SlideShare a Scribd company logo
1 of 76
Download to read offline
Overview of Analysis Methods
• Fundamental Analysis
• Quantitative Analysis
• Technical Analysis
• Market Theories
 Efficient market hypothesis
 Random walk theory
 Rational expectations hypothesis
Fundamental Macroeconomic Analysis
• The Fiscal Policy Impact
• The Monetary Policy Impact
• The Flow of Funds Impact
• The Inflation Impact
Fundamental Industry Analysis
• Classifying Industries by Product or Service
• Classifying Industries by Stage of Growth
• Classifying Industries by Competitive Forces
• Classifying Industries by Stock Characteristics
Fundamental Valuation Models
• Dividend Discount Model
• Using the Price-Earnings Ratio
Technical Analysis
• Comparing Technical Analysis to Fundamental Analysis
• Commonly Used Tools in Technical Analysis
Analysis Methods
• A great deal of information is available when making an
investment decision. There is market and economic, data,
stock charts, industry and company characteristics, and a
wealth of financial statistical data. there are different
branches of analysis which helps to organize the
information.
• Fundamental analysis
• Quantitative analysis
• Technical analysis
There is a need for a clear understanding of what the
techniques measure, how they are determined, and how
they are interpreted.
This involves a study of everything, other than the trading
on the securities markets, which can have an affect on a
security’s value: macroeconomic factors, industry
conditions, individual company financial conditions, and
qualitative factors such as management performance.
Fundamental analysis pays attention to a company’s
debt/equity ratio, profit margins, dividend payout, earnings
per share, sales penetration, market share, interest, asset and
dividend coverages, product or marketing innovation, and
the quality of its management.
Fundamental Analysis
The most important single factor affecting the price of a
corporate security is the actual or expected profitability of
the issuer.
E.g., are profits sufficient to service debt, to pay current
dividends, or to pay larger dividends?
Fundamental Analysis
The study of interest rates, economic variables, and industry
or stock valuation using computers, databases, statistics and
an objective, mathematical approach to valuation.
There is a search for patterns and the reasons behind these
patterns in order to identify and profit from anomalies in
valuation.
Quantitative techniques often use statistics to determine the
likelihood of a particular investment outcome.
Quantitative Analysis
Studies historical stock prices and stock market behaviour
to identify recurring patterns in the data. The process
requires large amounts of information, can be time
consuming and cumbersome.
Technical analysts study price movements, trading
volumes, and data on the number of rising and falling
stock issues over time looking for recurring patterns that
will allow them to predict future stock price movements.
Technical Analysis
It is believed that by studying the “price action” of the
market, analysts can have better insights into the emotions
and psychology of investors. The contention is - because
most investors fail to learn from their mistakes, identifiable
patterns exist. Factors such as mass investor psychology
and the influence of program trading affects market prices.
E.g., Greed can force prices to rise to a level far higher than
warranted by anticipated earnings. Also, uncertainty can
cause investors to overreact to news and sell quickly,
causing prices to drop suddenly.
Technical Analysis
Market Theories - Financial
Three theories are applicable in providing explanations of
the behavior of stock markets. They are:
• Efficient market hypothesis
• Random walk theory
• Rational expectations hypothesis
Efficient Market Hypothesis
Assumes that profit-seeking investors in the marketplace
react quickly to the release of new information.
As new information about a stock appears, investors
reassess the intrinsic value of the stock and adjust their
estimation of its price accordingly.
Therefore, at any given time, a stock’s price fully reflects all
available information and represents the best estimate of
the stock’s true value.
Random Walk Theory
Postulation that new information concerning a stock is
disseminated randomly over time. Therefore, price
changes are random and bear no relation to previous price
changes.
If this is true, then past price changes contain no useful
information about future price changes because any
developments affecting the company have already been
reflected in the current price of the stock.
Rational Expectations Hypothesis
Assumes that people are rational and make intelligent
economic decisions after weighing all available
information. It also assumes people have access to
necessary information and will use it intelligently in their
own self-interest.
Thus, past mistakes can be avoided by using the
information to anticipate change.
Market Theories: Summary
The efficient market hypothesis, the random walk theory
and the rational expectations hypothesis all suggest that
stock markets are efficient.
But studies exist that support these theories but also support
the existence of market in efficiencies. E.g., it is unlikely
that:
• New information is available to everyone at the same time
• All investors react immediately to all information in the
same way
• All investors make accurate forecasts and correct
decisions.
E.g., investors do not react in the same way to the similar
information. Some may buy a security at a certain price
hoping to receive income or make a capital gain and
another sell for profit.
Also, not everyone can make accurate forecasts and
correct valuation decisions.
Market Theories: Summary
Macro
Economic
Analysis
Macro-economic Factors
Investor expectations and the prices of securities can be
influenced by a myriad of factors. This factors can be
grouped under the following:
• Fiscal Policy
• Monetary Policy
• International Factors e.g. war, unexpected election
results, regulatory changes, technological innovation
etc.
• Business Cycles
Definitions
Fiscal Policy: The policy pursued by the federal government
to influence economic growth through the use of taxation
and government spending to smooth out/ influence
fluctuations of the business cycle. Or means by which a
government adjusts its spending levels and tax rates to
monitor and influence a nation's economy.
Monetary Policy: Deliberate manipulation/regulation of
the demand and supply of money in order to influence the
economy or Economic policy designed to improve the
performance of the economy by regulating money supply
and credit.
• Yield Curve: A graph showing the relationship between
yields of bonds of the same quality but different
maturities.
A normal yield curve is upward sloping depicting the
fact that short-term money usually has a lower yield
than longer-term funds. When short-term funds are
more expensive than longer term funds the yield curve
is said to be inverted.
Definitions
Fiscal Policy & Its Impact
The two most important tools of fiscal policy are levels of
government expenditures and taxation because they affect
overall economic performance and influence the
profitability of individual industries.
• Tax Changes: governments can alter the spending power
of individuals and businesses.
An increase in sales or personal income tax leaves
individuals with less disposable income, which curtails
their spending; a reduction in tax levels increases net
personal income and allows them to spend more.
Tax Changes (contd)
• Higher taxes on profits, generally speaking, reduce the
amount businesses can pay out in dividends or spend on
expansion. Increases in corporate taxes also limit
companies’ incentive to expand by lowering after-tax
profit levels.
It is noteworthy to mention that several factors limit the
effectiveness of fiscal policy.
E.g., the time-lag between the time fiscal action is taken
and the time taken for the action to affect the economy.
Fiscal Policy & Its Impact
• Government Spending: can influence aggregate spending
in the economy by increasing or decreasing government
spending on goods, services and capital programs. - an
increase in government spending stimulates the economy
in the short run, while a cutback in spending has the
opposite effect.
Equally, tax increases lower consumer spending and
business profitability, while tax cuts boost profits and
common share prices and thereby spur the economy.
Also, Import quotas and tariffs have been used to shield
domestic shoe, clothing and automobile producers from
foreign competition.
Fiscal Policy & Its Impact
• Government Debt: Fiscal and monetary policy choices
affect the general level of interest rates, the rate of
economic growth and the rate of corporate profit growth,
and all of them affect the valuation of stocks. With high
levels of government and consumer indebtedness, the
government’s ability to reduce taxes or increase
government spending is impaired.
Presently, consumer debt is at record-high levels as
consumers have been spending more and saving less.
This could have the long-term effect of increasing
interest rates and dampening future economic growth.
Fiscal Policy & Its Impact
Monetary Policy & Its Impact
The CBN is responsible for maintaining the external value
of the Naira and encouraging real, sustainable economic
growth by keeping inflation low, stable and predictable.
If these goals are threatened, the bank should take
corrective action by influencing the rate of monetary
growth and encourage interest rates to reflect the change.
If, during a period of economic expansion, demand for
credit grows and prices move upwards too quickly, the
Bank of Canada will try to lessen the pressure by
restraining the rate of growth of money and credit.
This usually leads to higher short-term interest rates.
On the other hand, if the economy appears to be slowing
down, the CBN may pursue an easier monetary policy that
increases the money supply and the availability of credit,
leading to lower short-term interest rates.
Changes in monetary policy affect interest rates and
corporate profits, the two most important factors affecting
the prices of securities.
Thus, market participants try to gauge the impact of each
piece of economic news
Monetary Policy & Its Impact
Monetary Policy And The Bond Market
When economic growth begins to accelerate, bond yields
rise rapidly, thereby tempering higher inflation.
If nothing is done nothing to calm the bond market’s fear of
inflation, then bond yields may soar, possibly leading to a
crisis in debt markets affecting Billions of dollars of debt.
Thus steps must be taken to raise short-term interest rates to
slow economic growth and contain inflationary pressures.
This may lead to a more moderate economic growth rate or
even a growth recession (a temporary slowdown in
economic growth that does not lead to a full recession).
If long-term rates now fall while short-term rates rise, then
the bond market might temporarily be signaling its
approval of the degree of economic slowing.
E.g, if short term interest rates is raised to slow down
economic growth and bond yields fall simultaneously,
reflecting the perceived success of this policy, then the
balance between economic growth and the needs of the
bond market would have been maintained.
Monetary Policy And The Bond Market
Monetary Policy & The Yield Curve
When long-term bond yields fall while short-term rates rise,
this is called an inverting or a tilting of the yield curve. It
suggests a temporary reprieve from short-term interest rate
pressure and less competition for equities from the level of
bond yields. The general process is:
