Description
There are 22 stock exchanges in India, the first being the Bombay Stock Exchange (BSE), which began formal trading in 1875, making it one of the oldest in Asia. Over the last few years, there has been a rapid change in the Indian securities market, especially in the secondary market.
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I NTRODUCTI ON TO I NDI AN CAPI TAL
MARKET
There are 22 stock exchanges in India, the first being the Bombay Stock Exchange (BSE),
which began formal trading in 1875, making it one of the oldest in Asia. Over the last few
years, there has been a rapid change in the Indian securities market, especially in the
secondary market. Advanced technology and online-based transactions have modernized the
stock exchanges. In terms of the number of companies listed and total market capitalization,
the Indian equity market is considered large relative to the country’s stage of economic
development. The number of listed companies increased from 5,968 in March 1990 to about
10,000 by May 1998 and market capitalization has grown almost 11 times during the same
period.
The debt market, however, is almost nonexistent in India even though there has been a large
volume of Government bonds traded. Banks and financial institutions have been holding a
substantial part of these bonds as statutory liquidity requirement. The portfolio restrictions on
financial institutions’ statutory liquidity requirement are still in place. A primary auction
market for Government securities has been created and a primary dealer system was
introduced in 1995. There are six authorized primary dealers. Currently, there are 31 mutual
funds, out of which 21 are in the private sector. Mutual funds were opened to the private
sector in 1992. Earlier, in 1987, banks were allowed to enter this business, breaking the
monopoly of the Unit Trust of India (UTI), which maintains a dominant position. Before 1992,
many factors obstructed the expansion of equity trading. Fresh capital issues were controlled
through the Capital Issues Control Act. Trading practices were not transparent, and there was a
large amount of insider trading. Recognizing the importance of increasing investor protection,
several measures were enacted to improve the fairness of the capital market. The Securities
and Exchange Board of India (SEBI) was established in 1988.
Despite the rules it set, problems continued to exist, including those relating to disclosure
criteria, lack of broker capital adequacy, and poor regulation of merchant bankers and
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underwriters. There have been significant reforms in the regulation of the securities market
since 1992 in conjunction with overall economic and financial reforms. In 1992, the SEBI Act
was enacted giving SEBI statutory status as an apex regulatory body. And a series of reforms
was introduced to improve investor protection, automation of stock trading, integration of
national markets, and efficiency of market operations. India has seen a tremendous change in
the secondary market for equity. Its equity market will most likely be comparable with the
world’s most advanced secondary markets within a year or two. The key ingredients that
underlie market quality in India’s equity market are:
• Exchanges based on open electronic limit order book;
• Nationwide integrated market with a large number of informed traders and fluency of
short or long positions; and
• No counterparty risk.
Among the processes that have already started and are soon to be fully implemented are
electronic settlement trade and exchange-traded derivatives. Before 1995, markets in India
used open outcry, a trading process in which traders shouted and hand signaled from within a
pit. One major policy initiated by SEBI from 1993 involved the shift of all exchanges to
screen-based trading, motivated primarily by the need for greater transparency. The first
exchange to be based on an open electronic limit order book was the National Stock Exchange
(NSE), which started trading debt instruments in J une 1994 and equity in November 1994. In
March 1995, BSE shifted from open outcry to a limit order book market. Currently, 17 of
India’s stock exchanges have adopted open electronic limit order.
1.1 CAPI TAL MARKET REFORMS AND DEVELOPMENTS
Over the last few years, SEBI has announced several far-reaching reforms to promote the
capital market and protect investor interests. Reforms in the secondary market have focused on
three main areas: structure and functioning of stock exchanges, automation of trading and post
trade systems, and the introduction of surveillance and monitoring systems. Computerized
online trading of securities, and setting up of clearing houses or settlement guarantee funds
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were made compulsory for stock exchanges. Stock exchanges were permitted to expand their
trading to locations outside their jurisdiction through computer terminals. Thus, major stock
exchanges in India have started locating computer terminals in far-flung areas, while smaller
regional exchanges are planning to consolidate by using centralized trading under a federated
structure. Online trading systems have been introduced in almost all stock exchanges. Trading
is much more transparent and quicker than in the past. Until the early 1990s, the trading and
settlement infrastructure of the Indian capital market was poor. Trading on all stock exchanges
was through open outcry, settlement systems were paper-based, and market intermediaries
were largely unregulated. The regulatory structure was fragmented and there was neither
comprehensive registration nor an apex body of regulation of the securities market. Stock
exchanges were run as “brokers clubs” as their management was largely composed of brokers.
There was no prohibition on insider trading, or fraudulent and unfair trade practices. Since
1992, there has been intensified market reform, resulting in a big improvement in securities
trading, especially in the secondary market for equity. Most stock exchanges have introduced
online trading and set up clearing houses/corporations. A depository has become operational
for scrip less trading and the regulatory structure has been overhauled with most of the powers
for regulating the capital market vested with SEBI. The Indian capital market has experienced
a process of structural transformation with operations conducted to standards equivalent to
those in the developed markets. It was opened up for investment by foreign institutional
investors (FIIs) in 1992 and Indian companies were allowed to raise resources abroad through
Global Depository Receipts (GDRs) and Foreign Currency Convertible Bonds (FCCBs). The
primary and secondary segments of the capital market expanded rapidly, with greater
institutionalization and wider participation of individual investors accompanying this growth.
However, many problems, including lack of confidence in stock investments, institutional
overlaps, and other governance issues, remain as obstacles to the improvement of Indian
capital market efficiency.
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I NTRODUCTI ON TO STOCK MARKET
Stock Market is a place where the trading takes place. A place where lots of money is
invested to buy stocks and lots of money is earned while selling stocks. Some people go with
profit and some people carries losses. But still for a trader it’s an everyday game. And in
games there are certain rules and regulations to be followed then only you can’t make
strategies and plans and play the game according to it and win it. For a new trader the first
thing to know about is where to invest, how to invest, how much to invest and win the game
of investment.
2.1 HOW TO I NVEST?
When an investor starts investing in the stocks or the commodity market he has some
prominent exchanges to invest in. Few important ones are as follows:
1. BSE (Bombay Stock Exchange): BSE is the oldest stock exchange in Asia and has the
greatest number of listed companies in the world, with 4700 listed as of August 2007. Here
the trading in stocks takes place. It is located at Dalal Street, Mumbai, India. On 31
December 2007, the equity market capitalization of the companies listed on the BSE was
US$ 1.79 trillion, making it the largest stock exchange in South Asia and the 12th largest in
the world. BSE’s key index is sensex.
2. NSE (National Stock Exchange): It is the largest stock exchange in India in terms of daily
turnover and number of trades, for both equities and derivative trading. NSE has a market
capitalization of around Rs 47, 01,923 crore (7 August 2009) and is expected to become the
biggest stock exchange in India in terms of market capitalization by 2009 end. NSE’s key
index is Nifty.
3. MCX (Multi Commodity Exchange): MCX is an independent commodity exchange
based in India. It was established in 2003 and is based in Mumbai. The turnover of the
exchange for the period Apr-Dec 2008 was INR 32 Trillion. MCX offers futures trading in
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Agricultural Commodities, Bullion, Ferrous & Nonferrous metals, Pulses, Oils & Oilseeds,
Energy, Plantations, Spices and other soft commodities
4. NCDEX (National Commodity & Derivatives Exchange Limited): NCDEX is an online
commodity exchange based in India. It was incorporated as a private limited company
incorporated on April 23, 2003 under the Companies Act, 1956. It obtained its Certificate for
Commencement of Business on May 9, 2003. It has commenced its operations on December
15, 2003. NCDEX is a closely held private company which is promoted by national level
institutions and has an independent Board of Directors and professionals not having vested
interest in commodity markets.
2.2 WHAT ARE STOCKS?
Plain and simple, stock is a share in the ownership of a company. Stock represents a claim on
the company's assets and earnings. As you acquire more stock, your ownership stake in the
company becomes greater. Whether you say shares, equity, or stock, it all means the same
thing. When you buy the shares of a company you become one of the many owners of that
much portion of a company. In other words you own a part of the company.
2.3 HOW TO TRADE I N STOCKS?
An investor can open the required accounts (Demat and Trading) with a registered broker
with NSE or BSE (whichever exchange he want to deal with) and start purchasing and selling
the stock of his wish.
2.4 WHAT ARE COMMODI TI ES?
A commodity is some good for which there demand is, but which is supplied without
qualitative differentiation across a market. It is a product that is the same no matter who
produces it. Generally, these are basic resources and agricultural products such as iron ore,
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crude oil, coal, ethanol, salt, sugar, coffee beans, soybeans, aluminium, copper, rice, wheat,
gold, silver and platinum in which trading is done throughout the Commodities of the world.
2.5 HOW TO TRADE I N COMMODI TI ES?
For trading in commodities an investor have to open a commodity account with either MCX
or NCDEX (whichever commodity exchange he wants to trade in) and start buying and
selling commodities. But dealing with the stock and the commodity market is nothing less
than solving a complicated problem in mathematics. You have to apply algorithms, use
formulae, study trend and above all analyze the market properly before you actually start
investing. Without all these steps your money will go in waste and you may incur huge
losses. Some of the basic tips for increasing profits and minimizing losses in the stock and the
trading market are:
1. Cut Your Losses
2. Let Your Profits Run
3. Follow the Trend
4. Don`t Overtrade
5. Always Trade Liquid Stocks
6. Keep Positions Small
7. Don`t Buy Something Because it Looks Cheap
8. Take tips and advises from proven experts.
So if you are planning to invest in the stock and the commodity market then see, analyze and
then act. There are many tips providing companies which are giving tips on how and where to
invest your money in the share market. They tell you exactly which stock is beneficial to
invest. They give you ideas about when and what to buy and when to sell. Follow the rules
and you will surely be the winner.
