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ACKNOWLEDGEMENT
The satisfaction and euphoria that accompany the successful completion of any
work would be incomplete unless we mention some of the persons, as an expression
of gratitude, which made it possible, whose constant guidance and encouragement
served as a beckon light and crowned the efforts and success.
A project is a major milestone during the study period of a student. As such this
project was a challenge and was an opportunity to prove my caliber. It would not
have been possible to see through the undertaken project without the guidance of
Prof. M Hanif. It was purely on the basis of his experience and knowledge that I
was able to clear all the theoretical and technical hurdles during the development
phases of this project work.
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Contents
Page
No.
Preface 4
Introduction 5
Approaches of Equity Analysis 6
Price Volume Relationship 7
Support & resistance 8
Role reversal 10
Tools of Technical Analysis 11
Moving averages 12
Exponential averages - short term trend 13
Exponential averages - medium term trend 14
Exponential averages - long term trend 15
Relative strength index 16
Fundamental analysis 17
Dividend Discount Model 18
Price to Earnings (P/E Ratio) 19
Price Earnings to Growth (PEG Ratio) 20
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PREFACE
The project revolves around methods of equity research which is divided into
fundamental analysis and technical analysis. The project started with basic
concepts like price volume relationship, support, resistance and role reversal.
After basic concepts, tools of technical analysis such as moving average,
exponential moving average (EMA), EMA’s short term, medium term and long
term trends and relative strength index are explained.
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INTRODUCTION
Today’s world is meant for money and developing with the money. Not for today but from many
years it is there in any form. Earlier nations were famous and powerful due to their money (gold
coins, valuable things and some special features). Now a days nation’s capacity depends upon
money, defense power and it depends on rise and fall in share market. Now its the biggest thing for
this world. Everybody wants to earn money and investing in shares is the best way to earn
unlimited money. But as it depends on the market, therefore which shares really can give more and
more money there is more risk attached to it. Hence a proper knowledge of shares and many more
things are required before investing in share market.
Equity Analysis refers to the methods used to determine the movements in the equity, direction of
the movements and the methods applied for the valuation of equities. It basically means analyzing
the performance of various shares in the stock market and taking investment decisions on the basis
of such analysis.
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APPROACHES OF EQUITY ANALYSIS
1. Technical Analysis
2. Fundamental Analysis
Technical Analysis is the study of market action primarily through charts and other technical tools
with a view to identify overbought and oversold positions. It is a study of the past behavior
patterns. It is more suitable for short term traders and speculators. These technical analysts believe
that stock market movements are 90% psychological and 10% logical.
The objective of Fundamental analysis is to find out intrinsic value of the share based on future
fundamentals and compare the same with market price i.e. it is a Pricing Decision. It is a study of
the future. It is more suitable for long term investors. These fundamental analysts believe that
stock market movements are 90% logical and 10% psychological.
The difference between the two abovementioned type of analysts can be undertood with the help of
the following example of shopping mall. In a shopping mall, a fundamental analyst would go to
each store, study the product that was being sold, and then decide whether to buy it or not. By
contrast, a technical analyst would sit on a bench in the mall and watch people go into the stores.
Disregarding the intrinsic value of the products in the store, his or her decision would be based on
the patterns or activity of people going into each store.
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PRICE VOLUME RELATIONSHIP
Share prices are determined by demand and supply. Demand and supply, on the other hand, are
determined by a number of rational as well as irrational factors. Share prices moves in trend which
persist for an appreciable length of time.
There is a close relationship between share prices and volume i.e. the no. of shares traded. In the
direction of the trend, volume should be high and against the trend volume should be low. If this
does not happen , there is a clear cut indication of trend reversal.
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SUPPORT AND RESISTANCE
A support level is the price at which buyers are expected to enter the market in sufficient numbers
to take control from sellers.
The market has a memory. When price falls to a new Low and then rallies, buyers who missed out
on the first trough will be inclined to buy if price returns to that level. Afraid of missing out for a
second time, they may enter the market in sufficient numbers to take control from sellers. The
result is a rally, reinforcing perceptions that price is unlikely to fall further and creating a support
level.
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A resistance level is the price level at which sellers are expected to enter the market in sufficient
numbers to take control from buyers.
When price makes a new High and then retreats, sellers who missed the previous peak will be
inclined to sell when price returns to that level. Afraid of missing out a second time, they may
enter the market in numbers sufficient to overwhelm buyers. The resulting correction will reinforce
market perceptions that price is unlikely to move higher and establish a resistance level.