• Rapidly rising bond yields cause a collapse in bond
prices. (Recall the inverse relationship between bond
prices and yields.)
• As short-term interest rates rise, the rate at which bond
yields increase slows down.
• As this rise in short-term rates continues, the economy
usually slows, bonds begin to stabilize and briefly fall
less than equities. This is due to the fact that a slowing of
economic growth benefits bonds at the expense of stocks.
• Suddenly, with each short-term interest rate increase, the
long-term rate begins to fall. This is crucial evidence that
the bond market is satisfied with the slowing of economic
growth.
A decline in long-term rates not only reduces competition
between equities and bonds, it may also result in lower
short-term rates.
Monetary Policy & The Yield Curve
On the other hand, higher real bond yields over time
increase the degree of competition between bonds and
equities and slowly undermine equity markets.
A tilting yield curve is, however, very different from
periods in which the whole yield curve is falling, as it
does in the late stages of a recession.
Monetary Policy & The Yield Curve
The Flow Of Funds Impact
When the relative valuation of stocks and bonds or stocks
and T-bills changes, capital flows from one asset class to
the other.
These flows are determined largely by shifts in the
demand for stocks and bonds on the part of Nigerian retail
and institutional investors and of foreign investors. These
shifts are caused largely by changes in interest rate levels.
However, understanding why these shifts occur is
important to determining if a rise or fall in stock market
levels is sustainable.
• Net Purchases Of Nigerian Equity Mutual Funds: Net
purchases of Canadian equity mutual funds influence the
TSX. Falling interest rates tend to improve the value of
stocks relative to bonds, equity mutual fund purchases
should rise as interest rates fall.
• Non-resident Net Purchases: the direction of the
markets is also influenced by new demand by foreign
investors for Nigerian stocks and bonds. Foreign
investors tend to view an appreciating market and a
strengthening currency as good reasons to buy that
country’s stocks.
The Flow Of Funds Impact
The Inflation Impact
Widespread uncertainty and lack of confidence in the future
is what inflationary conditions create. These factors tend to
result in higher interest rates, lower corporate profits, and
lower price-earnings multiples.
Thus, there is an inverse relationship between the rate of
inflation and price-earnings multiples.
Inflation also means higher inventory and labour costs for
manufacturers which is usually passed on to the final
consumer in the form of higher prices. This cannot be done
indefinitely for consumer resistance develops, reducing
corporate profits.
Industry
Analysis
Fundamental Industry Analysis
It is believed that industry and company profitability has
more to do with industry structure than with the product
that an industry sells.
Industry structure results from the strategies that companies
pursue relative to their competition. Companies pursue
strategies that they feel will give them a sustainable
competitive advantage and lead to long-term growth.
Pricing strategies and company cost structures affect not
just long-term growth, but the volatility of sales and
earnings.
Therefore, industry structure affects a company’s stock
valuation. It is a framework that can easily be applied to
virtually every industry.
This framework can be applied to virtually every industry.
Investors and investment analysts rely on research
departments and other sources of information on industry
structure.
Thus, industries can be classified by Product or Service,
Stage Of Growth, Competitive Forces and Stock
Characteristics,
Fundamental Industry Analysis
Industry Classification by Product or Service
Most industries are identified by the product or service they
provide. E.g., U.S. market has about 90 different industry
groups.
However, an astute investor can understand the competitive
forces within an industry by classifying industries based on
their prospects for growth and their degree of risk.
These two factors help determine stock values.
• Estimating Growth: involves the study of an industry’s
reported revenues and unit volume sales over the last
several years, preferably over more than one business
cycle. Three key questions should be asked:
How does the growth in sales compare with the rate of
growth in nominal Gross Domestic Product (GDP)?
How does the rate of change in real GDP compare with
the industry’s rate of change in unit volumes?
How does the industry’s price index compare with the
overall rate of inflation?
Industry Classification by Product or Service
• Estimating Growth contd
An extension of this approach to all companies in the same
industry should enable an assessment of how effectively any
one company is competing.
E.g., For example, is the company acquiring a growing share
of a growing industry, a growing share of a stable industry, a
growing share of a declining industry or a declining share of
a declining industry?
Also, a company’s revenues result from a combination of
the prices they charge and the volume of unit sales. Revenue
growth may result from higher prices or increased sales
volume.
Industry Classification by Product or Service
• Estimating Growth contd
Is recent revenue growth improving? How stable are prices
or volume?
The degree of stability is also important in understanding the
degree of investment risk and the possible timing of the
investment during a business cycle.
Industry Classification by Product or Service
• Laws Of Survivorship: All industries exhibit a life-cycle
characterized by Initial or Emerging Growth, Rapid
Growth, Maturity and Decline. But length of each stage
varies from industry to industry and from company to
company.
Each stage in the industry life cycle affects the
relationship between a firm’s pricing strategies and its
unit cost structure, as sales volume grows or declines.
Often, as the size of a market increases, a decline in unit
costs occurs due to economies of scale. These may result
from experience gained in production or volume price
discounts for raw materials used in production.
Industry Classification by Product or Service
Companies constantly strive to establish sustainable
competitive advantage, and firm usually become either:
• A low-cost producer capable of withstanding price
competition and otherwise generating the highest
possible profit margins; or
• A producer of a product that has real or perceived
differences from existing products. These differences
may make it possible to achieve higher profit margins
while avoiding intense price competition.
Industry Classification by Product or Service
Smaller market segments or niches are left un-serviced by
firms who focus on either of these strategies are usually
filled by smaller, specialized companies, known as niche
players.
Industry Classification by Product or Service
Classifying Industries By Stage Of Growth
• Emerging Growth Industries: New products or services
are being developed at all times to meet evolving needs
and demands- e.g., rapid innovation is particularly
evident in software and hardware development in the
computer industry.
Emerging growth industries may not always be directly
accessible to equity investors if privately owned
companies dominate the industry, or if the new product or
service is only one activity of a diversified corporation.
They maybe unprofitable at first, although future
prospects may appear promising. Large start-up
investments may even lead to negative cash flows.
• A growth industry - one in which sales and earnings are
consistently expanding at a faster rate than most other
industries. - these industries are referred to as growth
companies and their common shares as growth stocks.
They should have an above-average rate of earnings on
invested capital over a period of several years. It should
also be possible for the company to continue to achieve
similar or better earnings on additional invested capital,
showing increasing sales in terms of both Naira and units,
with a firm control of costs. Usually they have able,
aggressive managements willing to take risks with use of
capital.
Classifying Industries By Stage Of Growth
• There might be substantial spending on research to
develop new products. During the rapid growth period,
companies that survive lower their prices as their cost of
production declines and competition intensifies. Much of
their expansion is with the use of retained earnings – not
paying out large dividends. Investors are usually willing
to pay more for securities that promise growth of capital
i.e. growth securities are characterized by relatively high
price-earnings ratios and low dividend yields. They have
an above average risk of a sharp price decline if, the
marketplace comes to believe that future growth will not
meet expectations.
Classifying Industries By Stage Of Growth
• Mature Industries: characterized by a dramatic slowing
of growth to a rate that more closely matches the overall
rate of economic growth. Both earnings and cash flow
tend to be positive, but within the same industry, it is
more difficult to identify differences in products between
companies.
Price competition increases, profit margins usually fall,
and companies may expand into new businesses with
better prospects for growth.
Usually they experience slower, more stable growth rates
in sales and earnings.
Classifying Industries By Stage Of Growth
Mature Industries contd:
Though their share prices are not immune to decline, during
recessions, stable growth companies usually demonstrate a
decline in earnings that is less than that of the average
company.
Classifying Industries By Stage Of Growth
• Declining Industries: As industries move from the stable
to the declining stage, they tend to grow at rates
comparable to overall economic growth rate, or they stop
growing and begin to decline.
They produce products for which demand has declined
due to changes in technology, an inability to compete on
price, or changes in consumer tastes.
Cash flow may be large, because there is no need to invest
in new plant and equipment.
At the same time, profits may be low.
Classifying Industries By Stage Of Growth
According to M. Porter, there are five basic competitive
forces determine the attractiveness of an industry and the
changes that can drastically alter the future growth and
valuation of companies within the industry. These are:
• Ease of entry for new competitors to that industry
• Degree of competition between existing firms
• Potential for pressure from substitute products
• Extent to which buyers of the product or service can put
pressure on the company to lower prices:
Classifying Industries By Competitive Forces
• The extent to which suppliers of raw materials or inputs
can put pressure on the company to pay more for these
resources; these costs affect profit margins or product
quality.
Thus, companies can thrive only if they meet customers’
needs. Therefore, profit margins can be large only if
customers receive enough perceived value.
Classifying Industries By Competitive Forces
Classifying Industries By Stock Characteristics
Industries can be broadly classified as either Cyclical or
Defensive.
Few, if any, industries are immune from the adverse effects
of an overall downturn in the business cycle, but the term
cyclical applies to industries in which the effect on earnings
is most pronounced.
• Cyclical Industries: They usually are sensitive to global
economic conditions, swings in the prices of international
commodities markets, and changes in the level of foreign
exchange. When business conditions are improving,
