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Analyzing and Evaluating Investment Opportunities

VIEWS: 159 PAGES: 23

Investors must make intelligent judgments about the current state of the financial markets & possible changes. A logical starting point in assessing the stock market is to understand the economic factors that affect stock prices. Understanding the current & future state of the economy is the first step in understanding what is happening & what is likely to happen to the market. Because of the market’s impact on investor’s success, investors should seriously consider the market’s likely direction over some future period.

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									2012



   Investment
   Analyzing and Evaluating Investment Opportunities
   Investors must make intelligent judgments about the current state of the financial
   markets & possible changes. A logical starting point in assessing the stock market is to
   understand the economic factors that affect stock prices. Understanding the current &
   future state of the economy is the first step in understanding what is happening & what
   is likely to happen to the market. Because of the market’s impact on investor’s success,
   investors should seriously consider the market’s likely direction over some future
   period.




                                                                         ovirashi
                                                                           Basha
                                                                        1/1/2012
    CONTENTS

Investment & Investors Defined
Investment Areas
Investment Instruments
Company Selection
Risk-Return Analysis
Investors Focus Point
How To Trade
Market Efficiency
Market Analysis
Fundamental Analysis
Technical Analysis
Economy Analysis
Choosing a Right Broker
How to Open an account
Evaluating Market Condition
Recommendations for New Investors
Appendix
Investment:

An investment is the current commitment of dollars for a period of time in order to derive
future payments that will compensate the investor for :

               The time the funds are committed
               The expected rate of inflation
               The uncertainty of the future payments

Investor

The investor can be an individual, a government, a pension fund or a corporation.
Investors trade with the intention to earn some future rate of return out of his investment
which will provide a future stream of payments that will be greater than the current
outlay.

Major Factors:

There are two major factors that drive the motive of investors. These are:

               Required rate of return
               Risk associated with the investment

Any investor must analyze properly these two factors before investing in any sector.

Investment areas:

There are financial markets where all the investments take place. These markets offer
different investment instruments for the investors.

There are several types of markets for investment:

               Primary market
               Secondary Market
               Third Market
               Fourth Market
               Over the counter market

These markets are familiar for any kinds of investment related trading. These are the core
places for any investment to take place.
Types Of Investment Instruments

There are basically two types of investment instruments. These are:

               Money market instruments
               Capital market instruments

Among all these instruments followings are most popular

               Shares
               Bonds/Debentures
               Mutual Funds

Shares

Shares represents small portion of ownership of an entity. Stocks or shares are the core
instruments offered by a company to raise capital. Each share has a par value & a face
value which is comparable with it’s market value. The difference in value indicates the
position of a share in the stock market.

Investors invest in shares in order to get some future benefit which is termed as dividend.
Besides bonus shares are also lucrative offers of a share issue.

Bonds/Debentures

Bonds are long term debt instruments representing a contractual obligation on the part of
the issuer to pay interest and repay principal.

On the other side, debentures are unsecured bonds backed by the general credit of a
company.

Mutual Funds

The popular name for open end investment companies which continually stand ready to
sell new shares to public and to redeem their own outstanding shares on demand at a
price equal to an appropriate share of the value of their portfolio which is computed daily
at the close of the market.

These are usually investment companies i.e. financial intermediaries that sell shares to the
public and invests the proceeds in a diversified portfolio of securities.

Each share sold represents a proportionate interest in the portfolio of securities managed
by the investment company on behalf of the company’s shareholders.
Choosing Investment Instrument

For investing among shares, bonds and mutual funds, I would suggest for mutual funds
for investing for the first time.

The favorable reasons behind choosing the option are stated below:

Portfolio of shares

As mutual funds consists of portfolio of shares, there is diversion of risk observed.

Risk analysis

The risks are analyzed properly in order to make a diversified portfolio. It tries to
minimize the unsystematic risks for the investors.

Flexibility

There is flexibility to sell & redeem the shares at investors option.

Net Asset Value

The share price of mutual funds are based on net asset value per share.

Share Price

The share prices are quoted on a bid-offer basis which is a good practice.

Selling Shares

The investors can sell their share any time with a small fee to the company. This is
known as back-end load funds

Classification

For the privilege of the investors, there are two types of securities: Class A & Class B.
Class A is for short time holding of investments & Class B is for long term investments.