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RESEARCH METHODOLOGY
3.1 OBJ ECTI VE:
PRI ME OBJ ECTI VE:
Our project objective is to do fundamental analysis of ten sectors of the Indian
economy based on NSE.
SUBSI DI ARY OBJ ECTI VES:
1.To construct a portfolio on the bases of fundamental analysis of top 20 companies
out of 60 selected companies representing 10 different sectors.
2.To measure performs of virtual portfolio with actual market price.
3.2 TYPE OF RESEARCH
A descriptive research design has been used for the study.
3.3 SAMPLE SI ZE:
Sampling size will be primarily consisting of the top six companies listed in the BSE
or NSE out of selected ten sectors.
3.4 SAMPLI NG UNI T:
Sample unit will be of two companies out of selected six companies of above
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3.5 SAMPLI NG METHOD:
The sampling method will be on the basis of the Fundamental Analysis of the
companies.
3.6 DATA SOURCES:
PRI MARY DATA:
1. BSE
2. NSE
SECONDARY DATA:
1. Annual reports of the companies
2. Ratios
3. Library Research
4. Internet
3.7 EXPECTED CONTRI BUTI ON OF THE STUDY:
The Research will be useful to other students as reference. It will also be useful to Portfolio
managers to see comparison and to know the current situation of the top Indian companies.
3.8 LI MI TATI ONS OF THE STUDY:
• We have not included all the sectors and all industries of Indian stock exchanges.
• We can’t get all companies latest financial reports so we cannot calculate all the ratios
in fundamental analysis.
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I NTRODUCTI ON TO
FUNDAMENTAL ANALYSI S
Fundamental analysis is the cornerstone of investing. In fact, some would say that you aren't
really investing if you aren't performing fundamental analysis. Because the subject is so broad,
however, it's tough to know where to start. There are an endless number of investment
strategies that are very different from each other, yet almost all use the fundamentals. The goal
of this tutorial is to provide a foundation for understanding fundamental analysis. It's geared
primarily at new investors who don't know a balance sheet from an income statement. While
you may not be a "stock-picker extraordinaire" by the end of this tutorial, you will have a
much more solid grasp of the language and concepts behind security analysis and be able to
use this to further your knowledge in other areas without feeling totally lost. The biggest part
of fundamental analysis involves delving into the financial statements. Also known as
quantitative analysis, this involves looking at revenue, expenses, assets, liabilities and all the
other financial aspects of a company. Fundamental analysts look at this information to gain
insight on a company's future performance. A good part of this tutorial will be spent learning
about the balance sheet, income statement, cash flow statement and how they all fit together.
But there is more than just number crunching when it comes to analyzing a company. This is
where qualitative analysis comes in - the breakdown of all the intangible, difficult-to-measure
aspects of a company.
4.1 WHAT I S FUNDAMENTAL ANALY SI S?
In this section we are going to review the basics of fundamental analysis, examine how it can
be broken down into quantitative and qualitative factors, introduce the subject of intrinsic
value and conclude with some of the downfalls of using this technique. The Very Basics When
talking about stocks, fundamental analysis is a technique that attempts to determine a
security’s value by focusing on underlying factors that affect a company's actual business and
its future prospects. On a broader scope, you can perform fundamental analysis on industries
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or the economy as a whole. The term simply refers to the analysis of the economic well-being
of a financial entity as opposed to only its price movements. Fundamental analysis serves to
answer questions, such as:
• Is the company’s revenue growing?
• Is it actually making a profit?
• Is it in a strong-enough position to beat out its competitors in the future?
• Is it able to repay its debts?
• Is management trying to "cook the books"?
Of course, these are very involved questions, and there are literally hundreds of others you
might have about a company. It all really boils down to one question: Is the company’s stock a
good investment? Think of fundamental analysis as a toolbox to help you answer this
question. Note: The term fundamental analysis is used most often in the context of stocks, but
you can perform fundamental analysis on any security, from a bond to a derivative. As long as
you look at the economic fundamentals, you are doing fundamental analysis. For the purpose
of this tutorial, fundamental analysis always is referred to in the context of stocks.
4.2 FUNDAMENTALS: QUANTI TATI VE AND QUALI TATI VE
You could define fundamental analysis as “researching the fundamentals”, but that doesn’t tell
you a whole lot unless you know what fundamentals are. As we mentioned in the introduction,
the big problem with defining fundamentals is that it can include anything related to the
economic well-being of a company. Obvious items include things like revenue and profit, but
fundamentals also include everything from a company’s market share to the quality of its
management. The various fundamental factors can be grouped into two categories:
quantitative and qualitative. The financial meaning of these terms isn’t all that different from
their regular definitions. Here is how the MSN Encarta dictionary defines the terms:
• Quantitative – capable of being measured or expressed in numerical terms.
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• Qualitative – related to or based on the quality or character of something, often as
opposed to its size or quantity.
In our context, quantitative fundamentals are numeric, measurable characteristics about a
business. It’s easy to see how the biggest source of quantitative data is the financial
statements. You can measure revenue, profit, assets and more with great precision. Turning to
qualitative fundamentals, these are the less tangible factors surrounding a business - things
such as the quality of a company’s board members and key executives, its brand-name
recognition, patents or proprietary technology.
4.3 QUANTI TATI VE MEETS QUALI TATI VE
Neither qualitative nor quantitative analysis is inherently better than the other. Instead, many
analysts consider qualitative factors in conjunction with the hard, quantitative factors. Take the
Coca-Cola Company, for example. When examining its stock, an analyst might look at the
stock’s annual dividend payout, earnings per share, P/E ratio and many other quantitative
factors. However, no analysis of Coca-Cola would be complete without taking into account its
brand recognition. Anybody can start a company that sells sugar and water, but few companies
on earth are recognized by billions of people. It’s tough to put your finger on exactly what the
Coke brand is worth, but you can be sure that it’s an essential ingredient contributing to the
company’s ongoing success.
4.4 THE CONCEPT OF I NTRI NSI C VALUE
Before we get any further, we have to address the subject of intrinsic value. One of the
primary assumptions of fundamental analysis is that the price on the stock market does not
fully reflect a stock’s “real” value. After all, why would you be doing price analysis if the
stock market were always correct? In financial jargon, this true value is known as the intrinsic
value.
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For example, let’s say that a company’s stock was trading at Rs.20. After doing extensive
homework on the company, you determine that it really is worth Rs.25. In other words, you
determine the intrinsic value of the firm to be Rs.25. This is clearly relevant because an
investor wants to buy stocks that are trading at prices significantly below their estimated
intrinsic value. This leads us to one of the second major assumptions of fundamental analysis:
in the long run, the stock market will reflect the fundamentals. There is no point in buying a
stock based on intrinsic value if the price never reflected that value. Nobody knows how long
“the long run” really is. It could be days or years.
This is what fundamental analysis is all about. By focusing on a particular business, an
investor can estimate the intrinsic value of a firm and thus find opportunities where he or she
can buy at a discount. If all goes well, the investment will pay off over time as the market
catches up to the fundamentals.
The big unknowns are:
1) You don’t know if your estimate of intrinsic value is correct; and
2) You don’t know how long it will take for the intrinsic value to be reflected in the
marketplace.
4.5 CRI TI CI SMS OF FUNDAMENTAL ANALYSI S
The biggest criticisms of fundamental analysis come primarily from two groups: proponents of
technical analysis and believers of the “efficient market hypothesis”. Technical analysis is the
other major form of security analysis. We’re not going to get into too much detail on the
subject.
Put simply, technical analysts base their investments (or, more precisely, their trades) solely
on the price and volume movements of securities. Using charts and a number of other tools,
they trade on momentum, not caring about the fundamentals. While it is possible to use both
techniques in combination, one of the basic tenets of technical analysis is that the market
discounts everything. Accordingly, all news about a company already is priced into a stock,
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and therefore a stock’s price movements give more insight than the underlying fundamental
factors of the business itself.
Followers of the efficient market hypothesis, however, are usually in disagreement with both
fundamental and technical analysts. The efficient market hypothesis contends that it is
essentially impossible to produce market-beating returns in the long run, through either
fundamental or technical analysis. The rationale for this argument is that, since the market
efficiently prices all stocks on an ongoing basis, any opportunities for excess returns derived
from fundamental (or technical) analysis would be almost immediately whittled away by the
market’s many participants, making it impossible for anyone to meaningfully outperform the
market over the long term.
4.6 QUALI TATI VE FACTORS - THE COMPANY
Before diving into a company's financial statements, we're going to take a look at some of the
qualitative aspects of a company.
Fundamental analysis seeks to determine the intrinsic value of a company's stock. But since
qualitative factors, by definition, represent aspects of a company's business that are difficult or
impossible to quantify, incorporating that kind of information into a pricing evaluation can be
quite difficult. On the flip side, as we've demonstrated, you can't ignore the less tangible
characteristics of a company.
In this section we are going to highlight some of the company-specific qualitative factors that
you should be aware of.
