exchange ratio ratio

Technical and fundamental analysis of exchange ratio based on UAE Exchange

CHAPTER- 1

INTRODUCTION

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INTRODUCTION

Investing, like marriage, isn't something that should be entered into lightly. You

wouldn't get married on a first date, would you? Ok, maybe some of us would, but

that's not really very Foolish. Before we marry... er, I mean invest in a company, there

are more than a few things we need to know about it.

Exchange Ratio

The share exchange ratio is very important in merger transactions. The share of

benefits for shareholders of merging parties depends on the value of the coefficient.

As a consequence of a merger 4 situations may occur:

1. owners of both companies benefit from the merger;

2. owners of the acquiring company lose, owners of the acquired company gain;

3. shareholders of both companies lose;

4. owners of the acquiring company gain and owners of the acquired company lose.

The declared aim of a merger is to make all participating parties benefit.

However, it is possible that one of merging firms has shares of the second entity, in an

amount sufficient to vote for a merger. Then, the merger can be voted through even if

the target's shareholders lose, at the expense of the shareholders of the acquiring

company. To avoid such situations, firms are required to obtain an opinion of an

independent auditor on a merger plan. However, the possibility of deliberate efforts

leading to a situation in which one of the companies lose, whilst the other gains

cannot be completely excluded. The situation in which 2merging companies lose is

not ration- al economically, and can only occur as a consequence of the transaction,

whereas ex ante benefits from the merger were expected. The aim of this study is to

determine whether in the case of transactions that took place in Poland shareholders

of merging companies gained from those transactions.

2


The research was based on the analysis of the results of the Larson-Gonedes exchange

ratio determination model. If the transaction is economically beneficial, and improves

the return on equity of joining companies, the share of benefits among the

shareholders of the acquiring and target companies depends on the share exchange

ratio. Depending on the distribution of shares in the new entity, all shareholders or

only one of the parties will benefit. Therefore, the share exchange ratio is of

paramount importance for merger transaction. The time scope of the analysis is the

first decade of the XXI century. Main differences between the two types of analysis:

Fundamental analysis Technical analysis

Focuses on what ought to happen in a

market

Focuses on what actually happens in a

market

Factors involved in price analysis:

1. Supply and demand

2. Seasonal cycles

3. Weather

4. Government policy

Charts are based on market action

involving:

1. Price

2. Volume

3. Open interest (futures only)

3


BACK GROUND OF THE PROBLEM

In an industry plagued with skepticism and a stock market increasingly difficult to

predict and contend with, if one looks hard enough there may still be a genuine aid for

the Day Trader and Short Term Investor.

The price of a security represents a consensus. It is the price at which one person

agrees to buy and another agrees to sell. The price at which an investor is willing to

buy or sell depends primarily on his expectations. If he expects the security's price to

rise, he will buy it; if the investor expects the price to fall, he will sell it. These simple

statements are the cause of a major challenge in forecasting security prices, because

they refer to human expectations. As we all know firsthand, humans expectations are

neither easily quantifiable nor predictable.

4


STATEMENT OF THE PROBLEM

If prices are based on investor expectations, then knowing what a security should sell

for (i.e., fundamental analysis) becomes less important than knowing what other

investors expect it to sell for. That's not to say that knowing what a security should

sell for isn't important--it is. But there is usually a fairly strong consensus of a stock's

future earnings that the average investor cannot disprove

OBJECTIVES Primary Objective: a) To do technical and fundamental analysis of exchange ratio

Secondary Objectives: a) To study the various theories of technical analysis and fundamental analysis

b) understand the movement and performance of stocks

c) understanding and analyzing the factors that affect the movement of stock prices in

the Indian Stock Markets

5


SIGNIFICANE OF THE STUDY

Fundamental analysis and technical analysis can co-exist in peace and complement

each other. Since all the investors in the stock market want to make the maximum

profits possible, they just cannot afford to ignore either fundamental or technical

analysis.

RESEARCH METHODOLOGY TYPE OF STUDY The research has been based on secondary data analysis. The study has been

exploratory as it aims at examining the secondary data for analyzing the previous

researches that have been done in the area of technical and fundamental analysis of

stocks. The knowledge thus gained from this preliminary study forms the basis for the

further detailed Descriptive research. In the exploratory study, the various technical

indicators that are important for analyzing stock were actually identified and

important ones short listed.

SAMPLE DESIGN The sample of the stocks for the purpose of collecting secondary data has been

selected on the basis of Random Sampling. The stocks are chosen in an unbiased manner and each stock is chosen independent of the other stocks chosen.

SAMPLE SIZE The sample size for the number of stocks is taken as 10 for technical analysis and 4

for fundamental analysis of exchange ratio as fundamental analysis is very exhaustive

and requires detailed study.

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LIMITATIONS Like all studies based on samples, this study also suffers from some limitations.

1. As the study depends on human perceptions so there are chances of study getting

biased.

2 Error due to some oversight or misinterpretation.

3 The scope of study was limited due to some constraints.

4. Any other error which could have crept in the course of the Project.

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CHAPTER- 2

INDUSTRY PROFILE AND COMPANY

PROFILE

8


INDUSTRY PROFILE Financial services are the economic services provided by the finance industry, which

encompasses a broad range of organizations that manage money, including credit

unions, banks, credit card companies, insurance, companies, consumer finance

companies, stock brokerages, investment funds and some government sponsored

enterprises.

A financial market is a market in which people and entities can trade financial

securities, commodities, and other fungible items of value at low transaction costs and

at prices that reflect supply and demand. Securities include stocks and bonds, and

commodities include precious metals or agricultural goods.

HISTORY OF FINANCIAL SERVICES The term "financial services" became more prevalent in the United States partly as a

result of the Gramm-Leach-Bliley Act of the late 1990s, which enabled different types

of companies operating in the U.S. financial services industry at that time to merge.

Companies usually have two distinct approaches to this new type of

business. One approach would be a bank which simply buys an insurance company or

an investment bank, keeps the original brands of the acquired firm, and adds the

acquisition to its holding company simply to diversify its earnings. Outside the U.S.

(e.g., in Japan), non-financial services companies are permitted within the holding

company. In this scenario, each company still looks independent, and has its own

customers, etc. In the other style, a bank would simply create its own brokerage

division or insurance division and attempt to sell those products to its own existing

customers, with incentives for combining all things with one company.

The financial sector is a component of a nation's economy created by the ebb

and flow of capital in the financial industry. Financial services include everything

from personal banking to the insurance industry, and they can make up a sizable

portion of a nation's economy. Evaluation of the true value of the financial sector can

be complicated, as the financial industry involves a great deal of paper pushing which

can sometimes be difficult to track and pin down.

Financial institutions like banks, insurance companies, brokerage houses,

investment firms, and so forth are all part of the financial sector.

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They can trade capital in a variety of ways, including funds, derivatives, investments;

debt instruments, and so forth, with much of the financial sector being dependent on

the extension of credit.

Consumers interact directly with the financial sector every time they apply for a credit

card, deposit a paycheck in a bank, or take out a home loan, and these actions occur

on a much larger scale between institutions and companies.

TYPES OF FINANCIAL MARKETS The financial markets can be divided into different subtypes:

Capital markets which consist of:

- Stock markets, which provide financing through the issuance of shares or

common stock, and enable the subsequent trading thereof.

- Bond markets, which provide financing through the issuance of bonds, and

enable the subsequent trading thereof.

Commodity markets, which facilitate the trading of commodities.

Money markets, which provide short term debt financing and investment.

Derivatives markets, which provide instruments for the management of financial

risk.

Futures markets, which provide standardized forward contracts for trading products

at some future date; see also forward market.