earnings tend to rise dramatically.
Cyclical Industries contd
Interest expenses on the debt of cyclical industries can
accentuate these swings in earnings. Cyclical industries fall
into three main groups:
• Commodity basic cyclical, such as forest products, mining,
and chemicals
• Industrial cyclical, such as transportation, capital goods,
and basic industries (steel, building materials)
• Consumer cyclical, such as merchandising companies and
automobiles
Classifying Industries By Stock Characteristics
Cyclical Industries contd
• Most cyclical industries benefit from a declining Naira
value, since this makes their exportable products
cheaper for international buyers.
Classifying Industries By Stock Characteristics
• Defensive Industries: they have relatively stable return
on equity (ROE) and tend to do well during recessions.
this category includes blue-chip and income stocks.
These are actually overlapping categories.
For example, the term blue-chip denotes shares of top
investment quality companies, which maintain earnings
and dividends through good times and bad. This record
usually reflects a dominant market position, strong
internal financing and effective management.
Classifying Industries By Stock Characteristics
• Speculative Industries: Though all investment in
common shares involves some degree of risk because of
ever-changing stock market values, the word speculative
is usually applied to industries (or share) in which the risk
and uncertainty are unusually high due to a lack of
definitive information - Emerging industries are often
considered speculative.
Profit potential of a new product or service attracts many
new companies and initial growth may be rapid. But a
shakeout occurs and many of the original participants are
forced out of business as the industry consolidates and a
few companies emerge as the leaders.
Classifying Industries By Stock Characteristics
Speculative Industries contd
The term speculative can also be used to describe any
company, even a large one, if its shares are treated as
speculative.
E.g, shares of growth companies can be bid up to high
multiples of estimated earnings per share as investors
anticipate continuing exceptional growth. Should investors
begin to doubt expectations, the price of the stock will fall.
Thus, investors are “speculating” on the likelihood of
continued future growth which ‘may’, not materialize
Classifying Industries By Stock Characteristics
• Return On Equity (Roe): This ratio is important to
shareholders because it reflects the profitability of their
capital in the business. It is key to understanding/
comparing defensive to cyclical industries. It is calculated
as:
During economic downturns, defensive industries also
demonstrate falling ROE, but their ROE falls less
dramatically than those of cyclical industries.
Classifying Industries By Stock Characteristics
(Net Earnings before extraordinary Items) X 100
Total Equity
During economic upturns and periods of prolonged
economic growth, the ROE of defensive industries tends not
to rise as much as that of cyclical industries.
Defensive industries tend to outperform cyclical industries
during recessions. Because the ROE of a cyclical industry
falls faster than the ROE of a defensive industry during
recessions, cyclical stock prices also fall faster.
Thus, stocks with a stable ROE demonstrate defensive price
characteristics. But, during periods of sustained economic
growth, the superior growth in the ROE of cyclical
industries tends to produce superior price performance in
those industries.
Classifying Industries By Stock Characteristics
Fundamental Valuation Models
• Dividend Discount Model (DDM): it shows how
companies with stable growth are priced (in theory). It
relates a stock’s current price to the present value of all
expected future dividends into the indefinite future. It
assumes:
– there will be an indefinite stream of dividend
payments, whose present values can be calculated.
– that these dividends will grow at a constant rate (g –
the growth rate in the formula).
The discount rate used is the market’s required or
expected rate of return for that type of investment i.e. rate
of return as the return that compensates investors for
investing in that stock, given its perceived riskiness.
Fundamental Valuation Models
It is represented in a mathematical formular as:
Where:
• Price is calculated as the current intrinsic value of the
stock in question
• Div0 - dividend paid out in the current year
• Div1 - expected dividend paid out by the company in 1yr
• r is the required rate of return on the stock
• g is the assumed constant growth rate for dividends
Price = Div0 (1+g) = Div1
r-g r-g
Fundamental Valuation Models
Example: ABC Company is expected to pay a N1 dividend
next year. It has a constant long-term growth rate (g) of 6%
and a required return (r) of 9%. Based on these inputs, the
DDM will price ABC at a value of:
(N1)/(0.09-0.06) = N33.33
Thus ABC stock has an intrinsic value of N33.33.
Interpretation: If ABC is selling for $25 in the market, the
stock is considered undervalued because it is selling below
its intrinsic value. Alternatively, if ABC is selling for $40,
the stock is considered overvalued because it is selling
above its intrinsic value.
Fundamental Valuation Models
It is noteworthy to mention that this is an over simplification
and future stock dividends are not predictable.
Also, a stock does not have a defined maturity, like a bond.
Fundamental Valuation Models
Price Earnings Ratio (P/E Ratio)
• Price Earnings Ratio (P/E Ratio): this allows
investors compare a companys’ prospects - a high P/E
ratio suggests a company has strong growth potential.
E.g., assume that earnings growth is constant and that the
rate at which dividends are paid out is constant (the
percentage of earnings paid out as dividends is known as
the dividend payout ratio). Then the price of the stock,
divided by next year’s earnings, will be equal to the
payout ratio divided by r – g, which is the same
denominator used in the DDM calculation.
For information purposes the formular is represented below
as it is essential to be able to interpret the ratio.
P/E = Payout Ratio/(r-g)
Given two similar companies that pay out a large proportion
of earnings, the company that can maintain these payout
levels has a more dependable earnings stream.
Therefore, all things being equal, a company with more
stable earnings should have a higher P/E ratio than a similar
type of company with less stable earnings.
Also, a growth company will have a higher P/E only if the
long-run growth rate (g) is expected to accelerate.
Price Earnings Ratio (P/E Ratio)
it is assumed that when confidence is high, P/E ratios are
also high, and when confidence is low, P/E ratios are low.
However, P/E levels are strongly inversely related to the
prevailing level of inflation and, therefore, to the prevailing
level of interest rates.
P/Es are volatile, because earnings vary. In some cases,
highly cyclical or economically sensitive companies may
have losses or low levels of earnings that produce unrealistic
or unusable P/Es.
To the extent the market is efficient, a low P/E may result
from the market’s ability to correctly anticipate an imminent
decline in earnings.
Price Earnings Ratio (P/E Ratio)
Technical Analysis
It is is the process of analyzing historical market action in
an effort to determine probable future price trends.
Technical analysts focus on the market itself, whether it be
the commodity, equity, interest rate or foreign exchange
market.
They study, and plot on charts, past and present
movements of prices, the volume of trading, statistical
indicators – trying to identify recurrent and predictable
patterns that can be used to predict future price moves.
Attempts to probe the psychology of investors collectively
or, i.e. the “mood” of the market. Market action is
dependent on 3 primary sources of information – price,
volume and time. It is based on three assumptions:
• That all influences on market action are automatically
accounted for or discounted in price activity – believing
known market influences are fully reflected in market
prices. That there is little advantage to fundamental
analysis. What is required is to study the price action. i.e.
“Letting the market talk,” -that the market will indicate
the direction and the extent of its next price move.
Technical Analysis
• Prices move in trends and those trends tend to persist
for relatively long periods of time. Thus, the primary
task of a technical analyst is to identify a trend in its early
stages and carry positions in that direction until the trend
reverses itself. - not as easy as it may sound.
• The future repeats the past. - belief that markets reflect
investor psychology and that the behavior of investors
tends to repeat itself. Investors tend to fluctuate between
pessimism, fear and panic, and optimism, greed and
euphoria. Comparing investor behavior as reflected in
market action with historical market behavior, the analyst
attempts to make predictions
Technical Analysis
Technical Analysis vs. Fundamental Analysis
Main difference: the technician studies the effects of supply
and demand (price and volume), while the fundamental
analyst studies the causes of price movements.
E.g. a fundamental analyst might suggest a bull market in
equities will likely come to an end due to rising interest
rates, a technical analyst would say that the appearance of a
head-and-shoulder top formation indicates a major market
top.
Studying fundamentals can give an investor a sense of the
long-term price prospects for an asset as this might be, the
first step in investment decision-making.
But, at the point of deciding when and at what level to enter
or leave a market, technical analysis can serve a vital role,
particularly when investing or trading leveraged investment
products such as futures or options.
Technical Analysis vs. Fundamental Analysis
Tools of Technical Analysis
Four main methods used by a technical analyst to identify
trends and possible trend turning points are:
• Chart Analysis – graphs, candlestick charts, line charts,
point and figure charts, reversal & continuation patterns
etc.
• Quantitative Analysis - statistical tools i.e. moving
averages and oscillators, Moving Average Convergence-
divergence (MACD)
• Analysis of Sentiment Indicators – used by contrarian
investors in determining what the majority of investors
expect prices to do in the future
• Cycle Analysis- Long-term (<2yrs), Seasonal (1yr),
Primary/intermediate (9 to 26 weeks) and Trading cycles
(four weeks), reflected in the Elliot wave theory that that
there are repetitive, predictable sequences of numbers and
cycles found in nature and similar predictable patterns in
the movement of stock prices.
Additional tools used include:
Volume changes: used to confirm other indicators in
bull/bear markets
Breadth of market: monitors the extent or broadness of a
market trend using the cumulative advance-decline line
Tools of Technical Analysis
Summary
• Fundamental analysis focuses on assessing the short-,
medium- and long-range prospects of different industries
and companies to determine how the prices of securities
will change.
• Quantitative analysis involves studying interest rates,
economic variables, and industry or stock valuation using
computers, databases, statistics and an objective,
mathematical approach to valuing a company.
• Technical analysis looks at historical stock prices and
stock market behavior to identify recurring and
predictable price patterns that can be used to predict
future price movements.
Fortuna Favi et Fortus Ltd.,
:118 Old Ewu Road, Aviation Estate, Lagos,
:07032530965 www.ffavifortus.com info@ffavifortus.com