4.6.1 BUSI NESS MODEL
You should understand the business model of any company you invest in. The "Oracle of
Omaha", Warren Buffett, rarely invests in tech stocks because most of the time he doesn't
understand them. This is not to say the technology sector is bad, but it's not Buffett's area of
expertise; he doesn't feel comfortable investing in this area. Similarly, unless you understand a
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company's business model, you don't know what the drivers are for future growth, and you
leave yourself vulnerable to being blindsided like shareholders of Boston Chicken were.
4.6.2 COMPETI TI VE ADVANTAGE
Another business consideration for investors is competitive advantage. A company's long-term
success is driven largely by its ability to maintain a competitive advantage - and keep it.
Powerful competitive advantages, such as Coca Cola's brand name and Microsoft's domination
of the personal computer operating system, create a moat around a business allowing it to keep
competitors at bay and enjoy growth and profits. When a company can achieve competitive
advantage, its shareholders can be well rewarded for decades.
4.6.3 MANAGEMENT
J ust as an army needs a general to lead it to victory, a company relies upon management to
steer it towards financial success. Some believe that management is the most important aspect
for investing in a company. It makes sense - even the best business model is doomed if the
leaders of the company fail to properly execute the plan. So how does an average investor go
about evaluating the management of a company? This is one of the areas in which individuals
are truly at a disadvantage compared to professional investors. You can't set up a meeting with
management if you want to invest a few thousand dollars. On the other hand, if you are a fund
manager interested in investing millions of dollars, there is a good chance you can schedule a
face-to-face meeting with the upper brass of the firm. Every public company has a corporate
information section on its website. Usually there will be a quick biography on each executive
with their employment history, educational background and any applicable achievements.
Don't expect to find anything useful here. Let's be honest: We're looking for dirt, and no
company is going to put negative information on its corporate website.
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4.6.4 CORPORATE GOVERNANCE
Corporate governance describes the policies in place within an organization denoting the
relationships and responsibilities between management, directors and stakeholders. These
policies are defined and determined in the company charter and its bylaws, along with
corporate laws and regulations. The purpose of corporate governance policies is to ensure that
proper checks and balances are in place, making it more difficult for anyone to conduct
unethical and illegal activities.
4.7 QUALI TATI VE FACTORS - THE I NDUSTRY
Each industry has differences in terms of its customer base, market share among firms,
industry-wide growth, competition, regulation and business cycles. Learning about how the
industry works will give an investor a deeper understanding of a company's financial health.
4.7.1 CUSTOMERS
Some companies serve only a handful of customers, while others serve millions. In general,
it's a red flag (a negative) if a business relies on a small number of customers for a large
portion of its sales because the loss of each customer could dramatically affect revenues. For
example, think of a military supplier who has 100% of its sales with the U.S. government. One
change in government policy could potentially wipe out all of its sales. For this reason,
companies will always disclose in their 10-K if any one customer accounts for a majority of
revenues.
4.7.2 MARKET SHARE
Understanding a company's present market share can tell volumes about the company's
business. The fact that a company possesses an 85% market share tells you that it is the largest
player in its market by far. Furthermore, this could also suggest that the company possesses
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some sort of "economic moat," in other words, a competitive barrier serving to protect its
current and future earnings, along with its market share. Market share is important because of
economies of scale. When the firm is bigger than the rest of its rivals, it is in a better position
to absorb the high fixed costs of a capital-intensive industry.
4.7.3 I NDUSTRY GROWTH
One way of examining a company's growth potential is to first examine whether the amount of
customers in the overall market will grow. This is crucial because without new customers, a
company has to steal market share in order to grow. In some markets, there is zero or negative
growth, a factor demanding careful consideration. For example, a manufacturing company
dedicated solely to creating audio compact cassettes might have been very successful in the
'70s, '80s and early '90s. However, that same company would probably have a rough time now
due to the advent of newer technologies, such as CDs and MP3s. The current market for audio
compact cassettes is only a fraction of what it was during the peak of its popularity.
4.7.4 COMPETI TI ON
Simply looking at the number of competitors goes a long way in understanding the
competitive landscape for a company. Industries that have limited barriers to entry and a large
number of competing firms create a difficult operating environment for firms. One of the
biggest risks within a highly competitive industry is pricing power. This refers to the ability of
a supplier to increase prices and pass those costs on to customers. Companies operating in
industries with few alternatives have the ability to pass on costs to their customers. A great
example of this is Wal-Mart. They are so dominant in the retailing business, that Wal-Mart
practically sets the price for any of the suppliers wanting to do business with them. If you want
to sell to Wal-Mart, you have little, if any, pricing power.
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4.7.5 REGULATI ON
Certain industries are heavily regulated due to the importance or severity of the industry's
products and/or services. As important as some of these regulations are to the public, they can
drastically affect the attractiveness of a company for investment purposes. In industries where
one or two companies represent the entire industry for a region (such as utility companies),
governments usually specify how much profit each company can make. In these instances,
while there is the potential for sizable profits, they are limited due to regulation.
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ECONOMY ANALYSI S
5.1 ECONOMI C CYCLE
Countries go through the business or economic cycle and the stage of the cycle at which a
country is in has a direct impact both on industry and individual companies. It affects
investment decisions, employment, demand and the profitability of companies.
The four stages of an economic cycle are:
• Depression
• Recovery
• Boom
• Recession
DEPRESSI ON
At the time of depression, demand is low and falling. Inflation rate is high and so are interest
rates in the market. Companies, crippled by high borrowing and falling sales, are forced to
curtail production, close down plants built at times of higher demand, and let workers go. The
whole economy gets ruined during this period. All the well established companies’ turns from
profitable trend to the loss making companies and the companies in the developing stage goes
into the liquidation.
RECOVERY
During this phase, the economy begins to recover. Investment begins a new and the demand
grows. Companies begin to post profits. Conspicuous spending begins once again. Once the
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recovery stage sets in fully, profits begin to grow at a higher proportionate rate. More and
more new companies are floated to meet the increasing demand in the economy. Companies
which were well established and were earning losses starts making profits again and the
economy starts regaining its position. If this is the case in some particular industry than many
new companies are also attracted towards this industry and the economy starts growing and
this stage and achieves the targeted growth slowly and gradually.
BOOM
During this phase of economy the demand of the stock reaches at an all time high. Investment
is also high. Interest rates are low. There is a great demand of the stock in the market. But,
gradually as time passes, the company tries to increase the supply o the stock in the market.
So, when supply begins to exceed the demand prices that had been rising begin to stabilize
and even fall. Slowly and gradually the market stabilizes and the boom phase matures and
prices also get stabilized with the changing situations of the market.
RECESSI ON
In the recession phase the economy slowly begins to downturn. Demand starts falling.
Interest rates and inflation rate is too high. Companies start finding it difficult to sell their
goods. The overall industry suffers a lot during this phase of the economy. The recession is
due to various reasons. No particular reason can be mentioned as such. The well established
companies also have to suffer a lot due to recession period. The market price of all the goods
of almost all the industries falls to a great extent.
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5.2 GLOBAL ECONOMY
The global economy refers to the increasing integration of fragmented national markets for
goods and services into a single global market. In such a market, companies may source from
one country, conduct research and development in another country and then takes orders in a
third country, and sells wherever there is existence of demand regardless of the customer’s
nationality.
GLOBAL ECONOMY SCENARI O
According to the report of the Business Economics and Public Policy, the economic growth
around the globe remained strong in 2008 despite the current credit crisis in the USA. The
IMF has projected the world economic growth to reach 4.8 percent in 2009. The emerging
economies i.e. China and India have an important role in the global economy. The stresses in
U.S. financial markets that first emerged in the summer of 2007 transformed themselves into
a full-blown global financial crisis in the fall of 2009.
Banks purchased vast quantities of loans used for house purchases in the United States. As
interest rates were increased in 2006 and 2007 in that country, many of those debtors began
to default, putting at risk the value of all the housing loans. This uncertainty has resulted in
the share prices of financial and non financial companies falling, affecting lending operations
between the banks. Financial institutions involved in property, and investment banks failed,
while other institutions experienced increasingly large losses on their investments in the
housing markets.
As the crisis intensified, the effects of financial turmoil on developing countries increased I
step, as risk aversion sent spreads soaring, equity markets tumbling, exchange rates falling
and capital flows into decline. In this situation, growth prospects for both high income
developing countries have deteriorated substantially, and a movement of global growth from
2.5 percent in 2008 to 0.9 percent in 2009.
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The potential risk to the global economy is high oil prices, currency instability and high ratios
of inflation. It is predicted that turmoil in the global financial markets affects the economic
growth around the world.
POTENTI AL ECONOMI C AND FI NANCI AL RI SKS
The potential risks to the global economy are high oil prices and high ratios of inflation. It is
predicted that turmoil in the global financial markets affects the economic growth around the
world. Weaker growth in the United States will have spill-over effects on trade and weaken
the economies of its trading partners and especially the emerging and under developed
countries. There are still global imbalances: between U.S. budget and current account deficits
and the accumulation of huge foreign currency reserves by Asian central banks remain the
potential risks to the global economy in 2008. It is clear that rising food and oil prices are
secondary risks for the world economy as they will be further inflated by the disruption in the
global financial market. Some of the reasons due to which crisis can last for a longer period
are as follows:
The credit a squeeze: It is a slow-burning crisis that is going to take a long time to unfold,
having an adverse impact on economic growth for years to come.
Housing collapse: The bubble in the residential property markets of the US and other rich
countries has only just started to deflate, and has much further to go.