Insurance markets, which facilitate the redistribution of various risks.

Foreign exchange markets, which facilitate the trading of foreign exchange.

The capital markets may also be divided into primary markets and secondary markets.

Newly formed (issued) securities are bought or sold in primary markets, such as

during initial public offerings. Secondary markets allow investors to buy and sell

existing securities. The transactions in primary markets exist between issuers and

investors, while in secondary market transactions exist among investors.

Liquidity is a crucial aspect of securities that are traded in secondary markets.

Liquidity refers to the ease with which a security can be sold without a loss of value.

Securities with an active secondary market mean that there are many buyers and

sellers at a given point in time. Investors benefit from liquid securities because they

can sell their assets whenever they want; an illiquid security may force the seller to

get rid of their asset at a large discount.

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COMPANY PROFILE UAE Exchange is a remittance and currency exchange company headquartered in

the United Arab Emirates with operations in a number of countries. . UAE

EXCHANGE is a leading global remittance and foreign exchange brand trusted by

millions of customers and partners, across the world. A peoples brand, UAE

EXCHANGE is known for quality and customer centric approach. Started over 30

years ago, UAE EXCHANGE provides world class services and earned trust of over

3.5 million customers, worldwide. With 570 + direct offices in 30 countries across

five continents makes the company the only brand in the segment to own a global

network of this magnitude. It is the largest remittance companies and has extensive

network in the Middle East and Asia.

HISTORY UAE Exchange was started operations in 23rd October, 1980 with a single office in

Abu Dhabi, United Arab Emirates, by Indian born entrepreneur BavaguthuShetty and

former United Arab Emirates Minister of Justice H.E. Abdulla Humaid Al Mazroei.

From then on it was on an expansion spree, building a global network of over 570

direct offices in close to 30 countries across five continents.

In 1993 UAE Exchange became a SWIFT (Society for Worldwide Interbank

Financial Telecommunication)member and the following two years opened

Operations in Oman and Kuwait as well as well as launching an express transfer, gold

card and bank notes service.

In 1999 it launched retail operations in India, which was to become the largest

operation outside its home base. It followed this with opening offices in Bangladesh,

the UK and Sri Lanka in the following three years.

By 2003, it has also added Australia when it acquired a local exchange house. The

same year it opened its 100th branch in India.

Between 2005 and 2009 it continued to expand, opening offices in Hong Kong,

Uganda, Jordan, Canada, New Zealand and China, as well as purchasing Money Dart

Global Services in the United States. It also launched a online money transfer portal,

Money2anywhere. X Pay, the bill payment solution using mobile phone was also

brought out in India.

Based in Abu Dhabi with Mr. Y Sudhir Kumar Shetty, COO Global Operations, at

the helm, UAE Exchange has been setting new standards in the global remittance

11


industry with diversified product and service offerings supported by the deployment

of latest technologies, resulting in excellent customer service and unmatched market

presence.

Constantly striving to provide more value to customers and in the process growing

exponentially has earned UAE Exchange the recognition as a Super brand for 2009

and 2010. The Super brands Council, the independent authority that honors branding

excellence and achievements in various sectors across the world has conferred this

honors on UAE Exchange.

Quality-driven approach with a customer-centric perspective has been the benchmark

of UAE Exchange operations. And it is this same penchant for excellence that has

won the global remittance major various global business excellence and quality

awards including the esteemed ISO 9001:2008 certification, Dubai Quality Award

and Sheikh Khalifa Excellence Award (SKEA) for the Finance sector in 2009.

Winning the prestigious UAE Emiratisation Award from the HRD committee in the

Banking & Financial Sector was yet another feather in its colourful cap. The DHDA

Award under the patronage of HH Sheikh Mohammed bin Rashid Al Maktoum for

efforts and achievements in the development of UAE Nationals added more lustre.

Over 6,500 trained multi-cultural UAE Exchange personnel representing more than

40 nationalities, across the globe, strive to ensure customer delight. So every

customer, no matter which part of the globe he walks in from, will get the same

attention and quality service to his complete satisfaction. This customer-centric

approach makes UAE Exchange a peoples brand. And its safe and fast transaction

process makes it the Worlds Trusted Money Transferred, which is an acclaim that the

brand earned from its relentless service of thirty years.

A prominent link in the prestigious conglomerate NMC Group, UAE Exchange stands

on three values Knowledge, Integrity, Commitment. The brand is driven by People,

Product and Process, which are in tandem with the vision set by its founders, guiding

it in its pursuit for excellence. And, in the process, delivering more value to its

esteemed customers worldwide.

1999 UAE Exchange became fully operational with its branch at MG Road,

Bangalore and the first Xpress Money payment given out on 1 September 1999 at P T

Usha branch Kochi.

12


2000 UAE Exchange started Money Exchange, later renamed as Foreign

Exchange, as per specific licenses received from the apex bank of the country, The

Reserve Bank of India.

2001 UAE Exchange added one more service Travel and Ticketing services. The

company is an IATA accredited passenger sales agent and also an active member of

TAAI. UAE Exchange has 7 IATA locations in India. The company also opened the

50th branch in Surat, Gujarat.

2002 a separate wing for Agency Business was formed. UAE Exchange also

included another service, Insurance, in 2003 partnering with LIC and United India

Assurance company.

2004 the company opened the 100th branch in Mattannur Kerala. In 2005 UAE

Exchange also started Tours along with Travel services.

2006 UAE Exchange opened its 200th branch at Mangalore.

2006 was a landmark year in the history of Indian operations of UAE Exchange.

The RBI elevated the company to Authorized Dealer II category, thus becoming the

first FFMC in Indian history to get the status.

2008 UAE Exchange entered into the realm of another service Gold Loan and

provides EMI repayment option for customers.

2009 the company received the license under payment and settlement acts from RBI

to operate a debit mode of payment system and thus introduced XPAY, an

indigenously developed mobile based payment system.

UAE Exchange is now present in the metros, semi-urban as well as rural areas of

India with over 240 own branches. The Country Head of UAE Exchange and

Financial Services Ltd is Mr. V George Antony and there are 10 Department Heads,

50 Divisional Heads, 8 Zonal Heads, 23 Regional Heads and 8 Regional Audit Heads

monitoring the operations of the companys branches across India.

VISSION STATEMENT OF UAE EXCHANGE To be an ever-dependable friend, the link that emotionally connects people across the

globe through technology-driven, professional, dedicated and timely services

delivered with a personal touch.

13


MISSION STATEMENT OF UAE EXCHANGE To stay ahead of the times in providing customer-friendly services delivered with

warmth; full fill the aspirations of the employees and the entire community; serve and

flourish in an environment of mutual trust and transparency.

AWARDS Quality is a way of life at UAE Exchange.

UAE Exchange wins the Dubai Quality Award-2009

Sheikh Khalifa Excellence Award (SKEA) in 2009

Noted for Super Brands in 2008, 2009, 2010, 2011

STP Excellence Award from Deutsche Bank- 2007, 2008,2009

Dubai Quality Appreciation Programme (DQAP)- 2007

Mohammed Bin Rashid Al Maktoum Business Award- 2008

Human Resource Development Award from HRD Committee in 2009

Best Performance Outlet under DSES- 2006, 2007, 2008, 2009, 2010,2011,2012

Dubai Human Resource Development Appreciation Award from Department of

Economy,

Government of DubaiBest Exchange House in Dubai by Show Case 500

ENDP Best Partner Award for 2007

FOUNDERS DR. B. R. SHETTY, Managing Director & CEO, UAE Exchange, is an entrepreneur

par excellence. His success story has been paved by humility and deep commitment

towards the people and the society.