Thus, a mutual fund can be a good choice for investors who are investing for the first
time.
Company Selection

The selection of a company for making investment decision is a prime factor for the
investors.

Followings are some basic factors that works behind company selection:

CAMEL Rating

The CAMEL rating of a company is a good indicator to rate a company. The CAMEL
Stands for:

               C= Capital Adequacy
               A= Asset Quality
               M= Management efficiency
               E= Earning Profit
               L= Liquidity position

The ratings vary with a range from 1 to 5 with a mark up through strong to
dissatisfactory.

                        Rating           Grade
                        1 to 1.4         Strong
                       1.5 to 2.4     Satisfactory
                       2.5 to 3.4      Moderate
                       3.5 to 4.4         Low
                        4.5 to 5     Dissatisfactory


Financial Statement Analysis

The analysis of financial statement is very important issue for the investors. Followings
are some important points to be taken care of :

               Analysis of Time Series Data
               Analysis of Cross Sectional Data
               Analysis of Different Ratios
               Analysis of Profit & Net Income Trend
               Feasibility of investment areas
               Analysis of Debt portion
               Analysis of Asset-Liability Management & Balance
               Liquidity position
               Dividends
               Net rate of return
               EPS
Prospectus Analysis

Incase of investing in an IPO issue, investors must properly go through the prospectus
issued by the company. The major issues include:

               Objective
               Company fact description
               History
               Manager background
               Financial statements
               Risks & return analysis

Company prospects:

For investing in existing company, following issues must be taken care of:

               Minimum paid up capital Tk 10 million
               The company must be a registered public limited company
               Shares to be subscribed by a minimum of 250 no.s of shareholders

Some other related factors are:

               Efficiency
               Leverage
               Profit Margin
               Use of Proceeds
               Operating History
               Operating Base
               Management
               Product differentiation
               Single vs. multi product


Stock Price Index:

To measure the market position of shares, there are several indices in operation. These
indices rate the companies according to their performance. These are stock market
indicators.

Some popular indices are:

               Dow Jones Industrial Average
               Standard & Poor’s 500 composite index
               DSE & CSE index
Category wise Company Selection:

There are four types of company category which determines the position of a company
based upon it’s performance. It also indicates financially sound & strong company.

The categories are:

               A category companies
               B category companies
               Z category companies
               G category companies

A category companies:

Companies which are regular in holding the current annual general meetings & have
declared dividend at the rate of ten percent or more in the last financial year.

B category companies

Companies which are regular in holding the annual general meeting but have failed to
declare dividend at least at the rate of ten percent in the last English calendar year

Z category companies

Companies which failed to hold the current annual general meetings or have failed to
declare any dividend or which are not in operation for more than six months or whose
accumulated loss after adjustments of revenue reserve, if any, is negative and exceeded
its paid up capital

G category companies

Newly listed shares of those companies, which do not fall under any of the categories,
shall be placed under G category companies for which the settlement procedure followed
for B category companies shall be applicable.

Investors who wish to take risk can invest in B,C or G category shares.
Investors who wish to get stable return can invest in A category companies’ shares.
Risk-Return Analysis

Required Rate of Return:

The minimum expected return on asset that an investor requires before investing

Risk:

The chance that the actual return on an investment will be different from the expected
return

Any investor must trade-off between the risk & return in order to ensure his future return
with a positive cash flow stream.

Determinants of required rate of return

Followings are some determinants of required rate of return:

        The real risk free rate
        Inflation
        Conditions in the capital market
        Investors attitude ( risk averse or risk taker )

Risk Components: Measures & Sources

The basic return for undertaking risk is denoted as ― Risk premium‖. Risk premium
considers the following things. These are termed as sources of risk:

        Business Risk
        Financial Risk
        Liquidity Risk
        Exchange Rate Risk
        Country Risk

The major measures of risk are:

        Variance of rates of return
        Standard Deviation of Rates of return
        Coefficient of Variation of rates of return
        Covariance of returns with the market portfolio

Any investor must take care of these issues when he tends to invest. The investment
company or the brokers can help him to assess the position
Relationship Between Risk and Return

The expected relationship between risk and return is a positive relationship. The more the
risk the more the return. The relationship shows that investors increase their required
rates of return as perceived risk ( uncertainty ) increases. The line that reflects the
combination of risk & return available on alternative investments is referred to as the
security market line (SML).