Inflation: Years of reckless money creation by central banks, supply/demand imbalances
have driven up the prices of key resources such as oil. The fading impacts of unusually-high
tech-driven productivity gains, and shortages of high level skills in many sectors such as
global mining and Chinese manufacturing, are combining to bring back the inflation problem.
Currency instability: The US needs to attract an extra $3 billion in foreign capital every
business day to finance its foreign trade deficit. If foreign governments, institutions and
private investors become less willing to provide that capital, the dollar will remain under
Page | 22
pressure; continue falling in value in terms of other currencies which would be set back to
many developing countries and emerging market economies in the world.
Cheap money: The greater the risk of global recession and of deflation, the more central
banks will force down short-term interest rates to combat that risk. In J apan the Central Bank
offered credit to commercial banks at virtually no cost.
World trade: The progress of globalization would not cease because of lower growth in the
world economy, even though progress will be slowed somewhat by rising protectionism in
the developed nations, where whole swathes of job classes are under increasing pressure from
foreign competition.
5.3 I NDI AN ECONOMY
I NDUSTRI AL PRODUCTI ON
The data on the industrial production shows initial indications of improvement. The overall
index of industrial production after registering a growth of 10.3 percent in October 2009
witnessed an even higher growth of 11.7 percent in November 2009.
Further the classifications of the industrial production shows the manufacturing and mining
sectors register growths of 12.7 percent and 10.0 percent respectively in November 2009.
Growth in the electricity sector was also seen to grow by 3.3 percent compared to the growth
recorded in the previous year.
Page | 23
CORE I NFRASTRUCTURE
The overall index of six core infrastructure industries registered a growth of 6.0 percent in
December 2009, which was 5.3 percentages higher than the growth recorded in the same
month of previous year.
The crude oil production after registering negative growth for five consecutive months,
witnessed a growth of 1.1 percent in December 09. Once again cement and finished steel
segments were best performers, with respective growths of 11.0 percent and 9.6 percent.
The coal and petroleum sectors remained laggards. The growth in coal production was 2.5
percent in December 09 much lower than the growth of 11.2 percent in the same month of
previous year. Similarly petroleum refinery segment registered 0.9 percent growth in
December 2009 as against a high growth of 3.0 percent recorded in corresponding month of
08.
Inflation
The skyrocketing food prices resulted into flaring of overall inflation; this continues to be a
major concern. The rate of inflation was increased by almost 2 percentages. This is changed
from 5.5 percent in November 09 to 7.3 percent in December 09. This was also higher than
the inflation rate of 6.2 percent recorded in December 2008.
In December 2009 the inflation rate for three broad segments – primary articles, fuel
lubricants and light and manufactured products was 14.9 percent, 4.3 percent and 5.2 percent
respectively.
Monetary Indicators
The broad money supply expanded by 10.9 percent during the April-December period of
2009-10. The corresponding growth during the previous fiscal was 12.4 percent.
The aggregate deposits increased by 9.8 percent during April-December period of 2009 10.
The growth during the first three quarters of 2008-09 was 11.7 percent. (Calculated from
March end up to the December)
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The bank credit went by 7.0 percent over the period April to December 2009-10, while the
growth in corresponding period of the last fiscal was 12.1 percent.
Stock Market Trends
High investment activity was seen in the stock market after the economic fundamentals
gained strength. The stock market remained bullish in the month of December 09 with BSE
Sensex closing at over 17k points by month end.
Fiscal Trends
The gross tax revenue collections during the period April-December 2009-10 amounted to Rs
4, 16, 094 crore a drop by 2.5 percent from Rs 4, 26,795 crore revenue collections over the
same period last fiscal. While income from the direct sources of tax revenue, i.e. income and
corporate tax increased however, collections from indirect sources witnessed a fall. Over the
period, April-December 2009-10 the growth in revenue from income tax was 12.2 percent
and in case of corporate tax it was 16.8 percent.
Growth in the custom duty, excise duty and service tax collections, on the other hand, was
negative 29.2 percent, (-) 18.2 percent and (-) 5.9 percent respectively.
The revenue receipts of the government witnessed a marginal increase, from Rs 3, 75,937
core in April- December 2008-09 to Rs 3, 89,271 crore during the same period this financial
year. With an additional expenditure of Rs 1,10, 324 crore during the period April-December
2009-10 vis-à-vis same period last year, the total expenditure saw an increase of 18.5 percent.
The resultant fiscal deficit over the corresponding period was Rs 3, 09, 980 crore.
Foreign Trade
The growth in the merchandise exports sector turned positive in November 2009 after a
thirteen-month period of decline. The growth recoded in December 2009 was relatively lower
than the growth seen in the previous month. In December 2009 the exports registered a
growth of 9.3 percent, as against the growth of 18.2 percent registered in November 2009.
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The imports also registered a positive growth after being in the negative territory for straight
eleven months of 2009 since J anuary. The imports grew by 27.2 percent in December 2009.
Oil imports grew by 42.8 percent, while non-oil imports increased by 22.4 percent.
Foreign Investments
Foreign direct investment of USD 1.7 billion was received in November 2009 as against the
inflows of USD 2.3 billion in the previous month. There was a decline in the portfolio
investments as well in November 09 vis-à-vis inflows in the previous month. The cumulative
investment inflows over the period April-November 2009-10 amounted to USD 47.1 billion.
Foreign Exchange Reserves
The forex reserves accumulated in November 2009 was USD 286.7 billion. Last year the
reserves had fallen to USD 247.6 billion in the same month.
Exchange Rate
The rupee witnessed slight appreciation in the month of J anuary 2010 vis-à-vis the USD. The
Rupee Dollar exchange rate which averaged Rs 46.6/USD in the month of December 2009
was at Rs 45.9/USD in J anuary 2010.
5.4 I NVESTMENT DECI SI ON
Investors should attempt to determine the stage of the economic cycle of the country. They
should invest at the end of a depression when the economy begins to recover. Investors
should disinvest either just before or during the boom, or, at the worst, just after the boom.
Investment and disinvestments made at these times will earn the investor greater benefits.
Here, as the economy is in recession stage, investors should disinvest their holdings in
cyclical industries and switch to growth or evergreen industries.
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COMPANY ANALYSI S
The company analysis is done on base of fundament analysis which is done on the bases of:
• Edward Altman’s Z score
• Ratios
• Earnings Per Share
• Book Value
• Market Capitalization
• Promoters’ Shareholding Pattern
6.1 EDWARD ALTMAN’ S Z SCORE
The Z-score formula for predicting bankruptcy was published in 1968 by Edward I.
Altman. He was then an Assistant Professor of Finance at New York University, and, in
2009, is still a professor at NYU, now as a long-tenured one. The Z-score is a formula
involving multiple variables that measures the financial health of a company. The formula
may be used to predict the probability that a firm will go into bankruptcy within two years. Z-
scores are still used occasionally as an easy-to-calculate control measure for the financial
distress status of companies in academic studies about other topics.
6.1.1 ESTI MATI ON OF THE FORMULA
The Z-score is a linear combination of four or five common business ratios, weighted by
coefficients that were estimated by Altman's application of the statistical method of
discriminate analysis to a dataset of publicly held manufacturers. Altman first identified a set
of firms which had declared bankruptcy, and he then collected a matched sample of firms
which had survived, with matching by industry and approximate size (assets).
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The estimation was originally based on data from publicly held manufacturers, but has since
been re-estimated based on other datasets for private manufacturing, non-manufacturing and
service companies.
The original data sample consisted of 66 firms, half of which had filed for bankruptcy under
Chapter 7. All businesses in the database were manufacturers and small firms with assets of
70% reliability (Eidleman). What is usually meant by accuracy is the percentage of
firms that are classified correctly, within the estimation sample, when the Z-score values for
firms are translated into yes/no predictions for whether each turns out to be bankrupt.
Because the parameters of the model are estimated based on the same sample, and because
the sample itself is not randomly selected, it is not reasonable to project that the formula will
achieve similar accuracy when applied for making predictions about other firms.
From about 1985 onwards, the Z-scores gained wide acceptance by auditors, management
accountants, courts, and database systems used for loan evaluation (Eidleman). The formula's
approach has been used in a variety of contexts and countries, although it was designed
originally for publicly held manufacturing companies with assets of more than $1 million.
Later variations by Altman take into account the book value of privately held shares, and the
fact that turnover ratios vary widely in non-manufacturing industries.
The Altman Z-Score model is not recommended for use with financial firms; because these
firms often have off-balance sheet liabilities that aren't captured by the financial statement
data used in the Altman Z-Score model. There are market-based formulas used to predict the
default of financial firms (such as the Merton Model), but these have limited predictive value
because they rely on market data (fluctuations of share and options prices to imply
fluctuations in asset values) to predict a market event (default, i.e., the decline in asset values
below the value of a firm's liabilities).
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6.1.5 ORI GI NAL Z-SCORE COMPONENT DEFI NI TI ONS VARI ABLE
DEFI NI TI ON WEI GHTI NG FACTOR
T
1
=Working Capital / Total Assets
T
2
=Retained Earnings / Total Assets
T
3
=Earnings before Interest and Taxes / Total Assets
T
4
=Market Value of Equity / Total Liabilities
T
5
=Sales/ Total Assets
Z Score Bankruptcy Model:
Z =1.2T
1
+1.4T
2
+3.3T
3
+.6T
4
+.999T
5
Zones of Discrimination:
Z >2.99 -“Safe” Zone
1.8
There are 22 stock exchanges in India, the first being the Bombay Stock Exchange (BSE), which began formal trading in 1875, making it one of the oldest in Asia. Over the last few years, there has been a rapid change in the Indian securities market, especially in the secondary market.