Armed with a degree in clinical pharmacy, Dr. Shetty set foot in UAE in 1972 and

founded the healthcare facility New Medical Centre (NMC) in 1975. After realising

the immense potential of the remittance sector and with a deep sense of yearning to

help the expatriate community, he established UAE Exchange in 1980 with its head

office located in Abu Dhabi.

Today, Dr. Shetty is among the top business icons in the Gulf region and a living

testimony of Corporate Social Responsibility. He has numerous awards to his credit

including the Padmashri, one of the highest civilian honours of the

14


Government of India bestowed on him for his outstanding achievements and

contributions to business and trade. The Abu Dhabi Government has also recognised

his contributions to the society by conferring on him the highest honors of the Abu

Dhabi Government the Order of Abu Dhabi. He was conferred with a Doctorate by

Georgia State University, Atlanta, USA.

Dr. Shetty has, during his highly successful business career, forayed into many sectors

including pharmaceuticals, healthcare, finance, FMCG, IT, hospitality, cosmetics,

jewellery, advertising, PR and real estate with astounding success in each one of

them. Dr. Shetty is also a member of various international business councils.

H. E. Abdulla Humaid Ali Al Mazroei, Chairman, NMC Group a conglomerate

dealing in a wide range of business activities and which include many leading brands

like UAE Exchange. He is a dynamic leader with visionary qualities and indefatigable

zeal, and his eventful life has been an absorbing journey through the labyrinths of

governance, politics, business, commerce and industry.

H.E. Mazroei joined the government of uae in 1968.his rise in the government

hierarchy was meteoric as he was promoted to the post of under secretary at the

ministry of foreign affairs.

He entered the higher corridors of power in 1977 with induction into the cabinet as

the minister of labour and social affairs. His tenure as advisor to the presidential

Court culminated after joining the league of pre-eminent ranks with his appointment

as the UAE minister of justice. H.E Mazroei is the member of the board of the general

authority for pension and social security, chairman of union insurance and member of

the board of Abu Dhabi international school. H.E Mazroeis entrepreneurial initives

found matching synergy in the business acumen of Dr B R Shetty, to signal the

beginning of a strong relationship as a business mentor and trusted partner. His

ongoing quests towards creating successful business concepts and organizational

evolution have created a benchmark for professionals, who are in pursuit of

excellence across the globe. In his capacity as chairman of NMC Group H.E Mazroei

has always given vision and direction to the varied activities of the business group.

15


UAE EXCHANGE STANDS FOR The customers-by delivering quality products and services which meets their diverse

money transfer and foreign exchange needs, and providing them the best experience

with our quality service and support systems.

The people-by treating them with dignity and respect, fostering an environment for

them to brow and develop on tyrannically and extrinsically, and to provide a reward

structure which motivates them to contribute optimally to the organization and

themselves.

The investors-by aggressively pursuing our financial goals and ensuring stable

growth in economic profit, and keeping all our organizational systems and processes

viable for contributing to increasing returns on investment.

The environment-by responsibly utilizing our resources and help protecting it for

future generation, and doing business fairly and with integrity in the best interests of

the marketplace.

The communities-by facilitating meaningful contributions of a financial and non-

financial nature which would help address the problems and impediments, and being a

responsible neighbor, by contributing to the cultural and social integration of the

communities we serve.

CUSTOMER TOUCH POINTS AVALIABLE WITH UAE EXCHANGE a. SMS 6000 Etisalat and Du Mobiles

b. Telephone 04 3535350

c. Customer Suggestion form

d. Fax- 043530200

e. Email- [email protected]

f. Website www.uaeexchange.com

g. Social Medias like facebook, Linked In

16


CHAPTER- 3

REVIEW LITERATURE

17


REVIEW LITERATURE The share exchange ratio is very important in merger transactions. The share of



1. owners of both companies benefit from the merger;

2. owners of the acquiring company lose, owners of the acquired company gain;

3. shareholders of both companies lose;

4. owners of the acquiring company gain and owners of the acquired company lose.

The declared aim of a merger is to make all participating parties benefit.



the target's shareholders lose, at the expense of the shareholders of the acquiring com-

pany. To avoid such situations, firms are required to obtain an opinion of an inde-

pendent auditor on a merger plan. However, the possibility of deliberate efforts lead-

ing to a situation in which one of the companies lose, whilst the other gains cannot be

completely excluded. The situation in which 2 merging companies lose is not ration-

al economically, and can only occur as a consequence of the transaction, whereas ex

ante benefits from the merger were expected. The aim of this study is to determine

whether in the case of transactions that took place in Poland shareholders of merging

companies gained from those transactions.








first decade of the XXI century.

The theoretical aspects of the determination of the relevant share exchange ratio. The

model approach of determining the share exchange ratio was developed by Larson

and Gonedes (1969) and Yagil (1987). The starting point of the Larson-Gonedes

model is to determine the minimum and maximum share exchange ratios, which are

18


acceptable to the shareholders of the acquiring and target companies, which can be

defined as the product of the price/earnings ratio and earnings per share of companies:

The share exchange ratio is very important in merger transactions. The share of



1) owners of both companies benefit from the merger;

2) owners of the acquiring company lose, owners of the acquired company gain;

3) shareholders of both companies lose;

4) owners of the acquiring company gain and owners of the acquired company

lose. The declared aim of a merger is to make all participating parties benefit.



the target's shareholders lose, at the expense of the shareholders of the acquiring com-

pany. To avoid such situations, firms are required to obtain an opinion of an inde-

pendent auditor on a merger plan. However, the possibility of deliberate efforts lead-

ing to a situation in which one of the companies lose, whilst the other gains cannot be

completely excluded. The situation in which 2 merging companies lose is not ration-

al economically, and can only occur as a consequence of the transaction, whereas ex

ante benefits from the merger were expected. The aim of this study is to determine

whether in the case of transactions that took place in Poland shareholders of merging

companies gained from those transactions.








first decade of the XXI century.

The theoretical aspects of the determination of the relevant share exchange ratio.

Themodel approach of determining the share exchange ratio was developed by Larson

and Gonedes (1969) and Yagil (1987). The starting point of the Larson-Gonedes

model is to determine the minimum and maximum share exchange ratios, which are

19


acceptable to the shareholders of the acquiring and target companies, which can be

defined as the product of the price/earnings ratio and earnings per share of companies:

where P1, P2 prices, respectively, of the acquiring company 1 and the target com-

pany 2; PE1, PE2 price/earnings ratios for companies 1 and 2; EPS1, EPS2 earn-

ings per share for companies 1 and 2.

Thus, the share prices are defined as the value of price/earnings ratio multiplied by the

value of earnings per share. The authors assume that the price/earnings ratio

takesinto account investors' expectations as to the future growthofprofit of the com-

pany. Under this assumption, the current decline in income may result in only a slight

decrease in the share price if investors believe that future profits of the company will

grow significantly. This situation increases the price/earnings ratio. The expected

price of the shares after the merger depends on the expected value of the price/earn-

ings ratio after the merger, the combined profits of 2 companies and the number of

shares, which is the number of shares of the acquiring company and the shares issued

in exchange for shares of the target company, the number of which is equal to the

number of target's shares, multiplied by the exchange ratio:

where P12 expected price of the shares after the merger; PE12 expected value of

price/earnings ratio after the merger; E1 profit of the acquiring company; E2 prof-

it of the acquired company; S1 the number of shares of the acquiring company; S2

the number of shares of the acquired company; ER the share exchange ratio.