More Related Content

What's hot

Dow theory by P. Sai Prathyusha (1ST M.COM BUSINESS FINANCE)
Dow theory  by  P. Sai Prathyusha (1ST M.COM BUSINESS FINANCE)Dow theory  by  P. Sai Prathyusha (1ST M.COM BUSINESS FINANCE)
Dow theory by P. Sai Prathyusha (1ST M.COM BUSINESS FINANCE)SaiLakshmi115
 
Efficient market hypothesis
Efficient market hypothesisEfficient market hypothesis
Efficient market hypothesisKamlesh Pawar
 
Derivatives in Capital Market
Derivatives in Capital MarketDerivatives in Capital Market
Derivatives in Capital MarketSyed Irshad Ali
 
Fundamental analysis and technical analysis
Fundamental analysis and technical analysisFundamental analysis and technical analysis
Fundamental analysis and technical analysisMohammed Umair
 
Efficient Market Hypothesis (EMH)
Efficient Market Hypothesis (EMH)Efficient Market Hypothesis (EMH)
Efficient Market Hypothesis (EMH)Faheem Hasan
 
Fundamental analysis Intro
Fundamental analysis IntroFundamental analysis Intro
Fundamental analysis IntroBFSI academy
 
Technical Analysis
Technical AnalysisTechnical Analysis
Technical Analysissnehalsoni
 
Exchange Traded vs OTC Markets
Exchange Traded vs OTC MarketsExchange Traded vs OTC Markets
Exchange Traded vs OTC MarketsWalid Saafan
 
EFFICIENT MARKET THEORY.pptx
EFFICIENT MARKET THEORY.pptxEFFICIENT MARKET THEORY.pptx
EFFICIENT MARKET THEORY.pptxAATMIKSHARMA6
 
Introduction to capital markets
Introduction to capital marketsIntroduction to capital markets
Introduction to capital marketsHarpriya Chandar
 
Security analysis
Security analysisSecurity analysis
Security analysisSimran Kaur
 

What's hot (20)

Dow theory by P. Sai Prathyusha (1ST M.COM BUSINESS FINANCE)
Dow theory  by  P. Sai Prathyusha (1ST M.COM BUSINESS FINANCE)Dow theory  by  P. Sai Prathyusha (1ST M.COM BUSINESS FINANCE)
Dow theory by P. Sai Prathyusha (1ST M.COM BUSINESS FINANCE)
 
Fundamental analysis
Fundamental analysisFundamental analysis
Fundamental analysis
 
Arbitrage pricing theory (apt)
Arbitrage pricing theory (apt)Arbitrage pricing theory (apt)
Arbitrage pricing theory (apt)
 
Efficient market hypothesis
Efficient market hypothesisEfficient market hypothesis
Efficient market hypothesis
 
Moving average -Technical Analysis
Moving average -Technical AnalysisMoving average -Technical Analysis
Moving average -Technical Analysis
 
Derivatives in Capital Market
Derivatives in Capital MarketDerivatives in Capital Market
Derivatives in Capital Market
 
Fundamental analysis and technical analysis
Fundamental analysis and technical analysisFundamental analysis and technical analysis
Fundamental analysis and technical analysis
 
Technical analysis
Technical analysisTechnical analysis
Technical analysis
 
Sharpe Single Index Model
Sharpe Single Index ModelSharpe Single Index Model
Sharpe Single Index Model
 
Efficient Market Hypothesis (EMH)
Efficient Market Hypothesis (EMH)Efficient Market Hypothesis (EMH)
Efficient Market Hypothesis (EMH)
 
Investment and speculation
Investment and speculationInvestment and speculation
Investment and speculation
 
Efficient market hypothesis
Efficient market hypothesisEfficient market hypothesis
Efficient market hypothesis
 
Unit 1 types of investors
Unit 1 types of investorsUnit 1 types of investors
Unit 1 types of investors
 
Portfolio analysis
Portfolio analysisPortfolio analysis
Portfolio analysis
 
Fundamental analysis Intro
Fundamental analysis IntroFundamental analysis Intro
Fundamental analysis Intro
 
Technical Analysis
Technical AnalysisTechnical Analysis
Technical Analysis
 
Exchange Traded vs OTC Markets
Exchange Traded vs OTC MarketsExchange Traded vs OTC Markets
Exchange Traded vs OTC Markets
 
EFFICIENT MARKET THEORY.pptx
EFFICIENT MARKET THEORY.pptxEFFICIENT MARKET THEORY.pptx
EFFICIENT MARKET THEORY.pptx
 
Introduction to capital markets
Introduction to capital marketsIntroduction to capital markets
Introduction to capital markets
 
Security analysis
Security analysisSecurity analysis
Security analysis
 

Similar to Fundamental & Technical analysis

Module 2 - Fundamental and Technical Analysis.pptx
Module 2 - Fundamental and Technical Analysis.pptxModule 2 - Fundamental and Technical Analysis.pptx
Module 2 - Fundamental and Technical Analysis.pptxMrRSaravananAsstProf
 
Fundamental and technical analysis
Fundamental and technical analysisFundamental and technical analysis
Fundamental and technical analysisRiteshGoswami2
 
Fundamental of technical analysis
Fundamental of technical analysisFundamental of technical analysis
Fundamental of technical analysisparshuram2455
 
Accounting questions project
Accounting questions projectAccounting questions project
Accounting questions projectRohit Sethi
 
Transmission Mechanism of Monetary Policy
Transmission Mechanism of Monetary PolicyTransmission Mechanism of Monetary Policy
Transmission Mechanism of Monetary PolicyAmandiNiwarthanaWeer
 
Demand Forecasting in the restaurant management
Demand Forecasting in the restaurant managementDemand Forecasting in the restaurant management
Demand Forecasting in the restaurant managementErichViray
 
Introduction toDemand Forecasting part one
Introduction toDemand Forecasting part oneIntroduction toDemand Forecasting part one
Introduction toDemand Forecasting part oneErichViray
 
Economics and Business Management
Economics and Business ManagementEconomics and Business Management
Economics and Business Managementlakmioshi
 
Nature and Scope of Managerial Economics
Nature and Scope of Managerial EconomicsNature and Scope of Managerial Economics
Nature and Scope of Managerial Economicsdvy92010
 
ECONOMICS FOR BUSINESS UNIT 1.pptx
ECONOMICS FOR BUSINESS UNIT 1.pptxECONOMICS FOR BUSINESS UNIT 1.pptx
ECONOMICS FOR BUSINESS UNIT 1.pptxDleela
 
FUNDAMENTAL ANALYSIS -2
FUNDAMENTAL ANALYSIS -2FUNDAMENTAL ANALYSIS -2
FUNDAMENTAL ANALYSIS -2Vikash Barnwal
 
Demand estimating and forcasting
Demand estimating and forcastingDemand estimating and forcasting
Demand estimating and forcastingMuntaquir Hasnain
 
Lecture 7 - Stock Market and EMF
Lecture 7 - Stock Market and EMFLecture 7 - Stock Market and EMF
Lecture 7 - Stock Market and EMFRyan Herzog
 
Macroeconomic Trends - Impact on Investment Decision Process
Macroeconomic Trends - Impact on Investment Decision ProcessMacroeconomic Trends - Impact on Investment Decision Process
Macroeconomic Trends - Impact on Investment Decision ProcessVeronica Lopez-Lopez
 

Similar to Fundamental & Technical analysis (20)

Fundamental n Technical analysis
Fundamental n Technical analysisFundamental n Technical analysis
Fundamental n Technical analysis
 
Module 2 - Fundamental and Technical Analysis.pptx
Module 2 - Fundamental and Technical Analysis.pptxModule 2 - Fundamental and Technical Analysis.pptx
Module 2 - Fundamental and Technical Analysis.pptx
 
Fundamental and technical analysis
Fundamental and technical analysisFundamental and technical analysis
Fundamental and technical analysis
 
Fundamental of technical analysis
Fundamental of technical analysisFundamental of technical analysis
Fundamental of technical analysis
 
Demand forecasting
Demand forecastingDemand forecasting
Demand forecasting
 
Accounting questions project
Accounting questions projectAccounting questions project
Accounting questions project
 
Transmission Mechanism of Monetary Policy
Transmission Mechanism of Monetary PolicyTransmission Mechanism of Monetary Policy
Transmission Mechanism of Monetary Policy
 
Demand Forecasting in the restaurant management
Demand Forecasting in the restaurant managementDemand Forecasting in the restaurant management
Demand Forecasting in the restaurant management
 
