impact of financial decisions on share price

7/30/2019 Impact of Financial Decisions on Share Price

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INTRODUCTION

Meaning of Financial Management

Financial Management means planning, organizing, directing and controlling the

financial activities such as procurement and utilization of funds of the enterprise. It

means applying general management principles to financial resources of the

enterprise.

Scope/Elements

1. Investment decisions includes investment in fixed assets (called as capitalbudgeting). Investment in current assets are also a part of investment decisions

called as working capital decisions.

2. Financial decisions - They relate to the raising of finance from variousresources which will depend upon decision on type of source, period of

financing, cost of financing and the returns thereby.

Dividend decision - The finance manager has to take decision with regards to the net

profit distribution. Net profits are generally divided into two:

a. Dividend for shareholders- Dividend and the rate of it has to bedecided.

b. Retained profits- Amount of retained profits has to be finalized whichwill depend upon expansion and diversification plans of the enterprise.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and

control of financial resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.2. To ensure adequate returns to the shareholders which will depend upon the

earning capacity, market price of the share, expectations of the shareholders.


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3. To ensure optimum funds utilization. Once the funds are procured, they shouldbe utilized in maximum possible way at least cost.

4. To ensure safety on investment, i.e, funds should be invested in safe venturesso that adequate rate of return can be achieved.

5. To plan a sound capital structure-There should be sound and fair compositionof capital so that a balance is maintained between debt and equity capital.

TYPES OF FINANCE FUNCTIONS/DECISIONS

The following explanation will help in understanding each finance function in detail

Investment Decision

One of the most important finance functions is to intelligently allocate capital to long

term assets. This activity is also known as capital budgeting. It is important to allocate

capital in those long term assets so as to get maximum yield in future. Following are

the two aspects of investment decision

a. Evaluation of new investment in terms of profitabilityb. Comparison of cut off rate against new investment and prevailing investment.

Since the future is uncertain therefore there are difficulties in calculation of expected

return. Along with uncertainty comes the risk factor which has to be taken into

consideration. This risk factor plays a very significant role in calculating the expected

return of the prospective investment. Therefore while considering investment proposal

it is important to take into consideration both expected return and the risk involved.

Investment decision not only involves allocating capital to long term assets but also

involves decisions of using funds which are obtained by selling those assets which

become less profitable and less productive. It wise decisions to decompose

depreciated assets which are not adding value and utilize those funds in securing other

beneficial assets. An opportunity cost of capital needs to be calculating while

dissolving such assets. The correct cut off rate is calculated by using this opportunity

cost of the required rate of return (RRR)


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Financial Decision

Financial decision is yet another important function which a financial manger must

perform. It is important to make wise decisions about when, where and how should a

business acquire funds. Funds can be acquired through many ways and channels.

Broadly speaking a correct ratio of an equity and debt has to be maintained. This mix

of equity capital and debt is known as a firms capital structure. A firm tends to

benefit most when the market value of a companys share maximizes this not only is a

sign of growth for the firm but also maximizes shareholders wealth. On the other hand

the use of debt affects the risk and return of a shareholder. It is more risky though it

may increase the return on equity funds. A sound financial structure is said to be one

which aims at maximizing shareholders return with minimum risk. In such a scenario

the market value of the firm will maximize and hence an optimum capital structure

would be achieved. Other than equity and debt there are several other tools which are

used in deciding a firm capital structure.

Dividend Decision

Earning profit or a positive return is a common aim of all the businesses. But the key

function a financial manger performs in case of profitability is to decide whether to

distribute all the profits to the shareholder or retain all the profits or distribute part of

the profits to the shareholder and retain the other half in the business. Its the financial

managers responsibility to decide a optimum dividend policy which maximizes the

market value of the firm. Hence an optimum dividend payout ratio is calculated. It is a

common practice to pay regular dividends in case of profitability Another way is to

issue bonus shares to existing shareholders.

Liquidity Decision

It is very important to maintain a liquidity position of a firm to avoid insolvency.

Firms profitability, liquidity and riskall are associated with the investment in current

assets. In order to maintain a tradeoff between profitability and liquidity it is

important to invest sufficient funds in current assets. But since current assets do not

earn anything for business therefore a proper calculation must be done before

investing in current assets. Current assets should properly be valued and disposed of


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from time to time once they become non profitable. Currents assets must be used in

times of liquidity problems and times of insolvency.

Role of finance functions in organizational processes

Contemporary organizations need to practice cost control if they are to survive the

recessionary times. Given the fact that many top tier companies are currently mired in

low growth and less activity situations, it is imperative that they control their costs as

much as possible. This can happen only when the finance function in these companies

is diligent and has a hawk eye towards the costs being incurred. Apart from this,

companies also have to introduce efficiencies in the way their processes operate and

this is another role for the finance function in modern day organizations. Further,

there must be synergies between the various processes and this is where the finance

function can play a critical role. Lest one thinks that the finance function, which is

essentially a support function, has to do this all by themselves, it is useful to note that,

many contemporary organizations have dedicated project office teams for each

division, which perform this function. In other words, whereas the finance function

oversees the organizational processes at a macro level, the project office teams

indulge in the same at the micro level. This is the reason why finance and project

budgeting and cost control have assumed significance because after all, companies

exist to make profits and finance is the lifeblood that determines whether

organizations are profitable or failures.