From the shareholders' point of view it is important that the merger does not reduce

the wealth of shareholders, but rather increases it. For the shareholders of the

acquiring company, this condition can be written as:

20


Substituting dependencies on the value of shares and the expected value of the

coefficient of price/earnings ratio to the condition that ensures that the shareholders of

the acquiring company at least do not lose, the equation can be obtained: which after

transformation gives the maximum value of the share exchange ratio, which does not

result in the loss of wealth by the shareholders of the acquiring company as a result

of business combination

Literature review: Empirical results of the share exchange ratio determination model for mature stock

markets. The presented Larson-Gonedes (1969) model was highly acclaimed, both

theoretically (Lev, 1970; Gonedes and Larson, 1971) and empirically (Conn and

Nielsen, 1977; Conn, 1980; Cooke et al., 1994; Bae and Sakthivel, 2000). The

Larson-Gonedes theoretical model was used for empirical studies by Conn and

Nielsen (1977). Conn and Nielsen conducted the study on the sample of 131 mergers

in 19601969 for the companies listed at New York Stock Exchange or American

Stock Exchange. The companies in the sample were listed at the stock exchange at

least one year prior to the merger, to find the mutual relation between values of

companies before the period when the valuation was influenced by information on the

merger. As the expected price of the new entity P12 was taken the price of the

acquiring company for the periods: the merger announcement period, the merger

completion moment and a month after the merger. Grewal S.S and Navjot Grewall (1984) revealed some basic investment

rules and rules for selling shares. They warned the investors not to buy

unlisted shares, as Stock Exchanges do not permit trading in unlisted shares.

Another rule that they specify is not to buy inactive shares, ie, shares in

which transactions take place rarely. The main reason why shares are

inactive is because there are no buyers for them. They are mostly shares of

companies, which are not doing well.

A third rule according to them is not to buy shares in closely-held

companies because these shares tend to be less active than those of widely

held ones since they have a fewer number of shareholders. They caution not

to hold the shares for a long period, expecting a high price, but to sell

whenever one earns a reasonable reward.

21


Jack Clark Francis2 (1986) revealed the importance of the rate of return in

investments and reviewed the possibility of default and bankruptcy risk. He

opined that in an uncertain world, investors cannot predict exactly what rate

of return an investment will yield. However he suggested that the investors

can formulate a probability distribution of the possible rates of return.

He also opined that an investor who purchases corporate securities must

face the possibility of default and bankruptcy by the issuer. Financial

analysts can foresee bankruptcy. He disclosed some easily observable

warnings of a firm's failure, which could be noticed by the investors to avoid

such a risk.

Preethi Singh3(1986) disclosed the basic rules for selecting the company to

invest in. She opined that understanding and measuring return md risk is

fundamental to the investment process. According to her, most investors are

'risk averse'. To have a higher return the investor has to face greater risks.

She concludes that risk is fundamental to the process of investment. Every

investor should have an understanding of the various pitfalls of investments.

The investor should carefully analyse the financial statements with special

reference to solvency, profitability, EPS, and efficiency of the company.

David.L.Scott and William Edward4 (1990) reviewed the important risks of

owning common stocks and the ways to minimise these risks. They

commented that the severity of financial risk depends on how heavily a

business relies on debt. Financial risk is relatively easy to minimise if an

investor sticks to the common stocks of companies that employ small

amounts of debt. They suggested that a relatively easy way to ensure some

degree of liquidity is to restrict investment in stocks having a history of

adequate trading volume. Investors concerned about business risk can

reduce it by selecting common stocks of firms that are diversified in several

unrelated industries.

Lewis Mandells (1992) reviewed the nature of market risk, which according

to him is very much 'global'. He revealed that certain risks that are so global

22


that they affect the entire investment market. Even the stocks and bonds of

the well-managed companies face market risk. He concluded that market

risk is influenced by factors that cannot be predicted accurately like

economic conditions, political events, mass psychological factors, etc.

Market risk is the systemic risk that affects all securities simultaneously and

it cannot be reduced through diversification.

Nabhi Kumar Jain6 (1992) specified certain tips for buying shares for

holding and also for selling shares. He advised the investors to buy shares of

a growing company of a growing industry. Buy shares by diversifying in a

number of growth companies operating in a different but equally fast

growing sector of the economy. He suggested selling the shares the moment

company has or almost reached the peak of its growth. Also, sell the shares

the moment you realise you have made a mistake in the initial selection of

the shares. The only option to decide when to buy and sell high priced

shares is to identify the individual merit or demerit of each of the shares in

the portfolio and arrive at a decision.

Carter Randal7 (1992) offered to investors the underlying principles of

winning on the stock market. He emphasised on long term vision and a plan

to reach the goals. He advised the investors that to be successful, they

should never be pessimists. He revealed that though there has been a major

economic crisis almost every year, it remains true that patient investors have

consistently made money in the equities market. He concluded that investing

in the stock market should be an un-emotional endeavour and suggested that

investors should own a stock if they believe it would perform well.

L.C.Gupta8 (1992) revealed the findings of his study that there is existence

of wild speculation in the Indian stock market. The over speculative

character of the Indian stock market is reflected in extremely high

concentration of the market activity in a handful of shares to the neglect of

the remaining shares and absolutely high trading velocities of the

23


speculative counters. He opined that, short- term speculation, if excessive,

could lead to "artificial price". An artificial price is one which is not justified

by prospective earnings, dividends, financial strength and assets or which is

brought about by speculators through rumours, manipulations, etc. He

concluded that such artificial prices are bound to crash sometime or other as

history has repeated and proved.

Yasaswy N.J.9 (1993) disclosed how 'turnaround stocks' offer big profits to

bold investors and also the risks involved in investing in such stocks.

Turnaround stocks are stocks with extraordinary potential and are relatively

under priced at a given point of time. He also revealed that when the

economy is in recession and the fundamentals are weak, the stock market,

being a barometer of the economy, also tends to be depressed. A depressed

stock market is an ideal hunting ground for 'bargain hunters', who are

aggressive investors. Sooner or later recovery takes place which may take a

very long time. He concluded that the investors' watch work is 'caution' as

he may lose if the turnaround strategy does not work out as anticipated.

Sunil Damodar'o (1993) evaluated the 'Derivatives' especially the 'futures' as

a tool for short-term risk control. He opined that derivatives have become an

indispensable tool for finance managers whose prime objective is to manage

or reduce the risk inherent in their portfolios. He disclosed that the over-

riding feature of 'financial futures' in risk management is that these

instruments tend to be most valuable when risk control is needed for a short-

term, ie, for a year or less. They tend to be cheapest and easily available for

protecting against or benefiting from short term price. Their low execution

costs also make them very suitable for frequent and short term trading to

manage risk, more effectively.

Yasaswy J.N." (1993) evaluated the quantum of risks involved in different

types of stocks. Defensive stocks are low risk stocks and hence the returns

are relatively low but steady. Cyclical stocks involve higher risks and hence

the rewards are higher when compared to the growth stocks. Growth stocks

24


belong to the medium risk category and they offer medium returns which

are much better. than defensive stocks, but less than the cyclical stocks. The

market price of growth stocks does fluctuate, sometimes even violently

during short periods of boom and bust. He emphasised the financial and

organisational strength of growth stocks, which recover soon, though they

may hit bad patches once in a way.

Donald E Fischer and Ronald J. Jordan12 (1994) analysed the relation between risk, investor preferences and investor behaviour. The risk return

measures on portfolios are the main determinants of an investor's attitude

towards them. Most investors seek more return for additional risk assumed.

The conservative investor requires large increase in return for assuming

small increases in risk. The more aggressive investor will accept smaller

increases in return for large increases in risk. They concluded that the

psychology of the stock market is based on how investors form judgements

about uncertain future events and how they react to these judgements.