Introduction toDemand Forecasting part one
Introduction toDemand Forecasting part oneIntroduction toDemand Forecasting part one
Introduction toDemand Forecasting part one
 
chapter9.pptx
chapter9.pptxchapter9.pptx
chapter9.pptx
 
Economics and Business Management
Economics and Business ManagementEconomics and Business Management
Economics and Business Management
 
Nature and Scope of Managerial Economics
Nature and Scope of Managerial EconomicsNature and Scope of Managerial Economics
Nature and Scope of Managerial Economics
 
SECTION VII - CHAPTER 43 - Model Building Process
SECTION VII - CHAPTER 43 - Model Building ProcessSECTION VII - CHAPTER 43 - Model Building Process
SECTION VII - CHAPTER 43 - Model Building Process
 
ECONOMICS FOR BUSINESS UNIT 1.pptx
ECONOMICS FOR BUSINESS UNIT 1.pptxECONOMICS FOR BUSINESS UNIT 1.pptx
ECONOMICS FOR BUSINESS UNIT 1.pptx
 
FUNDAMENTAL ANALYSIS -2
FUNDAMENTAL ANALYSIS -2FUNDAMENTAL ANALYSIS -2
FUNDAMENTAL ANALYSIS -2
 
sapm (2).pptx
sapm (2).pptxsapm (2).pptx
sapm (2).pptx
 
Demand estimating and forcasting
Demand estimating and forcastingDemand estimating and forcasting
Demand estimating and forcasting
 
4th chapter
4th chapter4th chapter
4th chapter
 
Lecture 7 - Stock Market and EMF
Lecture 7 - Stock Market and EMFLecture 7 - Stock Market and EMF
Lecture 7 - Stock Market and EMF
 
Macroeconomic Trends - Impact on Investment Decision Process
Macroeconomic Trends - Impact on Investment Decision ProcessMacroeconomic Trends - Impact on Investment Decision Process
Macroeconomic Trends - Impact on Investment Decision Process
 

More from Fortuna Favi et Fortus Ltd.

Communications, Marketing and Relationship Management
Communications, Marketing and Relationship ManagementCommunications, Marketing and Relationship Management
Communications, Marketing and Relationship ManagementFortuna Favi et Fortus Ltd.
 
Risk analysis , operating performance and value ratios
Risk analysis , operating performance and value ratiosRisk analysis , operating performance and value ratios
Risk analysis , operating performance and value ratiosFortuna Favi et Fortus Ltd.
 
Understanding and managing bias in investment clients
Understanding and managing bias in investment clientsUnderstanding and managing bias in investment clients
Understanding and managing bias in investment clientsFortuna Favi et Fortus Ltd.
 
Individual client asset allocation and investment strategies
Individual client asset allocation and investment strategiesIndividual client asset allocation and investment strategies
Individual client asset allocation and investment strategiesFortuna Favi et Fortus Ltd.
 
Incorporating Behavioural Training into the Selling Process for Brokerages Firms
Incorporating Behavioural Training into the Selling Process for Brokerages FirmsIncorporating Behavioural Training into the Selling Process for Brokerages Firms
Incorporating Behavioural Training into the Selling Process for Brokerages FirmsFortuna Favi et Fortus Ltd.
 
Incorporating behavioural Training into the Selling Process for Brokerages Firms
Incorporating behavioural Training into the Selling Process for Brokerages FirmsIncorporating behavioural Training into the Selling Process for Brokerages Firms
Incorporating behavioural Training into the Selling Process for Brokerages FirmsFortuna Favi et Fortus Ltd.
 

More from Fortuna Favi et Fortus Ltd. (15)

AML Presentation 2 - Nigeria.pptx
AML Presentation 2 - Nigeria.pptxAML Presentation 2 - Nigeria.pptx
AML Presentation 2 - Nigeria.pptx
 
AML Presentation 2 - Nigeria.pptx
AML Presentation 2 - Nigeria.pptxAML Presentation 2 - Nigeria.pptx
AML Presentation 2 - Nigeria.pptx
 
Commodities fundamentals futures & forwards
Commodities fundamentals futures & forwardsCommodities fundamentals futures & forwards
Commodities fundamentals futures & forwards
 
Communications, Marketing and Relationship Management
Communications, Marketing and Relationship ManagementCommunications, Marketing and Relationship Management
Communications, Marketing and Relationship Management
 
The financial advisor
The financial advisorThe financial advisor
The financial advisor
 
Components of organisational CRM
Components of organisational CRMComponents of organisational CRM
Components of organisational CRM
 
Risk analysis , operating performance and value ratios
Risk analysis , operating performance and value ratiosRisk analysis , operating performance and value ratios
Risk analysis , operating performance and value ratios
 
Fundamentals of Option Contracts
Fundamentals of Option ContractsFundamentals of Option Contracts
Fundamentals of Option Contracts
 
Fundamentals of Option Contracts
Fundamentals of Option ContractsFundamentals of Option Contracts
Fundamentals of Option Contracts
 
Risk Return Basics for Investing
Risk Return Basics for InvestingRisk Return Basics for Investing
Risk Return Basics for Investing
 
Derivatives Fundamentals
Derivatives FundamentalsDerivatives Fundamentals
Derivatives Fundamentals
 
Understanding and managing bias in investment clients
Understanding and managing bias in investment clientsUnderstanding and managing bias in investment clients
Understanding and managing bias in investment clients
 
Individual client asset allocation and investment strategies
Individual client asset allocation and investment strategiesIndividual client asset allocation and investment strategies
Individual client asset allocation and investment strategies
 
Incorporating Behavioural Training into the Selling Process for Brokerages Firms
Incorporating Behavioural Training into the Selling Process for Brokerages FirmsIncorporating Behavioural Training into the Selling Process for Brokerages Firms
Incorporating Behavioural Training into the Selling Process for Brokerages Firms
 
Incorporating behavioural Training into the Selling Process for Brokerages Firms
Incorporating behavioural Training into the Selling Process for Brokerages FirmsIncorporating behavioural Training into the Selling Process for Brokerages Firms
Incorporating behavioural Training into the Selling Process for Brokerages Firms
 

Recently uploaded

Collective Mining | Corporate Presentation - April 2024
Collective Mining | Corporate Presentation - April 2024Collective Mining | Corporate Presentation - April 2024
Collective Mining | Corporate Presentation - April 2024CollectiveMining1
 
Falcon Invoice Discounting unlock your cash flow potential
Falcon Invoice Discounting unlock your cash flow potentialFalcon Invoice Discounting unlock your cash flow potential
Falcon Invoice Discounting unlock your cash flow potentialFalcon Invoice Discounting
 
Mandalay Resources 2024 April IR Presentation
Mandalay Resources 2024 April IR PresentationMandalay Resources 2024 April IR Presentation
Mandalay Resources 2024 April IR PresentationMandalayResources
 
Osisko Gold Royalties Ltd - Corporate Presentation, April 10, 2024
Osisko Gold Royalties Ltd - Corporate Presentation, April 10, 2024Osisko Gold Royalties Ltd - Corporate Presentation, April 10, 2024
Osisko Gold Royalties Ltd - Corporate Presentation, April 10, 2024Osisko Gold Royalties Ltd
 
Collective Mining | Corporate Presentation | April 2024
Collective Mining | Corporate Presentation | April 2024Collective Mining | Corporate Presentation | April 2024
Collective Mining | Corporate Presentation | April 2024CollectiveMining1
 
Q1 Probe Gold Quarterly Update- April 2024
Q1 Probe Gold Quarterly Update- April 2024Q1 Probe Gold Quarterly Update- April 2024
Q1 Probe Gold Quarterly Update- April 2024Probe Gold
 

Recently uploaded (7)

Collective Mining | Corporate Presentation - April 2024
Collective Mining | Corporate Presentation - April 2024Collective Mining | Corporate Presentation - April 2024
Collective Mining | Corporate Presentation - April 2024
 
Falcon Invoice Discounting unlock your cash flow potential
Falcon Invoice Discounting unlock your cash flow potentialFalcon Invoice Discounting unlock your cash flow potential
Falcon Invoice Discounting unlock your cash flow potential
 
Korea District Heating Corporation 071320 Algorithm Investment Report
Korea District Heating Corporation 071320 Algorithm Investment ReportKorea District Heating Corporation 071320 Algorithm Investment Report
Korea District Heating Corporation 071320 Algorithm Investment Report
 
Mandalay Resources 2024 April IR Presentation
Mandalay Resources 2024 April IR PresentationMandalay Resources 2024 April IR Presentation
Mandalay Resources 2024 April IR Presentation
 
Osisko Gold Royalties Ltd - Corporate Presentation, April 10, 2024
Osisko Gold Royalties Ltd - Corporate Presentation, April 10, 2024Osisko Gold Royalties Ltd - Corporate Presentation, April 10, 2024
Osisko Gold Royalties Ltd - Corporate Presentation, April 10, 2024
 
Collective Mining | Corporate Presentation | April 2024
Collective Mining | Corporate Presentation | April 2024Collective Mining | Corporate Presentation | April 2024
Collective Mining | Corporate Presentation | April 2024
 