Page | 1
I NTRODUCTI ON TO I NDI AN CAPI TAL
MARKET
There are 22 stock exchanges in India, the first being the Bombay Stock Exchange (BSE),
which began formal trading in 1875, making it one of the oldest in Asia. Over the last few
years, there has been a rapid change in the Indian securities market, especially in the
secondary market. Advanced technology and online-based transactions have modernized the
stock exchanges. In terms of the number of companies listed and total market capitalization,
the Indian equity market is considered large relative to the country’s stage of economic
development. The number of listed companies increased from 5,968 in March 1990 to about
10,000 by May 1998 and market capitalization has grown almost 11 times during the same
period.
The debt market, however, is almost nonexistent in India even though there has been a large
volume of Government bonds traded. Banks and financial institutions have been holding a
substantial part of these bonds as statutory liquidity requirement. The portfolio restrictions on
financial institutions’ statutory liquidity requirement are still in place. A primary auction
market for Government securities has been created and a primary dealer system was
introduced in 1995. There are six authorized primary dealers. Currently, there are 31 mutual
funds, out of which 21 are in the private sector. Mutual funds were opened to the private
sector in 1992. Earlier, in 1987, banks were allowed to enter this business, breaking the
monopoly of the Unit Trust of India (UTI), which maintains a dominant position. Before 1992,
many factors obstructed the expansion of equity trading. Fresh capital issues were controlled
through the Capital Issues Control Act. Trading practices were not transparent, and there was a
large amount of insider trading. Recognizing the importance of increasing investor protection,
several measures were enacted to improve the fairness of the capital market. The Securities
and Exchange Board of India (SEBI) was established in 1988.
Despite the rules it set, problems continued to exist, including those relating to disclosure
criteria, lack of broker capital adequacy, and poor regulation of merchant bankers and
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underwriters. There have been significant reforms in the regulation of the securities market
since 1992 in conjunction with overall economic and financial reforms. In 1992, the SEBI Act
was enacted giving SEBI statutory status as an apex regulatory body. And a series of reforms
was introduced to improve investor protection, automation of stock trading, integration of
national markets, and efficiency of market operations. India has seen a tremendous change in
the secondary market for equity. Its equity market will most likely be comparable with the
world’s most advanced secondary markets within a year or two. The key ingredients that
underlie market quality in India’s equity market are:
• Exchanges based on open electronic limit order book;
• Nationwide integrated market with a large number of informed traders and fluency of
short or long positions; and
• No counterparty risk.
Among the processes that have already started and are soon to be fully implemented are
electronic settlement trade and exchange-traded derivatives. Before 1995, markets in India
used open outcry, a trading process in which traders shouted and hand signaled from within a
pit. One major policy initiated by SEBI from 1993 involved the shift of all exchanges to
screen-based trading, motivated primarily by the need for greater transparency. The first
exchange to be based on an open electronic limit order book was the National Stock Exchange
(NSE), which started trading debt instruments in J une 1994 and equity in November 1994. In
March 1995, BSE shifted from open outcry to a limit order book market. Currently, 17 of
India’s stock exchanges have adopted open electronic limit order.
1.1 CAPI TAL MARKET REFORMS AND DEVELOPMENTS
Over the last few years, SEBI has announced several far-reaching reforms to promote the
capital market and protect investor interests. Reforms in the secondary market have focused on
three main areas: structure and functioning of stock exchanges, automation of trading and post
trade systems, and the introduction of surveillance and monitoring systems. Computerized
online trading of securities, and setting up of clearing houses or settlement guarantee funds
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were made compulsory for stock exchanges. Stock exchanges were permitted to expand their
trading to locations outside their jurisdiction through computer terminals. Thus, major stock
exchanges in India have started locating computer terminals in far-flung areas, while smaller
regional exchanges are planning to consolidate by using centralized trading under a federated
structure. Online trading systems have been introduced in almost all stock exchanges. Trading
is much more transparent and quicker than in the past. Until the early 1990s, the trading and
settlement infrastructure of the Indian capital market was poor. Trading on all stock exchanges
was through open outcry, settlement systems were paper-based, and market intermediaries
were largely unregulated. The regulatory structure was fragmented and there was neither
comprehensive registration nor an apex body of regulation of the securities market. Stock
exchanges were run as “brokers clubs” as their management was largely composed of brokers.
There was no prohibition on insider trading, or fraudulent and unfair trade practices. Since
1992, there has been intensified market reform, resulting in a big improvement in securities
trading, especially in the secondary market for equity. Most stock exchanges have introduced
online trading and set up clearing houses/corporations. A depository has become operational
for scrip less trading and the regulatory structure has been overhauled with most of the powers
for regulating the capital market vested with SEBI. The Indian capital market has experienced
a process of structural transformation with operations conducted to standards equivalent to
those in the developed markets. It was opened up for investment by foreign institutional
investors (FIIs) in 1992 and Indian companies were allowed to raise resources abroad through
Global Depository Receipts (GDRs) and Foreign Currency Convertible Bonds (FCCBs). The
primary and secondary segments of the capital market expanded rapidly, with greater
institutionalization and wider participation of individual investors accompanying this growth.
However, many problems, including lack of confidence in stock investments, institutional
overlaps, and other governance issues, remain as obstacles to the improvement of Indian
capital market efficiency.
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I NTRODUCTI ON TO STOCK MARKET
Stock Market is a place where the trading takes place. A place where lots of money is
invested to buy stocks and lots of money is earned while selling stocks. Some people go with
profit and some people carries losses. But still for a trader it’s an everyday game. And in
games there are certain rules and regulations to be followed then only you can’t make
strategies and plans and play the game according to it and win it. For a new trader the first
thing to know about is where to invest, how to invest, how much to invest and win the game
of investment.
2.1 HOW TO I NVEST?
When an investor starts investing in the stocks or the commodity market he has some
prominent exchanges to invest in. Few important ones are as follows:
1. BSE (Bombay Stock Exchange): BSE is the oldest stock exchange in Asia and has the
greatest number of listed companies in the world, with 4700 listed as of August 2007. Here
the trading in stocks takes place. It is located at Dalal Street, Mumbai, India. On 31
December 2007, the equity market capitalization of the companies listed on the BSE was
US$ 1.79 trillion, making it the largest stock exchange in South Asia and the 12th largest in
the world. BSE’s key index is sensex.
2. NSE (National Stock Exchange): It is the largest stock exchange in India in terms of daily
turnover and number of trades, for both equities and derivative trading. NSE has a market
capitalization of around Rs 47, 01,923 crore (7 August 2009) and is expected to become the
biggest stock exchange in India in terms of market capitalization by 2009 end. NSE’s key
index is Nifty.
3. MCX (Multi Commodity Exchange): MCX is an independent commodity exchange
based in India. It was established in 2003 and is based in Mumbai. The turnover of the
exchange for the period Apr-Dec 2008 was INR 32 Trillion. MCX offers futures trading in
Page | 5
Agricultural Commodities, Bullion, Ferrous & Nonferrous metals, Pulses, Oils & Oilseeds,
Energy, Plantations, Spices and other soft commodities
4. NCDEX (National Commodity & Derivatives Exchange Limited): NCDEX is an online
commodity exchange based in India. It was incorporated as a private limited company
incorporated on April 23, 2003 under the Companies Act, 1956. It obtained its Certificate for
Commencement of Business on May 9, 2003. It has commenced its operations on December
15, 2003. NCDEX is a closely held private company which is promoted by national level
institutions and has an independent Board of Directors and professionals not having vested
interest in commodity markets.
2.2 WHAT ARE STOCKS?
Plain and simple, stock is a share in the ownership of a company. Stock represents a claim on
the company's assets and earnings. As you acquire more stock, your ownership stake in the
company becomes greater. Whether you say shares, equity, or stock, it all means the same
thing. When you buy the shares of a company you become one of the many owners of that
much portion of a company. In other words you own a part of the company.
2.3 HOW TO TRADE I N STOCKS?
An investor can open the required accounts (Demat and Trading) with a registered broker
with NSE or BSE (whichever exchange he want to deal with) and start purchasing and selling
the stock of his wish.
2.4 WHAT ARE COMMODI TI ES?
A commodity is some good for which there demand is, but which is supplied without
qualitative differentiation across a market. It is a product that is the same no matter who
produces it. Generally, these are basic resources and agricultural products such as iron ore,
Page | 6
crude oil, coal, ethanol, salt, sugar, coffee beans, soybeans, aluminium, copper, rice, wheat,
gold, silver and platinum in which trading is done throughout the Commodities of the world.
2.5 HOW TO TRADE I N COMMODI TI ES?
For trading in commodities an investor have to open a commodity account with either MCX
or NCDEX (whichever commodity exchange he wants to trade in) and start buying and
selling commodities. But dealing with the stock and the commodity market is nothing less
than solving a complicated problem in mathematics. You have to apply algorithms, use
formulae, study trend and above all analyze the market properly before you actually start
investing. Without all these steps your money will go in waste and you may incur huge
losses. Some of the basic tips for increasing profits and minimizing losses in the stock and the
trading market are:
1. Cut Your Losses
2. Let Your Profits Run
3. Follow the Trend
4. Don`t Overtrade
5. Always Trade Liquid Stocks
6. Keep Positions Small
7. Don`t Buy Something Because it Looks Cheap
8. Take tips and advises from proven experts.
So if you are planning to invest in the stock and the commodity market then see, analyze and
then act. There are many tips providing companies which are giving tips on how and where to
invest your money in the share market. They tell you exactly which stock is beneficial to
invest. They give you ideas about when and what to buy and when to sell. Follow the rules
and you will surely be the winner.