R.Venkataramani.l"l994) disclosed the uses and dangers of derivatives. The

derivative products can lead us to a dangerous position if its full implications

are not clearly understood. Being off balance shekt in nature, more and more

derivative products are traded than the cash market products and they suffer

heavily due to their sensitive nature. He brought to the notice of the

investors the 'Over the counter product' (OTC) which are traded across the

counters of a bank. OTC products (eg. Options and futures) are tailor made

for the particular need of a customer and serve as a perfect hedge. He

emphasised the use of futures as an instrument of hedge, for it is of low cost.

K.Sivakumar. '"1994) disclosed new parameters that will help investors

identify the best company to invest in. He opined that Economic Value

Added (EVA) is more powerful than other conventional tools for investment

decision making like EPS and price earning ratio. EVA looks at how capital

raised by the company from all sources has been put to use. Higher the

EVA, higher the returns to the shareholder. A company with a higher EVA

25


is likely to show a higher increase in the market price of its shares. To be

effective in comparing companies, he suggested that EVA per share

(EVAPS) must be calculated. It indicates the super profit per share that is

available to the investor. The higher the EVAPS, the higher is the likely

appreciation in the value in future. He also revealed a startling result of

EVA calculation of companies in which 200 companies show a negative

value addition that includes some blue chip companies in the Indian Stock

Market.

Pattabhi Ram.V.15 (1995) emphasised the need for doing fundamental

analysis'and doing Equity Research (ER) before selecting shares for

investment. He opined that the investor should look for value with a margin

of safety in relation to price. The margin of safety is the gap between price

and value. He revealed that the Indian stock market is an inefficient market

because of the absence of good communication network, rampant price

rigging, the absence of free and instantaneous flow of information,

professional broking and so on. He concluded that in such inefficient

market, equity research will produce better results as there will be frequent

mismatch between price and value that provides opportunities to the long-

term value oriented investor. He added that in the Indian stock market

investment returns would improve only through quality equity research.

Philippe Jhorion and Sarkis Joseph Khouryl6 (1996) reviewed international

factors of risks and their effect on financial markets. He opined that

domestic investment is a subset of the global asset allocation decision and

that it is impossible to evaluate the risk of domestic securities without

reference to international factors. Investors

26


CHAPTER- 4

TECHNICAL ANALYSIS

27


A CONCEPTUAL OVERVIEW

TECHNICAL ANALYSIS:

Technical analysis can be conditionally divided into some main parts such as:

Types of charts

Graphical methods

Analytical methods

Technical indicators

Technical analysis is concerned with predicting future price trends from historical price and volume data. The underlying axiom of technical analysis is that all

fundamentals (including expectations) are factored into the market and are reflected in

exchange rates.

A technical analysis is based on three axioms:

Movement of the market considers everything

Movement of prices is purposeful

History repeats itself

SUPPORT AND RESISTANCE

Support is a level at which bulls (i.e., buyers) take control over the prices and prevent

them from falling lower.

28


Resistance, on the other hand, is the point at which sellers (bears) take control of

prices and prevent them from rising higher. The price at which a trade takes place is

the price at which a bull and bear agree to do business. It represents the consensus of

their expectations.

Support levels indicate the price where the most of investors believe that prices will

move higher. Resistance levels indicate the price at which the most of investors feel

prices will move lower.

Role Reversal

When a resistance level is successfully broken through, that level becomes a support

level. Similarly, when a support level is successfully broken through, that level

becomes a resistance level.

29


DOW THEORY TRENDS:

The ideas of Charles Dow, the first editor of the Wall Street Journal, form the basis of

technical analysis. The Dow theory is a method of interpreting and signaling changes

in the stock market direction based on the monitoring of the Dow Jones Industrial and

Transportation Averages. Dow created the Industrial Average, of top blue chip stocks,

and a second average of top railroad stocks (now the Transport Average). He believed

that the behavior of the averages reflected the hopes and fears of the entire

market. The behavior patterns that he observed apply to markets throughout the

world.

Three Movements

Markets fluctuate in more than one time frame at the same time:

Nothing is more certain than that the market has three well defined movements which

fit into each other.

The first is the daily variation due to local causes and the balance of buying

and selling at that particular time.

The secondary movement covers a period ranging from ten days to sixty days,

averaging probably between thirty and forty days.

The third move is the great swing covering from four to six years.

Bull markets are broad upward movements of the market that may last several

years, interrupted by secondary reactions. Bear markets are long declines

interrupted by secondary rallies. These movements are referred to as the

primary trend.

30


Secondary movements normally retrace from one third to two thirds of the

primary trend since the previous secondary movement.

Daily fluctuations are important for short-term trading, but are unimportant in

analysis of broad market movements.

Various cycles have subsequently been identified within these broad categories.

Primary Movements have Three Phases

The general conditions in the market:

Bull markets

Bull markets commence with reviving confidence as business conditions improve.

Prices rise as the market responds to improved earnings

Rampant speculation dominates the market and price advances are based on hopes

and expectations rather than actual results.

Bear markets

Bear markets start with abandonment of the hopes and expectations that

sustained inflated prices.

Prices decline in response to disappointing earnings.

Distress selling follows as speculators attempt to close out their positions and

securities are sold without regard to their true value.

Ranging Markets

A secondary reaction may take the form of a line which may endure for several

weeks. Price fluctuates within a narrow range of about five per cent.

31


Breakouts from a range can occur in either direction.

Advances above the upper limit of the line signal accumulation and higher

prices;

Declines below the lower limit indicate distribution and lower prices;

Volume is used to confirm price breakouts.

Trends

Bull Trends

A bull trend is identified by a series of rallies where each rally exceeds the highest

point of the previous rally. The decline, between rallies, ends above the lowest point

of the previous decline.

Successive higher highs and higher lows.

The start of an up trend is signaled when price makes a higher low (trough), followed

by a rally above the previous high (peak):

32


Start = higher Low + break above previous High.

The end is signaled by a lower high (peak), followed by a decline below the previous

low (trough):

End = lower High + break below previous Low.

A bear trend starts at the end of a bull trend: when a rally ends with a lower peak and

then retreats below the previous low. The end of a bear trend is identical to the start of

a bull trend.

Large Corrections

A large correction occurs when price falls below the previous low (during a bull

trend) or where price rises above the previous high (in a bear trend).

A bull trend starts when price rallies above the previous high,

A bull trend ends when price declines below the previous low,

A bear trend starts at the end of a bull trend (and vice versa).

33


ELLIOT WAVES THEORY BASICS

TRENDLINES

Breaking through support or resistance levels results in a change of traders

expectations (which causes supply/demand lines to shift).

An Uptrend is defined by successively higher low-prices. A rising trend can be

thought of as a rising support level: the bulls are in control and are pushing prices

higher. A Downtrend is defined by successively lower high-prices. A falling trend can

be thought of as a falling resistance level: the bears are in control and are pushing

prices lower.

34


MOVING AVERAGES

Moving averages are one of the oldest and most popular technical analysis tools. A

moving average is the average price of a financial instrument over a given time.

The moving average represents the consensus of investors expectations over the

indicated period of time.

The classic interpretation of a moving average is to use it in observing changes in

prices. Investors typically buy when the price of an instrument rises above its moving

average and sell when the it falls below its moving average.

TECHNICAL INDICATORS

There is a vast number of elaborated technical indicators:

MOVING AVERAGE MA

RELATIVE STRENGTH INDEX RSI :The Relative Strength Index Technical Indicator (RSI) is a price-following oscillator that ranges between 0 and 100. When

Wilder introduced the Relative Strength Index, he recommended using a 14-day

RSI.. Since then, the 9-day and 25-day Relative Strength Index indicators have also

gained popularity.

35


ADVANCE/DECLINE LINE: The advance/decline line shows, for some period,

the cumulative difference between advancing and declining issues.