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ROLE REVERSAL
Support levels, once penetrated, frequently become resistance levels and vice versa.
The market logic is fairly simple: buyers who purchase near a support level, only to see price fall,
are likely to sell in order to recover their losses, when price rallies to near their break-even point.
The support level then becomes a resistance level.
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TOOLS OF TECHNICAL ANALYSIS
There are various tools of Technical analysis. The most popular of them
are as follows:
1. Moving Average
2. Relative Strength Index (RSI)
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MOVING AVERAGES
Moving averages are one of the oldest and most popular technical analysis tools. A moving
average is the average price of a financial instrument over a given time. The moving average
represents the consensus of investor’s expectations over the indicated period of time.
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Exponential Moving Average
It is a type of moving average that is similar to a simple moving average, except that more weight
is given to the latest data. The exponential moving average is also known as "exponentially
weighted moving average". This type of moving average reacts faster to recent price changes than
a simple moving average.
MP > 8 days EMA > 13 days EMA = short term bull run
Bullish (8>13)
Bearish (8<13)
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Medium term trends - In case of EMA medium term period is a time frame of 3 to 4 months.
If the market price of a share is more than 34 days exponential moving average (EMA) which is
again more than 55 days EMA then it indicates market will be in a medium term bull run. In the
graph below black line represents 55 days EMA and blue one represents 34 days EMA
MP > 34 days EMA > 55 days EMA = Medium term bull run
Bearish (34<55)
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Long term trend - Long term period is a period of more than 1 year. In general, the 50- and
200-day EMAs are used as signals of long-term trends. If the market price of a share is more than
50 days EMA which is again more than 200 days EMA then it is expected that the market will
experience a long term bull run. In the graph below red line represents 50 days EMA and blue one
represents 200 days EMA.
When the market is in between the two moving average then it is said to be the sideways market.
MP > 50 days EMA > 200 days EMA = long term bullish trend
Bull market
Sideways market
Bear market
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RELATIVE STRENGTH INDEX (RSI)
It is an extremely useful and popular momentum oscillator. Relative Strength compares the
magnitude of recent gains to recent losses to determine situations which may be overbought and
oversold.
In this chart the RSI ranges from 0 to 100. A security is said to be overbought when the RSI
approaches the 70 level, and according to theory, it may be overvalued and has increased potential
for a pullback. When the RSI approaches 30, it is an indication that the security may be
undervalued.
100
RSI = 100 - -----------
1 + RS
Where RS = Average of n periods closes up/Average of n periods closes down
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FUNDAMENTAL ANALYSIS
Fundamental analysis begins with the assertion that the true or intrinsic value of any financial asset
equals the present value of all cash flows that the owner of the asset expects to receive.
Accordingly the fundamental stock analyst attempts to forecast the timing and the size of these
cash flows and then converts them to their equivalent present value by using an appropriate
discount rate. The analyst must attempt not only to estimate this discount rate but also to forecast
the stream of dividends that a particular stock will provide in future. This process is equivalent to
forecasting the firm’s earning per ratio and payout ratio.
The primary task of security analysis is to identify mispriced security by determining the future
benefits of owning those securities. This is the valuation that people use to justify stock prices. The
most common example of this type of valuation methodology is P/E ratio, which stands for Price
to Earnings Ratio. This form of valuation is based on historic ratios and statistics and aims to
assign value to a stock based on measurable attributes. This form of valuation is typically what
drives long-term stock prices.
In short, there are many different ways to value stocks. The key is to take each approach into
account while formulating an overall opinion of the stock. And remember, a great company is not
always a great investment.
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DIVIDEND DISCOUNT MODEL (DDM)
Dividend Discount Model is powerful, but it has shortcomings. DDM is merely a mechanical
valuation tool, which makes it subject to the axiom "garbage in, garbage out". Small changes in
inputs can result in large changes in the value of a company. Instead of trying to project the
dividend to infinity, terminal value techniques are often used. A simple annuity is used to estimate
the terminal value. This is done because it is harder to come to a realistic estimate of the cash
flows as time goes on.
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PRICE TO EARNINGS (P/E RATIO)
The most common valuation technique used by analysts is the price to earnings ratio, or P/E. To
compute this figure, take the stock price and divide it by the annual EPS figure. For example, if
the stock is trading at Rs10 and the EPS is Rs 0.50, the P/E is 20 times. To get a good feeling of
what P/E multiple a stock trades at, be sure to look at the historical and forward ratios.