Q1 Probe Gold Quarterly Update- April 2024
Q1 Probe Gold Quarterly Update- April 2024Q1 Probe Gold Quarterly Update- April 2024
Q1 Probe Gold Quarterly Update- April 2024
 

Fundamental & Technical analysis

  • 1.
  • 2. Overview of Analysis Methods • Fundamental Analysis • Quantitative Analysis • Technical Analysis • Market Theories  Efficient market hypothesis  Random walk theory  Rational expectations hypothesis Fundamental Macroeconomic Analysis • The Fiscal Policy Impact • The Monetary Policy Impact • The Flow of Funds Impact • The Inflation Impact
  • 3. Fundamental Industry Analysis • Classifying Industries by Product or Service • Classifying Industries by Stage of Growth • Classifying Industries by Competitive Forces • Classifying Industries by Stock Characteristics Fundamental Valuation Models • Dividend Discount Model • Using the Price-Earnings Ratio Technical Analysis • Comparing Technical Analysis to Fundamental Analysis • Commonly Used Tools in Technical Analysis
  • 4. Analysis Methods • A great deal of information is available when making an investment decision. There is market and economic, data, stock charts, industry and company characteristics, and a wealth of financial statistical data. there are different branches of analysis which helps to organize the information. • Fundamental analysis • Quantitative analysis • Technical analysis There is a need for a clear understanding of what the techniques measure, how they are determined, and how they are interpreted.
  • 5. This involves a study of everything, other than the trading on the securities markets, which can have an affect on a security’s value: macroeconomic factors, industry conditions, individual company financial conditions, and qualitative factors such as management performance. Fundamental analysis pays attention to a company’s debt/equity ratio, profit margins, dividend payout, earnings per share, sales penetration, market share, interest, asset and dividend coverages, product or marketing innovation, and the quality of its management. Fundamental Analysis
  • 6. The most important single factor affecting the price of a corporate security is the actual or expected profitability of the issuer. E.g., are profits sufficient to service debt, to pay current dividends, or to pay larger dividends? Fundamental Analysis
  • 7. The study of interest rates, economic variables, and industry or stock valuation using computers, databases, statistics and an objective, mathematical approach to valuation. There is a search for patterns and the reasons behind these patterns in order to identify and profit from anomalies in valuation. Quantitative techniques often use statistics to determine the likelihood of a particular investment outcome. Quantitative Analysis
  • 8. Studies historical stock prices and stock market behaviour to identify recurring patterns in the data. The process requires large amounts of information, can be time consuming and cumbersome. Technical analysts study price movements, trading volumes, and data on the number of rising and falling stock issues over time looking for recurring patterns that will allow them to predict future stock price movements. Technical Analysis
  • 9. It is believed that by studying the “price action” of the market, analysts can have better insights into the emotions and psychology of investors. The contention is - because most investors fail to learn from their mistakes, identifiable patterns exist. Factors such as mass investor psychology and the influence of program trading affects market prices. E.g., Greed can force prices to rise to a level far higher than warranted by anticipated earnings. Also, uncertainty can cause investors to overreact to news and sell quickly, causing prices to drop suddenly. Technical Analysis
  • 10. Market Theories - Financial Three theories are applicable in providing explanations of the behavior of stock markets. They are: • Efficient market hypothesis • Random walk theory • Rational expectations hypothesis
  • 11. Efficient Market Hypothesis Assumes that profit-seeking investors in the marketplace react quickly to the release of new information. As new information about a stock appears, investors reassess the intrinsic value of the stock and adjust their estimation of its price accordingly. Therefore, at any given time, a stock’s price fully reflects all available information and represents the best estimate of the stock’s true value.
  • 12. Random Walk Theory Postulation that new information concerning a stock is disseminated randomly over time. Therefore, price changes are random and bear no relation to previous price changes. If this is true, then past price changes contain no useful information about future price changes because any developments affecting the company have already been reflected in the current price of the stock.
  • 13. Rational Expectations Hypothesis Assumes that people are rational and make intelligent economic decisions after weighing all available information. It also assumes people have access to necessary information and will use it intelligently in their own self-interest. Thus, past mistakes can be avoided by using the information to anticipate change.
  • 14. Market Theories: Summary The efficient market hypothesis, the random walk theory and the rational expectations hypothesis all suggest that stock markets are efficient. But studies exist that support these theories but also support the existence of market in efficiencies. E.g., it is unlikely that: • New information is available to everyone at the same time • All investors react immediately to all information in the same way • All investors make accurate forecasts and correct decisions.
  • 15. E.g., investors do not react in the same way to the similar information. Some may buy a security at a certain price hoping to receive income or make a capital gain and another sell for profit. Also, not everyone can make accurate forecasts and correct valuation decisions. Market Theories: Summary
  • 17. Macro-economic Factors Investor expectations and the prices of securities can be influenced by a myriad of factors. This factors can be grouped under the following: • Fiscal Policy • Monetary Policy • International Factors e.g. war, unexpected election results, regulatory changes, technological innovation etc. • Business Cycles
  • 18. Definitions Fiscal Policy: The policy pursued by the federal government to influence economic growth through the use of taxation and government spending to smooth out/ influence fluctuations of the business cycle. Or means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. Monetary Policy: Deliberate manipulation/regulation of the demand and supply of money in order to influence the economy or Economic policy designed to improve the performance of the economy by regulating money supply and credit.
  • 19. • Yield Curve: A graph showing the relationship between yields of bonds of the same quality but different maturities. A normal yield curve is upward sloping depicting the fact that short-term money usually has a lower yield than longer-term funds. When short-term funds are more expensive than longer term funds the yield curve is said to be inverted. Definitions
  • 20. Fiscal Policy & Its Impact The two most important tools of fiscal policy are levels of government expenditures and taxation because they affect overall economic performance and influence the profitability of individual industries. • Tax Changes: governments can alter the spending power of individuals and businesses. An increase in sales or personal income tax leaves individuals with less disposable income, which curtails their spending; a reduction in tax levels increases net personal income and allows them to spend more.
  • 21. Tax Changes (contd) • Higher taxes on profits, generally speaking, reduce the amount businesses can pay out in dividends or spend on expansion. Increases in corporate taxes also limit companies’ incentive to expand by lowering after-tax profit levels. It is noteworthy to mention that several factors limit the effectiveness of fiscal policy. E.g., the time-lag between the time fiscal action is taken and the time taken for the action to affect the economy. Fiscal Policy & Its Impact
  • 22. • Government Spending: can influence aggregate spending in the economy by increasing or decreasing government spending on goods, services and capital programs. - an increase in government spending stimulates the economy in the short run, while a cutback in spending has the opposite effect. Equally, tax increases lower consumer spending and business profitability, while tax cuts boost profits and common share prices and thereby spur the economy. Also, Import quotas and tariffs have been used to shield domestic shoe, clothing and automobile producers from foreign competition. Fiscal Policy & Its Impact
  • 23. • Government Debt: Fiscal and monetary policy choices affect the general level of interest rates, the rate of economic growth and the rate of corporate profit growth, and all of them affect the valuation of stocks. With high levels of government and consumer indebtedness, the government’s ability to reduce taxes or increase government spending is impaired. Presently, consumer debt is at record-high levels as consumers have been spending more and saving less. This could have the long-term effect of increasing interest rates and dampening future economic growth. Fiscal Policy & Its Impact
  • 24. Monetary Policy & Its Impact The CBN is responsible for maintaining the external value of the Naira and encouraging real, sustainable economic growth by keeping inflation low, stable and predictable. If these goals are threatened, the bank should take corrective action by influencing the rate of monetary growth and encourage interest rates to reflect the change. If, during a period of economic expansion, demand for credit grows and prices move upwards too quickly, the Bank of Canada will try to lessen the pressure by restraining the rate of growth of money and credit. This usually leads to higher short-term interest rates.
  • 25. On the other hand, if the economy appears to be slowing down, the CBN may pursue an easier monetary policy that increases the money supply and the availability of credit, leading to lower short-term interest rates. Changes in monetary policy affect interest rates and corporate profits, the two most important factors affecting the prices of securities. Thus, market participants try to gauge the impact of each piece of economic news Monetary Policy & Its Impact
  • 26. Monetary Policy And The Bond Market When economic growth begins to accelerate, bond yields rise rapidly, thereby tempering higher inflation. If nothing is done nothing to calm the bond market’s fear of inflation, then bond yields may soar, possibly leading to a crisis in debt markets affecting Billions of dollars of debt. Thus steps must be taken to raise short-term interest rates to slow economic growth and contain inflationary pressures. This may lead to a more moderate economic growth rate or even a growth recession (a temporary slowdown in economic growth that does not lead to a full recession).
  • 27. If long-term rates now fall while short-term rates rise, then the bond market might temporarily be signaling its approval of the degree of economic slowing. E.g, if short term interest rates is raised to slow down economic growth and bond yields fall simultaneously, reflecting the perceived success of this policy, then the balance between economic growth and the needs of the bond market would have been maintained. Monetary Policy And The Bond Market
  • 28. Monetary Policy & The Yield Curve When long-term bond yields fall while short-term rates rise, this is called an inverting or a tilting of the yield curve. It suggests a temporary reprieve from short-term interest rate pressure and less competition for equities from the level of bond yields. The general process is: • Rapidly rising bond yields cause a collapse in bond prices. (Recall the inverse relationship between bond prices and yields.) • As short-term interest rates rise, the rate at which bond yields increase slows down.