CLOSING TICK: Closing tick is the difference between the number of shares that

closed on an uptick and those that closed on a downtick.

CLOSING ARMS: Closing arms or trin (trading index) is the ratio of average

trading volume in declining issues to average trading volume in advancing issues.

Z-BLOCK TRADES: zBlock trades are trades in excess of 10,000 shares.

HI-LO-CLOSE CHART: A hi-lo-close chart is a bar chart showing, for each day,

the high price, low price, and closing price.

CANDLESTICK CHART: A candlestick chart is an extended version of the hi-lo-

close chart. It plots the high, low, open, and closing prices, and also shows whether

the closing price was above or below the opening price.

POINT AND FIGURE CHARTS: Point-and-figure charts are a way of showing only

major price moves and their direction. A major up move is marked with an X,

while a major down move is marked with an O. A new column starts every time

there is a change in direction

HEAD AND SHOULDERS FORMATION: Once a chart is drawn, analysts

examine it for various formations or pattern types in an attempt to predict stock

price or market direction in the case of head-and-shoulders formation. When the

stock price pierces the neckline after the right shoulder is finished, its time to

sell.

ODD-LOT: The odd-lot indicator looks at whether odd-lot purchases are up or

down. HEMLINE: Followers of the hemline indicator claim that hemlines tend

to rise in good times.

SUPER BOWL: The Super Bowl indicator forecasts the direction of the market

based on whether the National Football Conference or the American Football

Conference wins. A win by the National Football Conference is bullish.

BETA: Beta is a risk measure comparing the volatility of a stock's price movement

to the general market.

MOMENTUM: Momentum measures the speed of price change and provides a

leading indicator of changes in trend.

UPSIDE/DOWNSIDE: Measures of Upside/Downside separate the volumes for

rising markets from those in falling markets. Since volume is independent of price,

it makes a valuable tool for measuring the quality of a price trend.

36


CHAPTER- 5

FUNDAMENTAL ANALYSIS

A CONCEPTUAL OVERVIEW

37


Fundamental analysis refers to the study of the core underlying elements that influence the economy of a particular entity. It is a method of study that attempts to

predict price action and market trends by analyzing economic indicators, government

policy and societal factors (to name just a few elements) within a business cycle

framework.

I. ECONOMIC ANALYSIS:

POLITICO-ECONOMIC ANALYSIS:

No industry or company can exist in isolation. It may have splendid managers and a

tremendous product. However, its sales and its costs are affected by factors, some of

which are beyond its control - the world economy, price inflation, taxes and a host of

others. It is important, therefore, to have an appreciation of the politico-economic

factors that affect an industry and a company.

The political equation A stable political environment is necessary for steady, balanced growth. If a country

is ruled by a stable government which takes decisions for the long-term development

of the country, industry and companies will prosper.

Foreign Exchange Reserves A country needs foreign exchange reserves to meet its commitments, pay for its

imports and service foreign debts.

Foreign Exchange Risk This is a real risk and one must be cognizant of the effect of a revaluation or

devaluation of the currency either in the home country or in the country the company

deals in.

Restrictive Practices Restrictive practices or cartels imposed by countries can affect companies and

industries.

crystallizing the exposure.

38


Foreign Debt and the Balance of Trade Foreign debt, especially if it is very large, can be a tremendous burden on an economy.

India pays around $ 5 billion a year in principal repayments and interest payments.

Inflation Inflation has an enormous effect in the economy. Within the country it erodes

purchasing power. As a consequence, demand falls. If the rate of inflation in the

country from which a company imports is high then the cost of production in that

country will automatically go up.

The Threat of Nationalization The threat of nationalization is a real threat in many countries the fear that a

company may become nationalized.

Interest Rates A low interest rate stimulates investment and industry. Conversely, high interest rates

result in higher cost of production and lower consumption.

Taxation The level of taxation in a country has a direct effect on the economy. If tax rates are

low, people have more disposable income.

Government Policy Government policy has a direct impact on the economy. A government that is

perceived to be pro industry will attract investment.

THE ECONOMIC CYCLE:

It affects investment decisions, employment, demand and the profitability of

companies.

The four stages of an economic cycle are: Depression

Recovery

Boom

Recession

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Depression At the time of depression, demand is low and falling. Inflation is high and so are

interest rates. 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.

Recovery During this phase, the economy begins to recover. Investment begins anew and the

demand grows. Companies begin to post profits. Conspicuous spending begins once

again.

Boom In the boom phase, demand reaches an all time high. Investment is also high. Interest

rates are low. Gradually as time goes on, supply begins to exceed the demand. Prices

that had been rising begin to stabilize and even fall. There is an increase in demand.

Then as the boom period matures prices begin to rise again.

Recession The economy slowly begins to downturn. Demand starts falling.. Interest rates and

inflation are high. Companies start finding it difficult to sell their goods. The

economy slowly begins to downturn.

II. INDUSTRY ANALYSIS

The importance of industry analysis is now dawning on the Indian investor as never

before.

40


Cycle The first step in industry is to determine the cycle it is in, or the stage of maturity of

the industry. All industries evolve through the following stages:

1. Entrepreneurial, sunrise or nascent stage

2. Expansion or growth stage

3. Stabilization, stagnation or maturity stage, and

4. Decline or sunset stage to properly establish itself. In the early days, it may actually

make losses.

The Entrepreneurial or Nascent Stage At the first stage, the industry is new and it can take some time for it to properly

establish itself.

The Expansion or Growth Stage Once the industry has established itself it enters a growth stage. As the industry grows,

many new companies enter the industry.

The Stabilization or Maturity Stage After the halcyon days of growth, an industry matures and stabilizes. Rewards are low

and so too is the risk. Growth is moderate. Though sales may increase, they do so at a

slower rate than before. Products are more standardized and less innovative and there

are several competitors.

41


The Decline or Sunset Stage Finally, the industry declines. This occurs when its products are no longer popular.

This may be on account of several factors such as a change in social habits The film

and video industries.

1. BARRIER TO ENTRY New entrants increase the capacity in an industry and the inflow of funds. The

question that arises is how easy is it to enter an industry ?

There are some barriers to entry:

a) Economies of scale b) Product differentiation c) Capital requirement d) Switching costs e) Access to distribution channels f) Cost disadvantages independent of scale g) Government policy h) Expected retaliation j) International cartels

2. THE THREAT OF SUBSTITUTION New inventions are always taking place and new and better products replace existing

ones. An industry that can be replaced by substitutes or is threatened by substitutes is

normally an industry one must be careful of investing in. An industry where this

occurs constantly is the packaging industry -bottles replaced by cans, cans replaced by

plastic bottles, and the like. To ward off the threat of substitution, companies often

have to spend large sums of money in advertising and promotion.

3. BARGAINING POWER OF THE BUYERS In an industry where buyers have control, i.e. in a buyer's market, buyers are

constantly forcing prices down, demanding better services or higher quality and this

often erodes profitability. The factors one should check are whether:

a) A particular buyer buys most of the products (large purchase volumes). If such

buyers withdraw their patronage, they can destroy an industry. They can also force

prices down.

42


b) Buyers can play one company against another to bring prices down.

4. BARGAINING POWER FOR THE SUPPLIERS An industry unduly controlled by its suppliers is also under threat. This occurs when:

a) The suppliers have a monopoly, or if there are few suppliers.

b) Suppliers control an essential.

c) Demand for the product exceeds.

d) The supplier supplies to various industries.

e) The switching costs are high.

f) The supplier's product does not have a substitute.

g) The supplier's product is an important input for the buyer's.

h) The buyer is not important to the supplier.

i) The supplier's product is unique.