Historical P/Es are computed by taking the current price divided by the sum of the EPS for the last
four quarters, or for the previous year. You should also look at the historical trends of the P/E by
viewing a chart of its historical P/E over the last several years. Specifically you want to find out
what range the P/E has traded in so that you can determine if the current P/E is high or low versus
its historical average.
Forward P/Es are probably the single most important valuation method because they reflect the
future growth of the company into the figure. And remember, all stocks are priced based on their
future earnings, not on their past earnings. However, past earnings are sometimes a good indicator
for future earnings. Forward P/Es are computed by taking the current stock price divided by the
sum of the EPS estimates for the next four quarters, or for the EPS estimate for next calendar of
fiscal year or two.
Also, it is important to remember that P/Es change constantly. If there is a large price change in a
stock you are watching, or if the earnings (EPS) estimates change, be sure to recompute the ratio.
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PRICE EARNINGS TO GROWTH (PEG RATIO)
This valuation technique has really become popular over the past decade or so. It is better than just
looking at a P/E because it takes three factors into account; the price, earnings, and earnings
growth rates. To compute the PEG ratio (a.k.a. Price Earnings to Growth ratio) divide the Forward
P/E by the expected earnings growth rate. This will yield a ratio that is usually expressed as a
percentage. The theory goes that as the percentage rises over 100% the stock becomes more and
more overvalued, and as the PEG ratio falls below 100% the stock becomes more and more
undervalued. The theory is based on a belief that P/E ratios should approximate the long-term
growth rate of a company's earnings.
Here's an example of how to use the PEG ratio. Say you are comparing two stocks that you are
thinking about buying. Stock A is trading at a forward P/E of 15 and expected to grow at 20%.
Stock B is trading at a forward P/E of 30 and expected to grow at 25%. The PEG ratio for Stock A
is 75% (15/20) and for Stock B is 120% (30/25). According to the PEG ratio, Stock A is a better
purchase because it has a lower PEG ratio, or in other words, you can purchase its future earnings
growth for a lower relative price than that of Stock B. Stock theory suggests that the stock market
should assign a PEG ratio of 100% to every stock. This would represent theoretical equilibrium
between the market value of a stock and anticipated earnings growth.
PEG ratio results greater than one suggest one of the following:
PEG ratio results of less than one suggest one of the following:
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PRICE TO BOOK VALUE (P/B RATIO)
P/B Ratio is a ratio used to compare a stock's market value to its book value. It is calculated by
dividing the current closing price of the stock by the latest quarter's book value per share. (P/BV).
Book value is the measure that each shareholder stands to get, were the company to be liquidated.
Calculated as:
A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that
something is fundamentally wrong with the company. As with most ratios, be aware that this
varies by industry.
This ratio also gives some idea of whether you're paying too much for what would be left if the
company went bankrupt immediately. Conventional wisdom suggests that there is very little
chance of going wrong if an investor were to put his money in a stock with a P/BV of less than
one.
Investors would need to look at the fundamentals of each sector over the medium term where
stocks are trading at a price to book value of less than one, and decide if there are growth
possibilities at the current stock prices.
This essentially means that, hypothetically, if you buy the complete equity of these stocks and sell
the assets in the market, the realization would be significantly higher than the price paid to buy the
shares. However, this is still a conjectural scenario; as such buy-outs would have to follow the
norms of a takeover which requires an open offer based on recent historical prices.
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Fundamental analysis on some BSE index shares
Valuation techniques like Price to Earnings (P/E) and Price to Book Value (P/B) will be used in
finding out the intrinsic value of the few stocks included in the Sensex Index..
Important assumptions
• For the purpose of calculating fair value by price to earning method we need earning per
share (EPS) of 4 quarters. Some analyst suggest to consider EPS of last four quarters and
some believe in considering sum of expected EPS for the next four quarters. Here we have
considered the EPS of the last 4 quarters.
• The industry average P/E Ratio has been considered based on the closing prices as on 1st
April, 2011.
• In the absence of latest information, book value per share as on 31st March, 2010 has been
considered.
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BAJAJ AUTO LTD.
Industry : Auto – 2 & 3 wheelers
123.95
The actual closing price as on 1st April, 2011 is `1459.50. This means the stock is quite
underpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 101.20 per
share.
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CIPLA LTD.