Page | 7
RESEARCH METHODOLOGY
3.1 OBJ ECTI VE:
PRI ME OBJ ECTI VE:
Our project objective is to do fundamental analysis of ten sectors of the Indian
economy based on NSE.
SUBSI DI ARY OBJ ECTI VES:
1.To construct a portfolio on the bases of fundamental analysis of top 20 companies
out of 60 selected companies representing 10 different sectors.
2.To measure performs of virtual portfolio with actual market price.
3.2 TYPE OF RESEARCH
A descriptive research design has been used for the study.
3.3 SAMPLE SI ZE:
Sampling size will be primarily consisting of the top six companies listed in the BSE
or NSE out of selected ten sectors.
3.4 SAMPLI NG UNI T:
Sample unit will be of two companies out of selected six companies of above
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3.5 SAMPLI NG METHOD:
The sampling method will be on the basis of the Fundamental Analysis of the
companies.
3.6 DATA SOURCES:
PRI MARY DATA:
1. BSE
2. NSE
SECONDARY DATA:
1. Annual reports of the companies
2. Ratios
3. Library Research
4. Internet
3.7 EXPECTED CONTRI BUTI ON OF THE STUDY:
The Research will be useful to other students as reference. It will also be useful to Portfolio
managers to see comparison and to know the current situation of the top Indian companies.
3.8 LI MI TATI ONS OF THE STUDY:
• We have not included all the sectors and all industries of Indian stock exchanges.
• We can’t get all companies latest financial reports so we cannot calculate all the ratios
in fundamental analysis.
Page | 9
I NTRODUCTI ON TO
FUNDAMENTAL ANALYSI S
Fundamental analysis is the cornerstone of investing. In fact, some would say that you aren't
really investing if you aren't performing fundamental analysis. Because the subject is so broad,
however, it's tough to know where to start. There are an endless number of investment
strategies that are very different from each other, yet almost all use the fundamentals. The goal
of this tutorial is to provide a foundation for understanding fundamental analysis. It's geared
primarily at new investors who don't know a balance sheet from an income statement. While
you may not be a "stock-picker extraordinaire" by the end of this tutorial, you will have a
much more solid grasp of the language and concepts behind security analysis and be able to
use this to further your knowledge in other areas without feeling totally lost. The biggest part
of fundamental analysis involves delving into the financial statements. Also known as
quantitative analysis, this involves looking at revenue, expenses, assets, liabilities and all the
other financial aspects of a company. Fundamental analysts look at this information to gain
insight on a company's future performance. A good part of this tutorial will be spent learning
about the balance sheet, income statement, cash flow statement and how they all fit together.
But there is more than just number crunching when it comes to analyzing a company. This is
where qualitative analysis comes in - the breakdown of all the intangible, difficult-to-measure
aspects of a company.
4.1 WHAT I S FUNDAMENTAL ANALY SI S?
In this section we are going to review the basics of fundamental analysis, examine how it can
be broken down into quantitative and qualitative factors, introduce the subject of intrinsic
value and conclude with some of the downfalls of using this technique. The Very Basics When
talking about stocks, fundamental analysis is a technique that attempts to determine a
security’s value by focusing on underlying factors that affect a company's actual business and
its future prospects. On a broader scope, you can perform fundamental analysis on industries
Page | 10
or the economy as a whole. The term simply refers to the analysis of the economic well-being
of a financial entity as opposed to only its price movements. Fundamental analysis serves to
answer questions, such as:
• Is the company’s revenue growing?
• Is it actually making a profit?
• Is it in a strong-enough position to beat out its competitors in the future?
• Is it able to repay its debts?
• Is management trying to "cook the books"?
Of course, these are very involved questions, and there are literally hundreds of others you
might have about a company. It all really boils down to one question: Is the company’s stock a
good investment? Think of fundamental analysis as a toolbox to help you answer this
question. Note: The term fundamental analysis is used most often in the context of stocks, but
you can perform fundamental analysis on any security, from a bond to a derivative. As long as
you look at the economic fundamentals, you are doing fundamental analysis. For the purpose
of this tutorial, fundamental analysis always is referred to in the context of stocks.
4.2 FUNDAMENTALS: QUANTI TATI VE AND QUALI TATI VE
You could define fundamental analysis as “researching the fundamentals”, but that doesn’t tell
you a whole lot unless you know what fundamentals are. As we mentioned in the introduction,
the big problem with defining fundamentals is that it can include anything related to the
economic well-being of a company. Obvious items include things like revenue and profit, but
fundamentals also include everything from a company’s market share to the quality of its
management. The various fundamental factors can be grouped into two categories:
quantitative and qualitative. The financial meaning of these terms isn’t all that different from
their regular definitions. Here is how the MSN Encarta dictionary defines the terms:
• Quantitative – capable of being measured or expressed in numerical terms.
Page | 11
• Qualitative – related to or based on the quality or character of something, often as
opposed to its size or quantity.
In our context, quantitative fundamentals are numeric, measurable characteristics about a
business. It’s easy to see how the biggest source of quantitative data is the financial
statements. You can measure revenue, profit, assets and more with great precision. Turning to
qualitative fundamentals, these are the less tangible factors surrounding a business - things
such as the quality of a company’s board members and key executives, its brand-name
recognition, patents or proprietary technology.
4.3 QUANTI TATI VE MEETS QUALI TATI VE
Neither qualitative nor quantitative analysis is inherently better than the other. Instead, many
analysts consider qualitative factors in conjunction with the hard, quantitative factors. Take the
Coca-Cola Company, for example. When examining its stock, an analyst might look at the
stock’s annual dividend payout, earnings per share, P/E ratio and many other quantitative
factors. However, no analysis of Coca-Cola would be complete without taking into account its
brand recognition. Anybody can start a company that sells sugar and water, but few companies
on earth are recognized by billions of people. It’s tough to put your finger on exactly what the
Coke brand is worth, but you can be sure that it’s an essential ingredient contributing to the
company’s ongoing success.
4.4 THE CONCEPT OF I NTRI NSI C VALUE
Before we get any further, we have to address the subject of intrinsic value. One of the
primary assumptions of fundamental analysis is that the price on the stock market does not
fully reflect a stock’s “real” value. After all, why would you be doing price analysis if the
stock market were always correct? In financial jargon, this true value is known as the intrinsic
value.
Page | 12
For example, let’s say that a company’s stock was trading at Rs.20. After doing extensive
homework on the company, you determine that it really is worth Rs.25. In other words, you
determine the intrinsic value of the firm to be Rs.25. This is clearly relevant because an
investor wants to buy stocks that are trading at prices significantly below their estimated
intrinsic value. This leads us to one of the second major assumptions of fundamental analysis:
in the long run, the stock market will reflect the fundamentals. There is no point in buying a
stock based on intrinsic value if the price never reflected that value. Nobody knows how long
“the long run” really is. It could be days or years.
This is what fundamental analysis is all about. By focusing on a particular business, an
investor can estimate the intrinsic value of a firm and thus find opportunities where he or she
can buy at a discount. If all goes well, the investment will pay off over time as the market
catches up to the fundamentals.
The big unknowns are:
1) You don’t know if your estimate of intrinsic value is correct; and
2) You don’t know how long it will take for the intrinsic value to be reflected in the
marketplace.
4.5 CRI TI CI SMS OF FUNDAMENTAL ANALYSI S
The biggest criticisms of fundamental analysis come primarily from two groups: proponents of
technical analysis and believers of the “efficient market hypothesis”. Technical analysis is the
other major form of security analysis. We’re not going to get into too much detail on the
subject.
Put simply, technical analysts base their investments (or, more precisely, their trades) solely
on the price and volume movements of securities. Using charts and a number of other tools,
they trade on momentum, not caring about the fundamentals. While it is possible to use both
techniques in combination, one of the basic tenets of technical analysis is that the market
discounts everything. Accordingly, all news about a company already is priced into a stock,
Page | 13
and therefore a stock’s price movements give more insight than the underlying fundamental
factors of the business itself.
Followers of the efficient market hypothesis, however, are usually in disagreement with both
fundamental and technical analysts. The efficient market hypothesis contends that it is
essentially impossible to produce market-beating returns in the long run, through either
fundamental or technical analysis. The rationale for this argument is that, since the market
efficiently prices all stocks on an ongoing basis, any opportunities for excess returns derived
from fundamental (or technical) analysis would be almost immediately whittled away by the
market’s many participants, making it impossible for anyone to meaningfully outperform the
market over the long term.
4.6 QUALI TATI VE FACTORS - THE COMPANY
Before diving into a company's financial statements, we're going to take a look at some of the
qualitative aspects of a company.
Fundamental analysis seeks to determine the intrinsic value of a company's stock. But since
qualitative factors, by definition, represent aspects of a company's business that are difficult or
impossible to quantify, incorporating that kind of information into a pricing evaluation can be
quite difficult. On the flip side, as we've demonstrated, you can't ignore the less tangible
characteristics of a company.
In this section we are going to highlight some of the company-specific qualitative factors that
you should be aware of.
