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  1. Bachelor Degree in Banking and Finance. BFN 306: Security Analysis and Portfolio Management 24 March 2023 1
  2. PART1: Security Analysis. 24 March 2023
  3. 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. 24 March 2023
  4. Investment, Speculation, Gambling and Investment Avenue 24 March 2023
  5. • 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. 24 March 2023 INVESTMENT
  6. • 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 24 March 2023 Why Do We Invest? The Right Savings Formula A. Income – Expenses = Savings × B. Income – Savings = Expenses √
  7. 24 March 2023 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.
  8. • Equity Securities: – Stocks • Derivative Securities: – Options – Future Contracts Investment Avenue • Money Market Securities: – Treasury Bill – Negotiable CDs • Fixed-Income Securities: – Bonds – Asset-Backed Securities
  9. 24 March 2023 Why Do We Invest? Capital growth Diversification Tax benefits Returns To Achieve:
  10. • 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 24 March 2023 WHAT IF WE DO NOT INVEST
  11. • You will need funds in retirement – To pay for food, clothing, and any other living expenses 24 March 2023 WHAT IF WE DO NOT INVEST
  12. • 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 24 March 2023 SPECULATION
  13. • 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. 24 March 2023 SPECULATION
  14. • 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. 24 March 2023 SPECULATION
  15. • 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. 24 March 2023 GAMBLING
  16. • 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 24 March 2023 GAMBLING
  17. 24 March 2023 Concepts of Security Analysis
  18. • 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. 24 March 2023 SECURITY ANALYSIS
  19. • 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 24 March 2023
  20. • 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:
  21.  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: 24 March 2023
  22.  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: 24 March 2023
  23. • 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: 24 March 2023
  24. • 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 24 March 2023
  25. • 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 24 March 2023
  26. • 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) 24 March 2023     ... 1 1 1 3 3 2 2 1 0        k D k D k D V
  27. • 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 24 March 2023   g k D g k g D V      1 0 0 1 54 $ 08 . 0 14 . 0 24 . 3 $ 1 0      g k D V
  28. • 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 24 March 2023 b ROE g x 
  29. Fundamental Analysis at Company Level … Growth rate of dividends 24 March 2023 • 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%
  30. Fundamental Analysis at Company Level … Growth rate of dividends 24 March 2023 • Therefore: • Finally, • In 2009, one share of Honda Motor Company Stock     68 . 31 $ 077 . 0 111 . 0 077 . 1 1 $ 1 2013 2014 2013         g k g D g k D P 04 . 23 $ 111 . 1 68 . 31 $ 1 $ 111 . 1 83 . 0 $ 111 . 1 66 . 0 $ 111 . 1 50 . 0 $ 4 3 2 2009       V
  31. 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: 24 March 2023
  32. • 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 24 March 2023
  33. • 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 24 March 2023
  34. • 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 24 March 2023
  35. 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: 24 March 2023
  36. • 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… 24 March 2023
  37. 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… 24 March 2023
  38. 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… 24 March 2023
  39. 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… 24 March 2023
  40. Technical Analysis - Logic 24 March 2023 Supply and demand determine prices Changes in supply and demand cause changes in prices Prices can be projected with charts and other technical tools
  41. • 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 24 March 2023
  42. • 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… 24 March 2023
  43. • 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. 24 March 2023 Technical Analysis – Charts
  44. • 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 24 March 2023
  45. 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. 24 March 2023 Line Charts …
  46. 24 March 2023 Line Charts …
  47. 24 March 2023 Line Charts
  48. • 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. 24 March 2023 Line Charts (Summary)
  49. 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 24 March 2023
  50. 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 24 March 2023
  51. 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). 24 March 2023
  52. Bar Charts • Consists of bars which are vertical line and Horizontal dash. Three possible bars are expected: 24 March 2023 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
  53. 24 March 2023 Bar Charts
  54. Bar 24 March 2023 Bar Charts ...
  55. Bar • Consider the following data for your analysis and draw a bar chart 24 March 2023 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
  56. • 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. 24 March 2023 Bar Charts (Summary)
  57. • 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. 24 March 2023 Candlestick Charts
  58. Candlestick Charts
  59. 24 March 2023 Candlestick Charts
  60. • 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. 24 March 2023 Candlestick Charts (Summary)
  61. 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. 24 March 2023
  62. 24 March 2023 Point and figure chart …
  63. • 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 24 March 2023