom and
the high price (H) at the top
– The Horizontal dash
• Consists of Open price (O) on the left side
and Close price (C) on the right side for the
time frame
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Bar Charts
• The chart is made up of a series of vertical lines
that represent each data point. This vertical line
represents the high and low for the trading
period, along with the closing price. The close
and open are represented on the vertical line by
a horizontal dash.
• The opening price on a bar chart is illustrated by
the dash that is located on the left side of the
vertical bar. Conversely, the close price is
represented by the dash on the right. Generally,
if the left dash (open) is lower than the right dash
(close) then the bar will be shaded green/black,
representing an up period for the stock, which
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Bar Charts
• A bar that is colored red signals that the stock
has gone down in value over that period. When
this is the case, the dash on the right (close) is
lower than the dash on the left (open).
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Bar Charts
• Consists of bars which are vertical line and
Horizontal dash. Three possible bars are
expected:
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Low
High
Low
High
Open
Close
Open = Closing Open < Closing
►Good for a day
Open > Closing
►Bad for a day
Open
Close
Open Close
High
Low

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Bar Charts

Bar
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Bar Charts ...

Bar
• Consider the following data for your
analysis and draw a bar chart
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Bar Charts ...
Date Open High Low Close
22 march, 2016 196.8 198.25 194.5 197.5
23 march, 2016 196.9 197.6 195.3 196.6
24 march, 2016 196.6 196.6 196.6 196.6
25 march, 2016 196.6 196.6 196.6 196.6
28 march, 2016 195.8 198.25 187.65 188.3
29 march, 2016 188.5 191.25 186.65 189.5
30 march, 2016 192.25 198.3 190.5 197.55
31 march, 2016 197.85 198.75 192.35 194.25
1 April, 2016 193.7 197.25 192 195.65

• The opening price is the horizontal dash
on the left side of the horizontal line and
the closing price is located on the right
side of the line.
• If the opening price is lower than the
closing price, the line is often shaded
black or green to represent a rising period.
• The opposite is true for a falling period,
which is represented by a red shade.
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Bar Charts (Summary)

• Candlestick charts are thought to have been
developed in the 18th century by Japanese
rice trader of financial instruments.
• Candlestick charts are an effective way of
visualizing price movements.
• When the close is higher than the open
(usually green or white) is called the Bullish
Candle.
• When the close is lower than the open
(usually red or black) is called Bearish
Candle.
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Candlestick Charts

Candlestick Charts

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Candlestick Charts

• Falling periods will typically have a red or
black candlestick body
• Rising periods will have a white or clear
candlestick body.
• Days where the open and closing prices
are the same will not have any wide body
or rectangle at all.
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Candlestick Charts (Summary)

Point and figure chart
• Is a charting technique used in technical
analysis, used to attempt to predict financial
market prices.
• Point and figure charting is unique in that it does
not plot price against time as all other
techniques do.
• Instead it plots price against changes in direction
by plotting a column of X’s as the price rises and
a column of O’s as the price falls.
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Point and figure chart …

• Benjamin Graham and David Dodd (2008), Security
Analysis, 6th Edition, The McGraw-Hill Companies,
Inc.
• Frank K. Reilly and Keith C. Brown (2012),
Investment Analysis & Portfolio Management, 10th
edition, South-Western, Cengage Learning.
• Jeffrey C. Hooke (2010), Security Analysis and
Business Valuation on Wall Street, A
Comprehensive Guide to Today's Valuation
Methods, 2nd edition, John Wiley & Sons, Inc.,
Hoboken, New Jersey.
• Bodie, Kane and Marcus (2012), Essentials of
Investments, 9th Edition, Mc Graw Hill.
REFERENCES
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