4.6.1 BUSI NESS MODEL
You should understand the business model of any company you invest in. The "Oracle of
Omaha", Warren Buffett, rarely invests in tech stocks because most of the time he doesn't
understand them. This is not to say the technology sector is bad, but it's not Buffett's area of
expertise; he doesn't feel comfortable investing in this area. Similarly, unless you understand a
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company's business model, you don't know what the drivers are for future growth, and you
leave yourself vulnerable to being blindsided like shareholders of Boston Chicken were.
4.6.2 COMPETI TI VE ADVANTAGE
Another business consideration for investors is competitive advantage. A company's long-term
success is driven largely by its ability to maintain a competitive advantage - and keep it.
Powerful competitive advantages, such as Coca Cola's brand name and Microsoft's domination
of the personal computer operating system, create a moat around a business allowing it to keep
competitors at bay and enjoy growth and profits. When a company can achieve competitive
advantage, its shareholders can be well rewarded for decades.
4.6.3 MANAGEMENT
J ust as an army needs a general to lead it to victory, a company relies upon management to
steer it towards financial success. Some believe that management is the most important aspect
for investing in a company. It makes sense - even the best business model is doomed if the
leaders of the company fail to properly execute the plan. So how does an average investor go
about evaluating the management of a company? This is one of the areas in which individuals
are truly at a disadvantage compared to professional investors. You can't set up a meeting with
management if you want to invest a few thousand dollars. On the other hand, if you are a fund
manager interested in investing millions of dollars, there is a good chance you can schedule a
face-to-face meeting with the upper brass of the firm. Every public company has a corporate
information section on its website. Usually there will be a quick biography on each executive
with their employment history, educational background and any applicable achievements.
Don't expect to find anything useful here. Let's be honest: We're looking for dirt, and no
company is going to put negative information on its corporate website.
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4.6.4 CORPORATE GOVERNANCE
Corporate governance describes the policies in place within an organization denoting the
relationships and responsibilities between management, directors and stakeholders. These
policies are defined and determined in the company charter and its bylaws, along with
corporate laws and regulations. The purpose of corporate governance policies is to ensure that
proper checks and balances are in place, making it more difficult for anyone to conduct
unethical and illegal activities.
4.7 QUALI TATI VE FACTORS - THE I NDUSTRY
Each industry has differences in terms of its customer base, market share among firms,
industry-wide growth, competition, regulation and business cycles. Learning about how the
industry works will give an investor a deeper understanding of a company's financial health.
4.7.1 CUSTOMERS
Some companies serve only a handful of customers, while others serve millions. In general,
it's a red flag (a negative) if a business relies on a small number of customers for a large
portion of its sales because the loss of each customer could dramatically affect revenues. For
example, think of a military supplier who has 100% of its sales with the U.S. government. One
change in government policy could potentially wipe out all of its sales. For this reason,
companies will always disclose in their 10-K if any one customer accounts for a majority of
revenues.
4.7.2 MARKET SHARE
Understanding a company's present market share can tell volumes about the company's
business. The fact that a company possesses an 85% market share tells you that it is the largest
player in its market by far. Furthermore, this could also suggest that the company possesses
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some sort of "economic moat," in other words, a competitive barrier serving to protect its
current and future earnings, along with its market share. Market share is important because of
economies of scale. When the firm is bigger than the rest of its rivals, it is in a better position
to absorb the high fixed costs of a capital-intensive industry.
4.7.3 I NDUSTRY GROWTH
One way of examining a company's growth potential is to first examine whether the amount of
customers in the overall market will grow. This is crucial because without new customers, a
company has to steal market share in order to grow. In some markets, there is zero or negative
growth, a factor demanding careful consideration. For example, a manufacturing company
dedicated solely to creating audio compact cassettes might have been very successful in the
'70s, '80s and early '90s. However, that same company would probably have a rough time now
due to the advent of newer technologies, such as CDs and MP3s. The current market for audio
compact cassettes is only a fraction of what it was during the peak of its popularity.
4.7.4 COMPETI TI ON
Simply looking at the number of competitors goes a long way in understanding the
competitive landscape for a company. Industries that have limited barriers to entry and a large
number of competing firms create a difficult operating environment for firms. One of the
biggest risks within a highly competitive industry is pricing power. This refers to the ability of
a supplier to increase prices and pass those costs on to customers. Companies operating in
industries with few alternatives have the ability to pass on costs to their customers. A great
example of this is Wal-Mart. They are so dominant in the retailing business, that Wal-Mart
practically sets the price for any of the suppliers wanting to do business with them. If you want
to sell to Wal-Mart, you have little, if any, pricing power.
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4.7.5 REGULATI ON
Certain industries are heavily regulated due to the importance or severity of the industry's
products and/or services. As important as some of these regulations are to the public, they can
drastically affect the attractiveness of a company for investment purposes. In industries where
one or two companies represent the entire industry for a region (such as utility companies),
governments usually specify how much profit each company can make. In these instances,
while there is the potential for sizable profits, they are limited due to regulation.
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ECONOMY ANALYSI S
5.1 ECONOMI C CYCLE
Countries go through the business or economic cycle and the stage of the cycle at which a
country is in has a direct impact both on industry and individual companies. It affects
investment decisions, employment, demand and the profitability of companies.
The four stages of an economic cycle are:
• Depression
• Recovery
• Boom
• Recession
DEPRESSI ON
At the time of depression, demand is low and falling. Inflation rate is high and so are interest
rates in the market. Companies, crippled by high borrowing and falling sales, are forced to
curtail production, close down plants built at times of higher demand, and let workers go. The
whole economy gets ruined during this period. All the well established companies’ turns from
profitable trend to the loss making companies and the companies in the developing stage goes
into the liquidation.
RECOVERY
During this phase, the economy begins to recover. Investment begins a new and the demand
grows. Companies begin to post profits. Conspicuous spending begins once again. Once the
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recovery stage sets in fully, profits begin to grow at a higher proportionate rate. More and
more new companies are floated to meet the increasing demand in the economy. Companies
which were well established and were earning losses starts making profits again and the
economy starts regaining its position. If this is the case in some particular industry than many
new companies are also attracted towards this industry and the economy starts growing and
this stage and achieves the targeted growth slowly and gradually.
BOOM
During this phase of economy the demand of the stock reaches at an all time high. Investment
is also high. Interest rates are low. There is a great demand of the stock in the market. But,
gradually as time passes, the company tries to increase the supply o the stock in the market.
So, when supply begins to exceed the demand prices that had been rising begin to stabilize
and even fall. Slowly and gradually the market stabilizes and the boom phase matures and
prices also get stabilized with the changing situations of the market.
RECESSI ON
In the recession phase the economy slowly begins to downturn. Demand starts falling.
Interest rates and inflation rate is too high. Companies start finding it difficult to sell their
goods. The overall industry suffers a lot during this phase of the economy. The recession is
due to various reasons. No particular reason can be mentioned as such. The well established
companies also have to suffer a lot due to recession period. The market price of all the goods
of almost all the industries falls to a great extent.
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5.2 GLOBAL ECONOMY
The global economy refers to the increasing integration of fragmented national markets for
goods and services into a single global market. In such a market, companies may source from
one country, conduct research and development in another country and then takes orders in a
third country, and sells wherever there is existence of demand regardless of the customer’s
nationality.
GLOBAL ECONOMY SCENARI O
According to the report of the Business Economics and Public Policy, the economic growth
around the globe remained strong in 2008 despite the current credit crisis in the USA. The
IMF has projected the world economic growth to reach 4.8 percent in 2009. The emerging
economies i.e. China and India have an important role in the global economy. The stresses in
U.S. financial markets that first emerged in the summer of 2007 transformed themselves into
a full-blown global financial crisis in the fall of 2009.
Banks purchased vast quantities of loans used for house purchases in the United States. As
interest rates were increased in 2006 and 2007 in that country, many of those debtors began
to default, putting at risk the value of all the housing loans. This uncertainty has resulted in
the share prices of financial and non financial companies falling, affecting lending operations
between the banks. Financial institutions involved in property, and investment banks failed,
while other institutions experienced increasingly large losses on their investments in the
housing markets.
As the crisis intensified, the effects of financial turmoil on developing countries increased I
step, as risk aversion sent spreads soaring, equity markets tumbling, exchange rates falling
and capital flows into decline. In this situation, growth prospects for both high income
developing countries have deteriorated substantially, and a movement of global growth from
2.5 percent in 2008 to 0.9 percent in 2009.
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The potential risk to the global economy is high oil prices, currency instability and high ratios
of inflation. It is predicted that turmoil in the global financial markets affects the economic
growth around the world.
POTENTI AL ECONOMI C AND FI NANCI AL RI SKS
The potential risks to the global economy are high oil prices and high ratios of inflation. It is
predicted that turmoil in the global financial markets affects the economic growth around the
world. Weaker growth in the United States will have spill-over effects on trade and weaken
the economies of its trading partners and especially the emerging and under developed
countries. There are still global imbalances: between U.S. budget and current account deficits
and the accumulation of huge foreign currency reserves by Asian central banks remain the
potential risks to the global economy in 2008. It is clear that rising food and oil prices are
secondary risks for the world economy as they will be further inflated by the disruption in the
global financial market. Some of the reasons due to which crisis can last for a longer period
are as follows:
The credit a squeeze: It is a slow-burning crisis that is going to take a long time to unfold,
having an adverse impact on economic growth for years to come.
Housing collapse: The bubble in the residential property markets of the US and other rich
countries has only just started to deflate, and has much further to go.