Industry : Pharmaceuticals
12.82
The actual closing price as on 1st April, 2011 is ` 320.80. This means that the stock is more or less
fairly priced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 73.55 per
share.
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DLF LTD.
Industry : Construction & Contracting – Real Estate
5.56
= ` 151.29
The actual closing price as on 1st April, 2011 is ` 271.30. This means that the stock is quite
overpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 75.58 per
share.
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HDFC BANK LTD.
Industry : Banks – Private Sector
79.09
= ` 2306.26
The actual closing price as on 1st April, 2011 is ` 2333.65. This means that the stock is fairly
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 433.66 per
share.
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INFOSYS TECHNOLOGIES LTD.
Industry : Computers - Software
107.02
= ` 2819.98
The actual closing price as on 1st April, 2011 is ` 3218.20. This means that the stock is slightly
overpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 383.82 per
share.
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LARSEN & TOUBRO LTD.
Industry : Engineering - Heavy
61.40
= ` 1140.20
The actual closing price as on 1st April, 2011 is ` 1650.95. This means that the stock is overpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 300.50 per
share.
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OIL & NATURAL GAS CORPORATION
Industry : Oil Drilling & Exploration
93.09
= ` 1367.49
The actual closing price as on 1st April, 2011 is ` 292.85. This means that the stock is highly
underpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 102.02 per
share.
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STATE BANK OF INDIA
Industry : Banks – Public Sector
159.23
= ` 1823.18
The actual closing price as on 1st April, 2011 is ` 2719.50. This means that the stock is quite
overpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 1038.57
per share.
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TATA MOTORS LTD.
Industry : Auto – LCVs/HCVs
31.46
= ` 1014.27
The actual closing price as on 1st April, 2011 is ` 1242.90. This means that the stock is slightly
overpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 237.37 per
share.
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TATA STEEL LTD.
Industry : Steel
81.82
= ` 929.48
The actual closing price as on 1st April, 2011 is ` 625.65. This means that the stock is quite
underpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 412.14 per
share.
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NTPC
Industry : Power – Generation & Distribution
10.12
= ` 204.42
The actual closing price as on 1st April, 2011 is ` 188.90. This means that the stock is quite fairly
priced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 77.28 per
share.
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ITC LTD.
Industry : Cigarettes
8.91
= ` 297.42
The actual closing price as on 1st April, 2011 is ` 182.70. This means that the stock is quite
underpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 18.12 per
share.
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RELIANCE INDUSTRIES LTD.
Industry : Refineries
59.97
= ` 1113.64
The actual closing price as on 1st April, 2011 is ` 1035.30. This means that the stock is slightly
underpriced.
Price-To-Book Value Ratio: The company’s book value as on 31st March 2010 is 392.21 per
share.
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SUMMARY OF ANALYSIS
The above analysis can be summarized as follows :
From the table, we can note that Bajaj Auto Ltd. And ITC Ltd. are underpriced according to P/E
analysis. However, these two stocks have a very high P/B ratio which suggests that they are quite
overpriced. Thus, there is a conflict under the two valuation methods.
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Similarly, State Bank of India and DLF Ltd. are overpriced according to P/E analysis. However,
both the stocks have a P/B ratio which is not too high which suggest that they may be slightly
underpriced or fairly priced. Hence, there is a conflict in both the valuation techniques.
In such situations, the investors have to consider various other factors affecting the stock prices
and the company’s future prospects before taking any investment decision. Also, technical analysis
may be considered in such situations.
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CONCLUSION
Stock markets movement is more influenced by sentiments rather than fundamental
reasons. There are a lot more factor which influences equity market both in short
term and long term. Factors such as political stability, government policies towards
a particular industry, foreign investments in the country, inflation, country’s growth
rate, technological environment etc are responsible for the growth of stock market.
Besides this it is very difficult to find out expected dividend growth. Required rate of
return are different for different persons depending upon the risk profile of the
investor. It is the investors who have to decide how much return he wants. Industry
P/E is taken as a benchmark but industry P/E does not differentiate between a strong
company and a weak company. A good company is always not a good investment.
The above fundamental and technical methods are not 100% correct. It only gives its
view just like other factors do. Therefore a wise investor will invest considering
every factor which influences stock market.
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Bibliographical References
Websites:
• www.moneycontrol.com
• www.investopedia.com
• www.economictimes.com
• www.wikipedia.org
Books:
• Strategic Financial Management Study Module – By ICAI
Newapapers:
• The Economic Times
• The Telegraph
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