The Pension Fund Management and Tax Activities of the Finance Function

The next role of the finance function is in payroll, claims processing, and acting as the

repository of pension schemes and gratuity. If the US follow the 401(k) rule and the

finance function manages the defined benefit and defined contribution schemes, in

India it is the EPF or the Employee Provident Funds that are managed by the finance

function. Of course, only large organizations have dedicated EPF trusts to take care of

these aspects and the norm in most other organizations is to act as facilitators for the

EPF scheme with the local or regional PF (Provident Fund) commissioner. The third

aspect of the role of the finance function is to manage the taxes and their collection at

source from the employees. Whereas in the US, TDS or Tax Deduction at Source

works differently from other countries, in India and much of the Western world, it is


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mandatory for organizations to deduct tax at source from the employees

commensurate with their pay and benefits. The finance function also has to coordinate

with the tax authorities and hand out the annual tax statements that form the basis of

the employees tax returns. Often, this is a sensitive and critical process since the tax

rules mandate very strict principles for generating the tax statements.

Payroll, Claims Processing, and Automation

We have discussed the pension fund management and the tax deduction. The other

role of the finance function is to process payroll and associated benefits in time and in

tune with the regulatory requirements. Further, claims made by the employees with

respect to medical, and transport allowances have to be processed by the finance

function. Often, many organizations automate this routine activity wherein the use of

ERP (Enterprise Resource Planning) software and financial workflow automation

software make the job and the task of claims processing easier. Having said that, it

must be remembered that the finance function has to do its due diligence on the

claims being submitted to ensure that bogus claims and suspicious activities are found

out and stopped. This is the reason why many organizations have experienced

chartered accountants and financial professionals in charge of the finance function so

that these aspects can be managed professionally and in a trustworthy manner. The

key aspect here is that the finance function must be headed by persons of high

integrity and trust that the management reposes in them must not be misused. In

conclusion, the finance function though a non-core process in many organizations has

come to occupy a place of prominence because of these aspects.

Definition

For making proper investment involving both risk and return, the investor has to make

study of the alternative avenues of the investment-their risk and return characteristics,

and make a proper projection or expectation of the risk and return of the alternative

investments under consideration. He has to tune the expectations to this preference of

the risk and return for making a proper investment choice. The process of analyzing

the individual securities and the market as a whole and estimating the risk and return

expected from each of the investments with a view to identify undervalues securities


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for buying and overvalues securities for selling is both an art and a science that is

what called security analysis.

Security

The security has inclusive of shares, scripts, bonds, debenture stock or any other

marketable securities of like nature in or of any debentures of a company or body

corporate, the government and semi government body etc.

In the strict sense of the word, a security is an instrument of promissory note or a

method of borrowing or lending or a source of contributing to the funds need by a

corporate body or non-corporate body, private security for example is also a security

as it is a promissory note of an individual or firm and gives rise to claim on money.

But such private securities of private companies or promissory notes of individuals,

partnership or firm to the intent that their marketability is poor or nil, are not part of

the capital market and do not constitute part of the security analysis.

Analysis of securities

Security analysis in both traditional sense and modern sense involves the projection of

future dividend or ensuring flows, forecast of the share price in the future and

estimating the intrinsic value of a security based on the forecast of earnings or

dividend.

Security analysis in traditional sense is essentially on analysis of the fundamental

value of shares and its forecast for the future through the calculation of its intrinsic

worth of share.

Modern security analysis relies on the fundamental analysis of the security, leading to

its intrinsic worth and also rise-return analysis depending on the variability of the

returns, covariance, safety of funds and the projection of the future returns.

If the security analysis based on fundamental factors of the company, then the forecast

of the share price has to take into account inevitably the trends and the scenario in the

economy, in the industry to which the company belongs and finally the strengths and

weaknesses of the company itself. Its management, promoters backward, financial

results, projection of expansion, term planning etc.


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Approaches to Security Analysis

Fundamental Analysis Technical Analysis Efficient Market Hypothesis

FUNDAMENTAL ANALYSIS

It's a logical and systematic approach to estimating the future dividends & share price

as these two constitutes the return from investing in shares. According to this

approach, the share price of a company is determined by the fundamental factors

affecting the Economy/ Industry/ Company such as Earnings Per Share, DIP ratio,

Competition, Market Share, Quality of Management etc. it calculates the true worth of

the share based on it's present and future earning capacity and compares it with the

current market price to identify the mis-priced securities.

Fundamental analysis involves a three-step examination, which calls for

1. Understanding of the macro-economic environment and developments.2. Analysing the prospects of the 9ndustry to which the firm belongs3. Assessing the projected performance of the company.