Inflation: Years of reckless money creation by central banks, supply/demand imbalances
have driven up the prices of key resources such as oil. The fading impacts of unusually-high
tech-driven productivity gains, and shortages of high level skills in many sectors such as
global mining and Chinese manufacturing, are combining to bring back the inflation problem.
Currency instability: The US needs to attract an extra $3 billion in foreign capital every
business day to finance its foreign trade deficit. If foreign governments, institutions and
private investors become less willing to provide that capital, the dollar will remain under
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pressure; continue falling in value in terms of other currencies which would be set back to
many developing countries and emerging market economies in the world.
Cheap money: The greater the risk of global recession and of deflation, the more central
banks will force down short-term interest rates to combat that risk. In J apan the Central Bank
offered credit to commercial banks at virtually no cost.
World trade: The progress of globalization would not cease because of lower growth in the
world economy, even though progress will be slowed somewhat by rising protectionism in
the developed nations, where whole swathes of job classes are under increasing pressure from
foreign competition.
5.3 I NDI AN ECONOMY
I NDUSTRI AL PRODUCTI ON
The data on the industrial production shows initial indications of improvement. The overall
index of industrial production after registering a growth of 10.3 percent in October 2009
witnessed an even higher growth of 11.7 percent in November 2009.
Further the classifications of the industrial production shows the manufacturing and mining
sectors register growths of 12.7 percent and 10.0 percent respectively in November 2009.
Growth in the electricity sector was also seen to grow by 3.3 percent compared to the growth
recorded in the previous year.
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CORE I NFRASTRUCTURE
The overall index of six core infrastructure industries registered a growth of 6.0 percent in
December 2009, which was 5.3 percentages higher than the growth recorded in the same
month of previous year.
The crude oil production after registering negative growth for five consecutive months,
witnessed a growth of 1.1 percent in December 09. Once again cement and finished steel
segments were best performers, with respective growths of 11.0 percent and 9.6 percent.
The coal and petroleum sectors remained laggards. The growth in coal production was 2.5
percent in December 09 much lower than the growth of 11.2 percent in the same month of
previous year. Similarly petroleum refinery segment registered 0.9 percent growth in
December 2009 as against a high growth of 3.0 percent recorded in corresponding month of
08.
Inflation
The skyrocketing food prices resulted into flaring of overall inflation; this continues to be a
major concern. The rate of inflation was increased by almost 2 percentages. This is changed
from 5.5 percent in November 09 to 7.3 percent in December 09. This was also higher than
the inflation rate of 6.2 percent recorded in December 2008.
In December 2009 the inflation rate for three broad segments – primary articles, fuel
lubricants and light and manufactured products was 14.9 percent, 4.3 percent and 5.2 percent
respectively.
Monetary Indicators
The broad money supply expanded by 10.9 percent during the April-December period of
2009-10. The corresponding growth during the previous fiscal was 12.4 percent.
The aggregate deposits increased by 9.8 percent during April-December period of 2009 10.
The growth during the first three quarters of 2008-09 was 11.7 percent. (Calculated from
March end up to the December)
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The bank credit went by 7.0 percent over the period April to December 2009-10, while the
growth in corresponding period of the last fiscal was 12.1 percent.
Stock Market Trends
High investment activity was seen in the stock market after the economic fundamentals
gained strength. The stock market remained bullish in the month of December 09 with BSE
Sensex closing at over 17k points by month end.
Fiscal Trends
The gross tax revenue collections during the period April-December 2009-10 amounted to Rs
4, 16, 094 crore a drop by 2.5 percent from Rs 4, 26,795 crore revenue collections over the
same period last fiscal. While income from the direct sources of tax revenue, i.e. income and
corporate tax increased however, collections from indirect sources witnessed a fall. Over the
period, April-December 2009-10 the growth in revenue from income tax was 12.2 percent
and in case of corporate tax it was 16.8 percent.
Growth in the custom duty, excise duty and service tax collections, on the other hand, was
negative 29.2 percent, (-) 18.2 percent and (-) 5.9 percent respectively.
The revenue receipts of the government witnessed a marginal increase, from Rs 3, 75,937
core in April- December 2008-09 to Rs 3, 89,271 crore during the same period this financial
year. With an additional expenditure of Rs 1,10, 324 crore during the period April-December
2009-10 vis-à-vis same period last year, the total expenditure saw an increase of 18.5 percent.
The resultant fiscal deficit over the corresponding period was Rs 3, 09, 980 crore.
Foreign Trade
The growth in the merchandise exports sector turned positive in November 2009 after a
thirteen-month period of decline. The growth recoded in December 2009 was relatively lower
than the growth seen in the previous month. In December 2009 the exports registered a
growth of 9.3 percent, as against the growth of 18.2 percent registered in November 2009.
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The imports also registered a positive growth after being in the negative territory for straight
eleven months of 2009 since J anuary. The imports grew by 27.2 percent in December 2009.
Oil imports grew by 42.8 percent, while non-oil imports increased by 22.4 percent.
Foreign Investments
Foreign direct investment of USD 1.7 billion was received in November 2009 as against the
inflows of USD 2.3 billion in the previous month. There was a decline in the portfolio
investments as well in November 09 vis-à-vis inflows in the previous month. The cumulative
investment inflows over the period April-November 2009-10 amounted to USD 47.1 billion.
Foreign Exchange Reserves
The forex reserves accumulated in November 2009 was USD 286.7 billion. Last year the
reserves had fallen to USD 247.6 billion in the same month.
Exchange Rate
The rupee witnessed slight appreciation in the month of J anuary 2010 vis-à-vis the USD. The
Rupee Dollar exchange rate which averaged Rs 46.6/USD in the month of December 2009
was at Rs 45.9/USD in J anuary 2010.
5.4 I NVESTMENT DECI SI ON
Investors should attempt to determine the stage of the economic cycle of the country. They
should invest at the end of a depression when the economy begins to recover. Investors
should disinvest either just before or during the boom, or, at the worst, just after the boom.
Investment and disinvestments made at these times will earn the investor greater benefits.
Here, as the economy is in recession stage, investors should disinvest their holdings in
cyclical industries and switch to growth or evergreen industries.
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COMPANY ANALYSI S
The company analysis is done on base of fundament analysis which is done on the bases of:
• Edward Altman’s Z score
• Ratios
• Earnings Per Share
• Book Value
• Market Capitalization
• Promoters’ Shareholding Pattern
6.1 EDWARD ALTMAN’ S Z SCORE
The Z-score formula for predicting bankruptcy was published in 1968 by Edward I.
Altman. He was then an Assistant Professor of Finance at New York University, and, in
2009, is still a professor at NYU, now as a long-tenured one. The Z-score is a formula
involving multiple variables that measures the financial health of a company. The formula
may be used to predict the probability that a firm will go into bankruptcy within two years. Z-
scores are still used occasionally as an easy-to-calculate control measure for the financial
distress status of companies in academic studies about other topics.
6.1.1 ESTI MATI ON OF THE FORMULA
The Z-score is a linear combination of four or five common business ratios, weighted by
coefficients that were estimated by Altman's application of the statistical method of
discriminate analysis to a dataset of publicly held manufacturers. Altman first identified a set
of firms which had declared bankruptcy, and he then collected a matched sample of firms
which had survived, with matching by industry and approximate size (assets).
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The estimation was originally based on data from publicly held manufacturers, but has since
been re-estimated based on other datasets for private manufacturing, non-manufacturing and
service companies.
The original data sample consisted of 66 firms, half of which had filed for bankruptcy under
Chapter 7. All businesses in the database were manufacturers and small firms with assets of
70% reliability (Eidleman). What is usually meant by accuracy is the percentage of
firms that are classified correctly, within the estimation sample, when the Z-score values for
firms are translated into yes/no predictions for whether each turns out to be bankrupt.
Because the parameters of the model are estimated based on the same sample, and because
the sample itself is not randomly selected, it is not reasonable to project that the formula will
achieve similar accuracy when applied for making predictions about other firms.
From about 1985 onwards, the Z-scores gained wide acceptance by auditors, management
accountants, courts, and database systems used for loan evaluation (Eidleman). The formula's
approach has been used in a variety of contexts and countries, although it was designed
originally for publicly held manufacturing companies with assets of more than $1 million.
Later variations by Altman take into account the book value of privately held shares, and the
fact that turnover ratios vary widely in non-manufacturing industries.
The Altman Z-Score model is not recommended for use with financial firms; because these
firms often have off-balance sheet liabilities that aren't captured by the financial statement
data used in the Altman Z-Score model. There are market-based formulas used to predict the
default of financial firms (such as the Merton Model), but these have limited predictive value
because they rely on market data (fluctuations of share and options prices to imply
fluctuations in asset values) to predict a market event (default, i.e., the decline in asset values
below the value of a firm's liabilities).
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6.1.5 ORI GI NAL Z-SCORE COMPONENT DEFI NI TI ONS VARI ABLE
DEFI NI TI ON WEI GHTI NG FACTOR
T
1
=Working Capital / Total Assets
T
2
=Retained Earnings / Total Assets
T
3
=Earnings before Interest and Taxes / Total Assets
T
4
=Market Value of Equity / Total Liabilities
T
5
=Sales/ Total Assets
Z Score Bankruptcy Model:
Z =1.2T
1
+1.4T
2
+3.3T
3
+.6T
4
+.999T
5
Zones of Discrimination:
Z >2.99 -“Safe” Zone
1.8