5. RIVALRY AMONG COMPETITORS Rivalry among competitors can cause an industry great harm. This occurs mainly by

price cuts, heavy advertising, additional high cost services or offers, and the like. This

rivalry occurs mainly when:

a) There are many competitors and supply exceeds demand. Companies resort to price

cuts and advertise heavily in order to attract customers for their goods.

b) The industry growth is slow and companies are competing with each other for a

greater market share.

c) The economy is in a recession and companies cut the price of their products and

offer better service to stimulate demand.

d) There is lack of differentiation between the product of one company and that of

another. In such cases, the buyer makes his choice on the basis of price or service.

e) In some industries economies of scale will necessitate large additions to existing

capacities in a company. The increase in production could result in over capacity &

price cutting.

f) Competitors may have very different strategies in selling their goods and in

competing they may be continuously trying to stay ahead

43


III. COMPANY ANALYSIS:

At the final stage of fundamental analysis, the investor analyzes the company. This

analysis has two thrusts:

How has the company performed vis--vis other similar companies and

How has the company performed in comparison to earlier years

It is imperative that one completes the politico economic analysis and the industry

analysis before a company is analyzed because the company's performance at a period

of time is to an extent a reflection of the economy, the political situation and the

industry. What does one look at when analyzing a company?

The different issues regarding a company that should be examined are:

The Management

The Company

The Annual Report

Ratios

Cash flow

THE MANAGEMENT:

The single most important factor one should consider when investing in a company

and one often never considered is its management.

In India management can be broadly

divided in two types:

Family Management

Professional Management

THE COMPANY:

An aspect not necessarily examined during an analysis of fundamentals is the

company. A company may have made losses consecutively for two years or more and

one may not wish to touch its shares - yet it may be a good company and worth

purchasing into. There are several factors one should look at.

1. How a company is perceived by its competitors? One of the key factors to ascertain is how a company is perceived by its competitors.

It is held in high regard. Its management may be known for its maturity, vision,

competence and aggressiveness. The investor must ascertain the reason and then

determine whether

44


the reason will continue into the foreseeable future.

2. Whether the company is the market leader in its products or in its segment Another aspect that should be ascertained is whether the company is the market leader

in its products or in its segment. When you invest in market leaders, the risk is less.

The

shares of market leaders do not fall as quickly as those of other companies. There is a

magic to their name that would make individuals prefer to buy their products as

opposed to others.

3. Company Policies The policy a company follows is also important. What is its plans for growth? What is

its vision? Every company has a life. If it is allowed to live a normal life it will grow

upto a point and then begin to level out and eventually die. It is at the point of leveling

out that it must be given new life. This can give it renewed vigour and a new lease of

life.

4. Labour Relations Labour relations are extremely important. A company that has motivated, industrious

work force has high productivity and practically no disruption of work. On the other

hand, a company that has bad industrial relations will lose several hundred mandays

as a consequence of strikes and go slows.

5. Where the company is located and where its factories are? One must also consider where the companies Plants and Factories are located..

THE ANNUAL REPORT:

The primary and most important source of information about a company is its Annual

Report. By law, this is prepared every year and distributed to the shareholders. Annual

Reports are usually very well presented. A tremendous amount of data is given about

the performance of a company over a period of time.

The Annual Report is broken down into the following specific parts:

A) The Director's Report,

B) The Auditor's Report,

C) The Financial Statements, and

D) The Schedules and Notes to the Accounts.

45


A. The Directors Report The Directors Report is a report submitted by the directors of a company to its

shareholders, advising them of the performance of the company under their

stewardship.

1. It enunciates the opinion of the directors on the state of the economy and the

political situation vis--vis the company.

2. Explains the performance and the financial results of the company in the period

under review. This is an extremely important part. The results and operations of the

various separate divisions are usually detailed and investors can determine the reasons

for their good or bad performance.

3. The Directors Report details the company's plans for modernization, expansion

and diversification. Without these, a company will remain static and eventually

decline.

4. Discusses the profit earned in the period under review and the dividend.

Recommended by the directors. This paragraph should normally be read with some

skepticism, as the directors will always argue that the performance was satisfactory. If

adverse economic conditions are usually at fault.

5. Elaborates on the directors' views of the company's prospects in the future.

6. Discusses plans for new acquisition and investments. An investor must

intelligently evaluate the issues raised in a Directors Report. Industry conditions and

the management's knowledge of the business must be considered.

B. The Auditor's Report The auditor represents the shareholders and it is his duty to report to the shareholders

and the general public on the stewardship of the company by its directors. Auditors

are required to report whether the financial statements presented do, in fact, present a

true and fair view of the state of the company. Investors must remember that the

auditors are their representatives and that they are required by law to point out if the

financial statements are not true and fair..

C.Financial Statements The published financial statements of a company in an Annual Report consist of its

Balance Sheet as at the end of the accounting period detailing the financing condition

46


of the company at that date, and the Profit and Loss Account or Income Statement

summarizing the activities of the company for the accounting period.

BALANCE SHEET

The Balance Sheet details the financial position of a company on a particular date; of

the company's assets (that which the company owns), and liabilities (that which the

company

owes), grouped logically under specific heads. It must however, be noted that the

Balance Sheet details the financial position on a particular day and that the position

can be materially different on the next day or the day after.

SOURCES OF FUNDS SHAREHOLDERS FUNDS SHARE CAPITAL (i) Private Placement

(ii) Public Issue

iii) Rights issues

RESERVES i) Capital Reserves

ii) Revenue Reserves

LOAN FUNDS i) Secured loans:

ii) Unsecured loans

FIXED ASSETS INVESTMENTS STOCK OR INVENTORIES i) Raw materials

ii) Work in progress

iii) Finished goods

47


CASH AND BANK BALANCES LOANS AND ADVANCES PROFIT AND LOSS ACCOUNT The Profit and Loss account summarizes the activities of a company during an

accounting period which may be a month, a quarter, six months, a year or longer, and

the result achieved by the company. It details the income earned by the company, its

cost and the resulting profit or loss. It is, in effect, the performance appraisal not only

of the company but also of its management- its competence, foresight and ability to

lead.

RATIOS:

Ratios express mathematically the relationship between performance figures and/or

assets/liabilities in a form that can be easily understood and interpreted.

No single ratio tells the complete story Ratios can be broken down into four broad categories:

(A) Profit and Loss Ratios These show the relationship between two items or groups of items in a profit and loss

account or income statement. The more common of these ratios are:

1. Sales to cost of goods sold.

2. Selling expenses to sales.

3. Net profit to sales and

4. Gross profit to sales.

(B) Balance Sheet Ratios These deal with the relationship in the balance sheet such as :

1. Shareholders equity to borrowed funds.

2. Current assets to current liabilities.

3. Liabilities to net worth.

4. Debt to assets and

5. Liabilities to assets.

48


(C) Balance Sheet and Profit and Loss Account Ratios. These relate an item on the balance sheet to another in the profit and loss account such

as:

1. Earnings to shareholder's funds.

2. Net income to assets employed.

3. Sales to stock.

4. Sales to debtors and

5. Cost of goods sold to creditors.

(D) Financial Statements and Market Ratios These are normally known as market ratios and are arrived at by relative financial

figures to market prices:

1. Market value to earnings and

2. Book value to market value.

(a) Market value

(b) Earnings

(c) Profitability

(d) Liquidity

(e) Leverage

(f) Debt Service Capacity

(g) Asset Management/Efficiency

(h) Margins.