The SML reflects the risk-return combinations available for all risky assets in the capital
market at a given time. Investors should select investments that are consistent with their
risk preferences, some would consider only low-risk investments whereas others
welcome high-risk investments.

Fundamental Risk Analysis:

There are two major risks associated with every investment. They are:

       Systematic Risk
       Unsystematic Risk

Systematic Risk:

The market risk associated with investment which cannot be avoided or ignored.

Unsystematic Risk:

The risks associated with investments which can be minimized with a portfolio
investment option but cannot be eliminated.

Any investor must measure these two risks & also evaluate the risk-return analysis to get
the maximum future outflow.


                         Unsystematic
                        (Diversifiable)            Standard
                             Risk                 Deviation of
                                                    Market
    Total                                          Portfolio
    Risk
                        Systematic
                           Risk
Investor’s Focus Points

Any investor should concern about the following matters:

       When to buy
       When to sell
       Which Instrument
       What Amount &
       How to trade

When to Buy & Sell:

When the market predicts that the prices of shares will go up then it is right time to buy
shares so that these can be sold at high prices afterwards.

When the market predicts that the prices of shares will go down then it is right time to
sell shares so that afterwards these share price may call for loss.

Amount:

The investors must identify the total number of shares that he wants to buy or sell. It may
be a bulk of shares or may be a small lot depending on investors investment opportunity
& also if the brokers advice them to do so.

Instrument:

Investors may invest in following types of categories:

       IPO
       Private Placement

How to Trade

Investors must draw a proper track about how he will make his investments. There are
few possible ways regarding this matter:

       Margin Trading
       Short Sale
       Own Investment
Margin Trading:

Margin trading is a way to make investment in stocks or securities through the financial
help of the broker. Here only a portion of the investment proceed comes from investors’
own money.

The remaining portion is borrowed from a broker. Followings are some features of
margin trading:

Method:

               Bet on a rise in the price of the security
               Higher leverage, magnifying upside & down side risks

Collateral:

Stocks purchased on margin must be maintained with the broker as collateral for the loan

Initial Margin:

The percentage of stock value that must be maintained with the broker

Maintenance Margin:

Minimum amount of equity maintained in the account.

Margin Call:

Call from a broker to put up more equity funds when exceeds minimum balance. Margin
arrangements differ for different securities.

Margin control:

The broker controls how much equity must be maintained by margin traders. The
equation is:

Equity = ( Total value of investment – Amount borrowed ) /Total Value of Investment

Here, High volatility stocks may not be marginable.
Short Sale

Short Sale is a way to make investment in stocks or securities through the borrowing of
securities with the help of the broker when a decline in price is estimated. Here only a
portion of the securities are supplied by the seller.

The remaining portion of securities are borrowed from a broker.

Followings are some features of short sale:

Method:

               Bet on a decline in the price of the security
               Higher leverage, magnifying upside & down side risks

Collateral:

The proceeds from the short sale must be maintained with the broker as collateral for the
loan

Mechanism:

               Borrow stocks from a broker
               Sell it, deposit the proceeds and margin money in an account
               Close out the position by buying the securities & returning it to the lender
               Short seller must pay any dividend paid during the short sale to the lender
               of the stock

Own Investment

Investors can make their own investment with full of their money. But there are several
risks associated with this kind of investment. Investors must take proper & expertise
advice incase of such investments.
Market Efficiency:

Efficient Market

A market in which the prices of securities fully reflect all known information quickly and
on average accurately. The concept postulates that investors will assimilate all relevant
information into prices in making their buy & sell decisions.

When Market is Efficient?

An efficient market exists when the following events occur:


       A large number of rational, profit maximizing investors exist who actively
       participate in the market by analyzing, valuing and trading stocks. These investors
       are price takers; that is one participant alone cannot affect the price of a security.

       Information is costless and widely available to market participants at
       approximately the same time

       Information is generated in a random fashion such that announcements are
       basically independent of one another

       Investors react quickly & fully to the new information, causing stock prices to
       adjust accordingly.


Forms Of Market Efficiency

Market efficiency can be of different types. Depending on Efficient Market Hypothesis
(EMH) and market data analysis market efficiency can be of following forms:

       Weak Form
       Semi Strong
       Strong

There are evidences related to market sectors which helps to indicate the form of market
efficiency.
Market Analysis

Market analysis consists of following three major analysis. These are:

               Fundamental Analysis
               Technical Analysis
               Economy Analysis

Fundamental Analysis

The idea that a security has an intrinsic value at any time, which is a function of
underlying economic variables.