  • 29. • As this rise in short-term rates continues, the economy usually slows, bonds begin to stabilize and briefly fall less than equities. This is due to the fact that a slowing of economic growth benefits bonds at the expense of stocks. • Suddenly, with each short-term interest rate increase, the long-term rate begins to fall. This is crucial evidence that the bond market is satisfied with the slowing of economic growth. A decline in long-term rates not only reduces competition between equities and bonds, it may also result in lower short-term rates. Monetary Policy & The Yield Curve
  • 30. On the other hand, higher real bond yields over time increase the degree of competition between bonds and equities and slowly undermine equity markets. A tilting yield curve is, however, very different from periods in which the whole yield curve is falling, as it does in the late stages of a recession. Monetary Policy & The Yield Curve
  • 31. The Flow Of Funds Impact When the relative valuation of stocks and bonds or stocks and T-bills changes, capital flows from one asset class to the other. These flows are determined largely by shifts in the demand for stocks and bonds on the part of Nigerian retail and institutional investors and of foreign investors. These shifts are caused largely by changes in interest rate levels. However, understanding why these shifts occur is important to determining if a rise or fall in stock market levels is sustainable.
  • 32. • Net Purchases Of Nigerian Equity Mutual Funds: Net purchases of Canadian equity mutual funds influence the TSX. Falling interest rates tend to improve the value of stocks relative to bonds, equity mutual fund purchases should rise as interest rates fall. • Non-resident Net Purchases: the direction of the markets is also influenced by new demand by foreign investors for Nigerian stocks and bonds. Foreign investors tend to view an appreciating market and a strengthening currency as good reasons to buy that country’s stocks. The Flow Of Funds Impact
  • 33. The Inflation Impact Widespread uncertainty and lack of confidence in the future is what inflationary conditions create. These factors tend to result in higher interest rates, lower corporate profits, and lower price-earnings multiples. Thus, there is an inverse relationship between the rate of inflation and price-earnings multiples. Inflation also means higher inventory and labour costs for manufacturers which is usually passed on to the final consumer in the form of higher prices. This cannot be done indefinitely for consumer resistance develops, reducing corporate profits.
  • 35. Fundamental Industry Analysis It is believed that industry and company profitability has more to do with industry structure than with the product that an industry sells. Industry structure results from the strategies that companies pursue relative to their competition. Companies pursue strategies that they feel will give them a sustainable competitive advantage and lead to long-term growth. Pricing strategies and company cost structures affect not just long-term growth, but the volatility of sales and earnings.
  • 36. Therefore, industry structure affects a company’s stock valuation. It is a framework that can easily be applied to virtually every industry. This framework can be applied to virtually every industry. Investors and investment analysts rely on research departments and other sources of information on industry structure. Thus, industries can be classified by Product or Service, Stage Of Growth, Competitive Forces and Stock Characteristics, Fundamental Industry Analysis
  • 37. Industry Classification by Product or Service Most industries are identified by the product or service they provide. E.g., U.S. market has about 90 different industry groups. However, an astute investor can understand the competitive forces within an industry by classifying industries based on their prospects for growth and their degree of risk. These two factors help determine stock values.
  • 38. • Estimating Growth: involves the study of an industry’s reported revenues and unit volume sales over the last several years, preferably over more than one business cycle. Three key questions should be asked: How does the growth in sales compare with the rate of growth in nominal Gross Domestic Product (GDP)? How does the rate of change in real GDP compare with the industry’s rate of change in unit volumes? How does the industry’s price index compare with the overall rate of inflation? Industry Classification by Product or Service
  • 39. • Estimating Growth contd An extension of this approach to all companies in the same industry should enable an assessment of how effectively any one company is competing. E.g., For example, is the company acquiring a growing share of a growing industry, a growing share of a stable industry, a growing share of a declining industry or a declining share of a declining industry? Also, a company’s revenues result from a combination of the prices they charge and the volume of unit sales. Revenue growth may result from higher prices or increased sales volume. Industry Classification by Product or Service
  • 40. • Estimating Growth contd Is recent revenue growth improving? How stable are prices or volume? The degree of stability is also important in understanding the degree of investment risk and the possible timing of the investment during a business cycle. Industry Classification by Product or Service
  • 41. • Laws Of Survivorship: All industries exhibit a life-cycle characterized by Initial or Emerging Growth, Rapid Growth, Maturity and Decline. But length of each stage varies from industry to industry and from company to company. Each stage in the industry life cycle affects the relationship between a firm’s pricing strategies and its unit cost structure, as sales volume grows or declines. Often, as the size of a market increases, a decline in unit costs occurs due to economies of scale. These may result from experience gained in production or volume price discounts for raw materials used in production. Industry Classification by Product or Service
  • 42. Companies constantly strive to establish sustainable competitive advantage, and firm usually become either: • A low-cost producer capable of withstanding price competition and otherwise generating the highest possible profit margins; or • A producer of a product that has real or perceived differences from existing products. These differences may make it possible to achieve higher profit margins while avoiding intense price competition. Industry Classification by Product or Service
  • 43. Smaller market segments or niches are left un-serviced by firms who focus on either of these strategies are usually filled by smaller, specialized companies, known as niche players. Industry Classification by Product or Service
  • 44. Classifying Industries By Stage Of Growth • Emerging Growth Industries: New products or services are being developed at all times to meet evolving needs and demands- e.g., rapid innovation is particularly evident in software and hardware development in the computer industry. Emerging growth industries may not always be directly accessible to equity investors if privately owned companies dominate the industry, or if the new product or service is only one activity of a diversified corporation. They maybe unprofitable at first, although future prospects may appear promising. Large start-up investments may even lead to negative cash flows.
  • 45. • A growth industry - one in which sales and earnings are consistently expanding at a faster rate than most other industries. - these industries are referred to as growth companies and their common shares as growth stocks. They should have an above-average rate of earnings on invested capital over a period of several years. It should also be possible for the company to continue to achieve similar or better earnings on additional invested capital, showing increasing sales in terms of both Naira and units, with a firm control of costs. Usually they have able, aggressive managements willing to take risks with use of capital. Classifying Industries By Stage Of Growth
  • 46. • There might be substantial spending on research to develop new products. During the rapid growth period, companies that survive lower their prices as their cost of production declines and competition intensifies. Much of their expansion is with the use of retained earnings – not paying out large dividends. Investors are usually willing to pay more for securities that promise growth of capital i.e. growth securities are characterized by relatively high price-earnings ratios and low dividend yields. They have an above average risk of a sharp price decline if, the marketplace comes to believe that future growth will not meet expectations. Classifying Industries By Stage Of Growth
  • 47. • Mature Industries: characterized by a dramatic slowing of growth to a rate that more closely matches the overall rate of economic growth. Both earnings and cash flow tend to be positive, but within the same industry, it is more difficult to identify differences in products between companies. Price competition increases, profit margins usually fall, and companies may expand into new businesses with better prospects for growth. Usually they experience slower, more stable growth rates in sales and earnings. Classifying Industries By Stage Of Growth
  • 48. Mature Industries contd: Though their share prices are not immune to decline, during recessions, stable growth companies usually demonstrate a decline in earnings that is less than that of the average company. Classifying Industries By Stage Of Growth
  • 49. • Declining Industries: As industries move from the stable to the declining stage, they tend to grow at rates comparable to overall economic growth rate, or they stop growing and begin to decline. They produce products for which demand has declined due to changes in technology, an inability to compete on price, or changes in consumer tastes. Cash flow may be large, because there is no need to invest in new plant and equipment. At the same time, profits may be low. Classifying Industries By Stage Of Growth
  • 50. According to M. Porter, there are five basic competitive forces determine the attractiveness of an industry and the changes that can drastically alter the future growth and valuation of companies within the industry. These are: • Ease of entry for new competitors to that industry • Degree of competition between existing firms • Potential for pressure from substitute products • Extent to which buyers of the product or service can put pressure on the company to lower prices: Classifying Industries By Competitive Forces
  • 51. • The extent to which suppliers of raw materials or inputs can put pressure on the company to pay more for these resources; these costs affect profit margins or product quality. Thus, companies can thrive only if they meet customers’ needs. Therefore, profit margins can be large only if customers receive enough perceived value. Classifying Industries By Competitive Forces
  • 52. Classifying Industries By Stock Characteristics Industries can be broadly classified as either Cyclical or Defensive. Few, if any, industries are immune from the adverse effects of an overall downturn in the business cycle, but the term cyclical applies to industries in which the effect on earnings is most pronounced. • Cyclical Industries: They usually are sensitive to global economic conditions, swings in the prices of international commodities markets, and changes in the level of foreign exchange. When business conditions are improving, earnings tend to rise dramatically.