The major ratios that are considered:

(i) Market value

(ii) Price- earnings ratio

(iii) Market-to-book ratio

(iv) Earnings

(v) Earning per share

(vi) Dividend per share

(vii) Dividend payout ratio

(viii) Leverage ratios

(ix) Return on investments/total assets

49


CASH FLOW:

A statement of sources and uses begins with the profit for the year to which are added

the increases in liability accounts (sources) and from which are reduced the increases

in

asset accounts (uses). The net result shows whether there has been an excess or deficit

of funds and how this was financed. Investors must examine a company's cash flow as

it reveals exactly where the money came from how it was utilized. Investors must be

concerned if a company is financing either its inventories or paying dividends from

borrowings without real growth as that shows deterioration.

50


CHAPTER-6

DATA ANALYSIS AND

INTERPRETATIONS

51


FUNDAMENTAL ANALYSIS OF STOCKS

Basically fundamental analysis is covered in 3 parts :

1. Market/ economy analysis

2. Industry Analysis

3. Company Analysis

UAE EXCHANGE The Indian banking industry: sector overview

With the economic growth picking up pace and the investment cycle on the way to

recovery, the banking sector has witnessed a transformation in its vital role of

intermediating between the demand and supply of funds

Public sector banks have been very proactive in their restructuring initiatives be it in

technology implementation or pruning their loss assets. Windfall treasury gains made

in the falling interest rate regime were used for writing off the doubtful and loss

assets.

Retail lending (especially mortgage financing) formed a significant portion of the

portfolio for most banks and they customized their products to cater to the diverse

demands.

Apart from streamlining their processes through technology initiatives such as ATMs,

telephone banking, online banking and web based products, banks also resorted to

cross selling of financial products such as credit cards, mutual funds and insurance

policies to augment their fee based income.

52


PORTERS FIVE FORCES MODEL FOR THE BANKING INDUSTRY

1) BARRIERS TO ENTRY: a. Economies of scale: Since the existing players in the market are well

established and already have a customer base, they are able to bear the cost

of using the advantages of technology to their maximum advantage.

b. Capital requirement for entry: i. The Banking Regulation Act prescribes the minimum capital requirements for

a bank Moreover, banks have to maintain a capital adequacy ratio of 9%

under the Basel I norms.

ii. Government has declared that the foreign banks will be permitted to establish

their presence in India by way of setting up a wholly owned banking

subsidiary (WOS) with a minimum capital of Rs.300 crore.

c. Access to distribution channels: Since banks have to set up their own distribution channels, all the cost has to be directly born by them.

d. Cost advantage independent of size: Existing banks have huge databases of customers which they use when they want to sell a new product launched by

them.

e. Legislation or Government action: Banks are governed by Banking Regulation Act, 1949 which specifies the rules and regulations applicable to

banks. RBI is the governing body of banks in India.

2) BARGAINING POWER OF BUYERS:

Due to increased competition, the services offered by banks to customers have

improved considerably.

3) BARGAINING POWER OF THE SUPPLIERS:

Suppliers to banks can be both - the customers and RBI.

a. Customers of banks provide money to banks in the form of deposits

and in return earn some interest on that.

b. RBI acts as a supplier to banks by selling govt. securities, treasury

bills, govt. bonds, etc.

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c. Call money market: Banks sometimes have to borrow from other banks

to meet CRR and SLR requirements, or other capital requirements as

provided by RBI.

4) THREAT OF SUBSTITUTES:

a. Product-for-product substitution: i. Banks provide interest on deposits made by people. Similar services

are offered by post offices which may act as substitutes to the

deposit schemes of banks.

ii. Some banks offer locker services to customers for yearly rates.

Similar services are provided by many post offices.

b. Generic substitution: People who deposit their savings in banks can invest their money in other sources like mutual funds, shares and other

securities and life insurance schemes.

5) COMPETITIVE RIVALRY:

a. Extent of competitor balance: b. Market growth rates:.

c. High Exit Barriers PEST Analysis for Banking Industry.

1. Political factors-: The major factors affecting the banking sector are the following.

Banking sector reforms As per the RBI roadmap for reforms in the first

stage from 2005 to 2009 foreign banks will be allowed to set up wholly owned

subsidiaries as well as get greater freedom to set up new branches.

Fulfilling the minimum priority sector credit -The government mandation of

fulfilling the minimum priority sector credit (of which 18 per cent is food

credit) has forced the domestic banks to cater to this segment despite the low

profitability and vulnerability of asset quality.

Banks have also been allowed to set up Offshore Banking Units in SEZs

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2. Economic factors-:

Basell II norms for the risk management in banking sector - The new Basel Accord has its foundation on three mutually reinforcing pillars. The first pillar

is compatible with the credit risk, market risk and operational risk. The second

pillar gives the bank responsibility to exercise the best ways to manage the

risk specific to that bank.

Concurrently, it also casts responsibility on the supervisors to review and

validate banks risk measurement models. .

Consolidation and merger and acquisitions in the banking sector-. HDFC bank also acquired TIMES BANK in 2001 which increased its customer base

by 3 lakh customers.

Universal Banking has been introduced. ICICI Bank ,HDFCs closest competitor is already into Universal Banking so HDFC is also getting into it

as now it is providing retail banking and also depository facilities in the form

of demat account.

3. Social factors-

Big and growing middle class in India -: This has been a major factor in the growth of the retail loans like consumer loans in the form of home loans, car

loans, education loans, auto loans etc. Retail loans have grown from 19% in

FY99 to 51% FY06.Consumer credit accounts for a meager 28.6 per cent of

the country's GDP and the buoyancy in the economy offers sufficient scope for

it to grow.

Geographical and Cultural diversity- This is leading to a greater demand for financial products and customization by the customers.

4. Technical factors- The Indian Financial Network (INFINET) was inaugurated in June 1999. It is

based on satellite communication using VSAT technology and would enable

faster connectivity within the financial sector.

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Banks (All): No of players = 40

Sector statistics:

We see the sector aggregates and make a financial comparison for the major banks

Top Players FY2014 Based on Total Income Based on OPBDT

Total Income Change OPBDT Change

(Rs Mn) (%) (Rs Mn) (%)

ICICI BANK 63161.9 54.50 ICICI BANK 37174 19.36

PNB 29218 14.91 PNB 22205.2 39.36

WESTER UNION MONEY TRANSFER 27709.5 23.78

WESTER UNION MONEY TRANSFER 16882.5 19.53

BANK OF INDIA 23317 25.43

BANK OF INDIA 76352.8 -1.29

UAE EXCAHNGE 18550.8 60.24

UAE EXCHANGE 14324 27.48

% change - indicates the change between current and corresponding quarter.

56


UAE Exchange

Vs Indu

stry Leaders

Statistic Industry Leader UAE UAEBank

Market Capitalization BBV 75.96B 5.83B 13 / 24

P/E Ratio (ttm) BMA 84.36 30.04 2 / 24

PEG Ratio (ttm, 5 yr expected) BCA 3.22 0.64 16 / 24

Revenue Growth (Qtrly YoY) BFR 29.70% 45.60% 4 / 24

EPS Growth (Qtrly YoY) IRE 154.00% 33.90% 6 / 24

Long-Term Growth Rate (5 yr) KB 44.5% 30.0% 2 / 24

Return on Equity (ttm) BFR 91.21% N/A N/A

Long-Term Debt/Equity (mrq) N/A

Dividend Yield (annual) LYG 6.20% 0.70% 18 / 24

TOP FOREIGN REGIONAL BANKS COMPANIES BY MARKET CAP

Company Symbol Price Change Market Cap P/E

Banco Bilbao Vizcaya Argentaria BBV 22.40 0.09% 75.96B 14.83

Lloyds TSB Group plc LYG 39.59 0.13% 55.45B 21.52

ABN AMRO Holding N

exchange ratio ratio

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