Fundamental Analysis at the company level involves analyzing basic financial variables
in order to estimate the company’s intrinsic value. These variables include:

       Sales
       Profit Margin
       Depreciation
       The tax rate
       Sources of financing
       Asset utilization
       Other Factors

Additional Analysis could involve the firm’s the firm’s competitive position and so on.
The end result of fundamental analysis at the company level is the data needed to
estimate the price of a stock using one of the valuation models.

In fundamental analysis ―intrinsic value‖ is an important consideration. Intrinsic value or
estimated value of a stock is its justified price, or the price supported by a company’s
fundamental financial variables.

Alternatively, for a short run estimate of intrinsic value the earnings multiplier model
could be used . Intrinsic value is the product of the estimated earnings per share(EPS) for
the next year and the estimated multiplier or P/E ratio. The equation for finding out the
intrinsic value:

Intrinsic Value = Po = Estimated EPS * Justified P/E Ratio
                     = E1 * Po / E1

If the intrinsic value is larger than the current market price, then the stock is undervalued.
Thus investors should buy at this time. If the intrinsic value is less than the current
market price, then the stock is overvalued. Thus investors should sell at this time.
Technical Analysis

The methodology of forecasting fluctuations in the prices of securities whether individual
securities or the market as a whole. Technical analysis can be defined as the use of
specific market generated data for the analysis of both the aggregate stock market and
individual stocks. It is sometimes called market or internal analysis because it utilizes the
record of the market itself to attempt to assess the demand for and supply of shares of a
stock or the entire market. Thus, technical analysis believe that for market forecasts the
market itself is its own best source of data.

Technical analysis assumes that prices are determined by the interaction of demand and
supply and reflect the net optimism of market participants. The followings are some key
points of technical analysis:

       Technical analysis is based on published market data and focuses on internal
       factors by analyzing movements in the market or a stock. In contrast, fundamental
       analysis focuses on economic and political factors which are external to the
       market itself.

       The focus of technical analysis is timing. Stock prices tend to move in trends as
       the stock price adjusts to a new equilibrium level. These trends can be analyzed
       and changes in trends detected by studying the action of price movements and
       trading volume across time. The emphasis is on likely price changes.

       Technicians tend to concentrate more on the short run. The techniques of
       technical analysis are designed to detect likely price movements over a relatively
       short time. Fundamental analysts on the other hand have a substantial interest in
       the intermediate and longer run.

Technical Analysis---DOW Theory:

This aims at evaluating the primary, secondary & daily movements. It identifies two
markets: 1. Bull market 2. Bear Market for investment purpose.

Strategies for Technical Analysis:

For a fair technical analysis followings things must be taken care of:

       Risk
       Transaction Cost
       Consistency
       Out of sample Validity
With the help of above and by applying ―Filter rule‖ strategy, a proper technical analysis
can be done.
Economy Analysis:

Investors must make intelligent judgments about the current state of the financial markets
& possible changes. A logical starting point in assessing the stock market is to understand
the economic factors that affect stock prices. Understanding the current & future state of
the economy is the first step in understanding what is happening & what is likely to
happen to the market. Because of the market’s impact on investor’s success, investors
should seriously consider the market’s likely direction over some future period.

Business Cycle & Stock Market:

Movements in aggregate economic activity such as expansion and contraction can be
termed as Business cycle. The relationship between the economy and the stock market is
interesting—stock price lead the economy. Historically it is the most sensitive indicator
of the business cycle. Therefore, investor must deal with a complex relationship. They are
closely related but stock prices tend to consistently turn before the economy.

Composite Indexes of General Economic Activity:

A series of leading, coincident and lagging indicators of economic activity that help to
assess the status of the business cycle.

Using Market Measures:

Market measures tell investors how all stocks in general are doing at any time or give
them a ―feel‖ for the market. Many investors are encouraged to invest if stocks are
moving upward whereas downward trends may encourage some to liquidate their
holdings and invest in money market assets or funds.

Some popular market measures are:

               Trend Analysis
               Historical Performance
               Portfolio Performance
               Calculating Beta

Valuing The Market:

While valuing the market following estimates are needed:

               The Stream of Benefit
               The Required Rate of Return
Overall Market Analysis:

Based on the above analysis, the major points to be highlighted are as below:

               If the investor can recognize the bottoming out of the economy before it
               occurs, a market rise can be predicted , at least based on past experience ,
               before the bottom is hit

               As the economy recovers, stock prices may be level off or even decline.
               Therefore, a second significant movement in the market may be
               predictable again based on past experience.