  • 53. Cyclical Industries contd Interest expenses on the debt of cyclical industries can accentuate these swings in earnings. Cyclical industries fall into three main groups: • Commodity basic cyclical, such as forest products, mining, and chemicals • Industrial cyclical, such as transportation, capital goods, and basic industries (steel, building materials) • Consumer cyclical, such as merchandising companies and automobiles Classifying Industries By Stock Characteristics
  • 54. Cyclical Industries contd • Most cyclical industries benefit from a declining Naira value, since this makes their exportable products cheaper for international buyers. Classifying Industries By Stock Characteristics
  • 55. • Defensive Industries: they have relatively stable return on equity (ROE) and tend to do well during recessions. this category includes blue-chip and income stocks. These are actually overlapping categories. For example, the term blue-chip denotes shares of top investment quality companies, which maintain earnings and dividends through good times and bad. This record usually reflects a dominant market position, strong internal financing and effective management. Classifying Industries By Stock Characteristics
  • 56. • Speculative Industries: Though all investment in common shares involves some degree of risk because of ever-changing stock market values, the word speculative is usually applied to industries (or share) in which the risk and uncertainty are unusually high due to a lack of definitive information - Emerging industries are often considered speculative. Profit potential of a new product or service attracts many new companies and initial growth may be rapid. But a shakeout occurs and many of the original participants are forced out of business as the industry consolidates and a few companies emerge as the leaders. Classifying Industries By Stock Characteristics
  • 57. Speculative Industries contd The term speculative can also be used to describe any company, even a large one, if its shares are treated as speculative. E.g, shares of growth companies can be bid up to high multiples of estimated earnings per share as investors anticipate continuing exceptional growth. Should investors begin to doubt expectations, the price of the stock will fall. Thus, investors are “speculating” on the likelihood of continued future growth which ‘may’, not materialize Classifying Industries By Stock Characteristics
  • 58. • Return On Equity (Roe): This ratio is important to shareholders because it reflects the profitability of their capital in the business. It is key to understanding/ comparing defensive to cyclical industries. It is calculated as: During economic downturns, defensive industries also demonstrate falling ROE, but their ROE falls less dramatically than those of cyclical industries. Classifying Industries By Stock Characteristics (Net Earnings before extraordinary Items) X 100 Total Equity
  • 59. During economic upturns and periods of prolonged economic growth, the ROE of defensive industries tends not to rise as much as that of cyclical industries. Defensive industries tend to outperform cyclical industries during recessions. Because the ROE of a cyclical industry falls faster than the ROE of a defensive industry during recessions, cyclical stock prices also fall faster. Thus, stocks with a stable ROE demonstrate defensive price characteristics. But, during periods of sustained economic growth, the superior growth in the ROE of cyclical industries tends to produce superior price performance in those industries. Classifying Industries By Stock Characteristics
  • 60. Fundamental Valuation Models • Dividend Discount Model (DDM): it shows how companies with stable growth are priced (in theory). It relates a stock’s current price to the present value of all expected future dividends into the indefinite future. It assumes: – there will be an indefinite stream of dividend payments, whose present values can be calculated. – that these dividends will grow at a constant rate (g – the growth rate in the formula).
  • 61. The discount rate used is the market’s required or expected rate of return for that type of investment i.e. rate of return as the return that compensates investors for investing in that stock, given its perceived riskiness. Fundamental Valuation Models
  • 62. It is represented in a mathematical formular as: Where: • Price is calculated as the current intrinsic value of the stock in question • Div0 - dividend paid out in the current year • Div1 - expected dividend paid out by the company in 1yr • r is the required rate of return on the stock • g is the assumed constant growth rate for dividends Price = Div0 (1+g) = Div1 r-g r-g Fundamental Valuation Models
  • 63. Example: ABC Company is expected to pay a N1 dividend next year. It has a constant long-term growth rate (g) of 6% and a required return (r) of 9%. Based on these inputs, the DDM will price ABC at a value of: (N1)/(0.09-0.06) = N33.33 Thus ABC stock has an intrinsic value of N33.33. Interpretation: If ABC is selling for $25 in the market, the stock is considered undervalued because it is selling below its intrinsic value. Alternatively, if ABC is selling for $40, the stock is considered overvalued because it is selling above its intrinsic value. Fundamental Valuation Models
  • 64. It is noteworthy to mention that this is an over simplification and future stock dividends are not predictable. Also, a stock does not have a defined maturity, like a bond. Fundamental Valuation Models
  • 65. Price Earnings Ratio (P/E Ratio) • Price Earnings Ratio (P/E Ratio): this allows investors compare a companys’ prospects - a high P/E ratio suggests a company has strong growth potential. E.g., assume that earnings growth is constant and that the rate at which dividends are paid out is constant (the percentage of earnings paid out as dividends is known as the dividend payout ratio). Then the price of the stock, divided by next year’s earnings, will be equal to the payout ratio divided by r – g, which is the same denominator used in the DDM calculation.
  • 66. For information purposes the formular is represented below as it is essential to be able to interpret the ratio. P/E = Payout Ratio/(r-g) Given two similar companies that pay out a large proportion of earnings, the company that can maintain these payout levels has a more dependable earnings stream. Therefore, all things being equal, a company with more stable earnings should have a higher P/E ratio than a similar type of company with less stable earnings. Also, a growth company will have a higher P/E only if the long-run growth rate (g) is expected to accelerate. Price Earnings Ratio (P/E Ratio)
  • 67. it is assumed that when confidence is high, P/E ratios are also high, and when confidence is low, P/E ratios are low. However, P/E levels are strongly inversely related to the prevailing level of inflation and, therefore, to the prevailing level of interest rates. P/Es are volatile, because earnings vary. In some cases, highly cyclical or economically sensitive companies may have losses or low levels of earnings that produce unrealistic or unusable P/Es. To the extent the market is efficient, a low P/E may result from the market’s ability to correctly anticipate an imminent decline in earnings. Price Earnings Ratio (P/E Ratio)
  • 68. Technical Analysis It is is the process of analyzing historical market action in an effort to determine probable future price trends. Technical analysts focus on the market itself, whether it be the commodity, equity, interest rate or foreign exchange market. They study, and plot on charts, past and present movements of prices, the volume of trading, statistical indicators – trying to identify recurrent and predictable patterns that can be used to predict future price moves.
  • 69. Attempts to probe the psychology of investors collectively or, i.e. the “mood” of the market. Market action is dependent on 3 primary sources of information – price, volume and time. It is based on three assumptions: • That all influences on market action are automatically accounted for or discounted in price activity – believing known market influences are fully reflected in market prices. That there is little advantage to fundamental analysis. What is required is to study the price action. i.e. “Letting the market talk,” -that the market will indicate the direction and the extent of its next price move. Technical Analysis
  • 70. • Prices move in trends and those trends tend to persist for relatively long periods of time. Thus, the primary task of a technical analyst is to identify a trend in its early stages and carry positions in that direction until the trend reverses itself. - not as easy as it may sound. • The future repeats the past. - belief that markets reflect investor psychology and that the behavior of investors tends to repeat itself. Investors tend to fluctuate between pessimism, fear and panic, and optimism, greed and euphoria. Comparing investor behavior as reflected in market action with historical market behavior, the analyst attempts to make predictions Technical Analysis
  • 71. Technical Analysis vs. Fundamental Analysis Main difference: the technician studies the effects of supply and demand (price and volume), while the fundamental analyst studies the causes of price movements. E.g. a fundamental analyst might suggest a bull market in equities will likely come to an end due to rising interest rates, a technical analyst would say that the appearance of a head-and-shoulder top formation indicates a major market top.
  • 72. Studying fundamentals can give an investor a sense of the long-term price prospects for an asset as this might be, the first step in investment decision-making. But, at the point of deciding when and at what level to enter or leave a market, technical analysis can serve a vital role, particularly when investing or trading leveraged investment products such as futures or options. Technical Analysis vs. Fundamental Analysis
  • 73. Tools of Technical Analysis Four main methods used by a technical analyst to identify trends and possible trend turning points are: • Chart Analysis – graphs, candlestick charts, line charts, point and figure charts, reversal & continuation patterns etc. • Quantitative Analysis - statistical tools i.e. moving averages and oscillators, Moving Average Convergence- divergence (MACD) • Analysis of Sentiment Indicators – used by contrarian investors in determining what the majority of investors expect prices to do in the future
  • 74. • Cycle Analysis- Long-term (<2yrs), Seasonal (1yr), Primary/intermediate (9 to 26 weeks) and Trading cycles (four weeks), reflected in the Elliot wave theory that that there are repetitive, predictable sequences of numbers and cycles found in nature and similar predictable patterns in the movement of stock prices. Additional tools used include: Volume changes: used to confirm other indicators in bull/bear markets Breadth of market: monitors the extent or broadness of a market trend using the cumulative advance-decline line Tools of Technical Analysis
  • 75. Summary • Fundamental analysis focuses on assessing the short-, medium- and long-range prospects of different industries and companies to determine how the prices of securities will change. • Quantitative analysis involves studying interest rates, economic variables, and industry or stock valuation using computers, databases, statistics and an objective, mathematical approach to valuing a company. • Technical analysis looks at historical stock prices and stock market behavior to identify recurring and predictable price patterns that can be used to predict future price movements.
  • 76. Fortuna Favi et Fortus Ltd., :118 Old Ewu Road, Aviation Estate, Lagos, :07032530965 www.ffavifortus.com info@ffavifortus.com