               Based on the last ten economic slumps, the market P/E usually rises just
               before the end of the slump. It then remains roughly unchanged over the
               next year.

The importance of analyzing business cycle turning points as an aid to market timing
cannot be overemphasized. Investors would have always increased their returns by
switching into cash before the business cycle peaks and into stocks before the cycle
reaches its trough. It is particularly important to switch into stocks before business cycle
troughs.

Choosing A Broker for Investment:

Choosing a broker before making investment decision is very important. The following
matters are important to note regarding this issue:

               Integrity
               Intelligence & Efficiency
               Experience in Market
               Someone who understands investor’s investment philosophy
               Reputation in the Market
               Costs & Commissions effective

Opening An Account:

               Open account with enlisted broker
               Apply in proper application form with two copies passport sized
               photograph
               There must be an introducer who also should be a member of that broker
               Incase of no introducer, with some other supporting documents one can
               proceed
               There is no maximum or minimum amount to be deposited
               Each investor is given a ―client code‖ for trading
Market Condition Analysis Before Investment:

Following market factors need to be considered before making any investment decision;
These are:

Money:

The monetary value of money should be considered

Economic Boom:

Analyzing trend & Govt. initiatives

Scenario of Capital Market

Whether the economy is in bullish or bearish form

Political Scenario

The political condition & stability is important

Natural Calamity

The effects of frequent natural calamity is another factor for consideration

Market Trend

The analysis of upward & downward market trend

Govt. Policy

The Govt. policy may favorably or unfavorably effect the investment decision

Investor Behavior

The behavior of investors incase of investment decision. the investors may be:

               Risk Averse
               Risk Taker
               Risk Neutral
Future Growth Analysis:

Analyzing of future growth is an important factor. The basic focus points are:

               Product Development
               Debt Position
               Capital Gain
               Upward Trend

Liquidity

The position of liquidity position of any company is important

Dividend Factor

The EPS & related dividend factors

Inside trading

The inside trading is another important consideration

Risk analysis

Analysis of country risk, exchange risk & financial risk are also need to be taken care of.




               Return
                  s                                         Risk-
                                                           Return
                                                           Analysis

             Variability
             of Return                                                  Positive
                Over                                                  Relationship
               Years
Recommendations for the Future Investors:

Followings are some recommendations for the future investors:

Choosing a right Broker

A very important issue for new investors to begin with.

Fundamental Analysis

Fundamental Analysis at the company level involves analyzing basic financial variables
in order to estimate the company’s intrinsic value. This must be analyzed by a new
investor.

Technical Analysis

Technical analysis assumes that prices are determined by the interaction of demand and
supply and reflect the net optimism of market participants. This should also be analyzed
by the investors.

Economy Analysis

Investors must make intelligent judgments about the current state of the financial markets
& possible changes.

Market Efficiency Measurement

The concept postulates that investors will assimilate all relevant information into prices in
making their buy & sell decisions.

Risk Factor Analysis

Different risk related factors must be considered by the new investors

Return Estimation

The minimum expected return on asset that an investor requires before investing. This
must be also evaluated by the investors.

Risk-Return Trade-Off

Trading Instrument selection depending on risk-return analysis is a considerable factor.
Dividend factors

The EPS & related dividend factors should be considered

Liquidity position

The position of liquidity position of any company is important for new investors.

Future growth of company

Analyzing of future growth is an important factor for new investors..

Proper time for investment---buy & sell

Investors should try to make proper investment decision with the help of broker about
when to buy & sell the securities.

Stock Market Index analysis

To measure the market position of shares, there are several indices in operation. These
indices rate the companies according to their performance. This rating is important for the
new investors.

Category wise company selection

There are four types of company category which determines the position of a company
based upon it’s performance. It also indicates financially sound & strong company.
Investors can consider these categories incase of company selection

Business Cycle analysis

Movements in aggregate economic activity such as expansion and contraction can be
termed as Business cycle. New investors can focus on this issue for his purpose.

Financial Statement analysis

Analyzing Different issues of financial statement is very important for new investors

Trading proceed

Whether to go for margin trading or short sale is another important factor

								
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