MACRO ECONOMIC ANALYSIS

The macro-economy is the overall economic environment in which all firms operate.

The key variables commonly used to describe the state of the macro-economy are

Growth Rate of Gross Domestic Product (GDP)

The Gross Domestic Product is measure of the total production of final goods

and services in the economy during a specified period usually a year. The growth rate

0 GDP is the most important indicator of the performance of the economy. The higher

the growth rate of GDP, other things being equal, the more favourable it is for the

stock market.


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Industrial Growth Rate

The stock market analysts focus more on the industrial sector. They look at the overall

industrial growth rate as well as the growth rates of different industries.

The higher the growth rate of the industrial sector, other things being equal,

the more favourable it is for the stock market.

Agriculture and Monsoons

Agriculture accounts for about a quarter of the Indian economy and has

important linkages, direct and indirect, with industry. Hence, the increase or decrease

of agricultural production has a significant bearing on industrial production andcorporate performance.

A spell of good monsoons imparts dynamism to the industrial sector and

buoyancy to the stock market. Likewise, a streak of bad monsoons casts its shadow

over the industrial sector and the stock market.

Savings and Investments

The demand for corporate securities has an important bearing on stock price

movements. So investment analysts should know what is the level of investment in

the economy and what proportion of that investment is directed toward the capital

market. The analysts should also know what are the savings and how the same are

allocated over various instruments like equities, bonds, bank deposits, small savings

schemes, and bullion. Other things being equal, the higher the level of savings and

investments and the greater the allocation of the same over equities, the more

favourable it is for the stock market.

Government Budget and Deficit

Government plays an important role in most economIes. The excess of government

expenditures over governmental revenues represents the deficit. While there are

several measures for deficit, the most popular measure is the fiscal deficit.

The fiscal deficit has to be financed with government borrowings, which isdone in three ways.


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1. The government can borrow from the reserve bank of India.2. The government can resort to borrowing in domestic capital market.

3.

The government may borrow from abroad.

Investment analysts examine the government budget to assess how it is likely to

impact on the stock market.

Price Level and Inflation

The price level measures the degree to which the nominal rate of growth in

GDP is attributable to the factor of inflation. The effect of inflation on the corporate

sector tends to be uneven. While certain industries may benefit, others tend to suffer.

Industries that enjoy a strong market for there products and which do not come under

the purview of price control may benefit. On the other hand, industries that have a

weak market and which come under the purview of price control tend to lose. On the

whole, it appears that a mild level of inflation is good for the stock market.

Interest Rate

Interest rates vary with maturity, default risk, inflation rate, produc6ivity of capital,

special features, and so on. A rise in interest rates depresses corporate profitability

and also leads to an increase in the discount rate applied by equity investors, both of

which have an adverse impact on stock prices. On the other hand, a fall in interest

rates improves corporate profitability and also leads to a decline in the discount rate

applied by equity investors, both of which have a favourable impact on stock prices.

Balance of Payments, Forex Reserves, and Exchange Rates

The balance of payments deficit depletes the forex reserves of the country and

has an adverse impact on the exchange rate; on the other hand a balance of payments

surplus augments the forex reserves of the country and has a favourable impact on the

exchange rate.


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Infrastructural Facilities and Arrangements

Infrastructural facilities and arrangements significantly influence industrial

performance. More specifically, the following are important

Adequate and regular supply of electric power at a reasonable tariff. A well developed transportation and communication system (railway

transportation, road network, inland waterways, port facilities, air links, and

telecommunications system).

An assured supply of basic industrial raw materials like steel, coal, petroleumproducts, and cement.

Responsive financial support for fixed assets and working capital.Sentiments

The sentiments of consumers and businessmen can have an important bearing

on economic performance. Higher consumer confidence leads to higher expenditure

on biggticket items. Higher business confidence gets translated into greater business

investment that has a stimulating effect on the economy. Thus, sentiments influence

consumption and investment decisions and have a bearing on the aggregate demand

for goods and services.

TECHNICAL ANALYSIS

Technical analysis involves a study of market-generated data like prices and

volumes to determine the future direction of price movement. Technical analysis

analyses internal market data with the help of charts and graphs. Subscribing to the

'castles in the air' approach, they view the investment game as an excercise in

anticipating the behaviour of market participants. They look at charts to understand

what the market participants have been doing and believe that this provides a basis for

predicting future behaviour.


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Definition

" The technical approach to investing is essentially a reflection of the idea that

prices move in trends which are determined by the changing attitudes of investors

toward a variety of economic, monetary, political and psychological forces. The art of

technical analysis- for it is an art - is to identify trend changes at an early stage and to

maintain an investment posture until the weight of the evidence indicates that the

trend has been reversed."

-Martin J. Pring

Charting techniques in technical analysis

Technical analysis uses a variety of charting techniques. The most popular

ones are

The Dow theory, Bar and line charts, The point and figure chart, The moving averages line and The relative strength line.

FUNDAMENTAL ANALYSIS

Fundamental analysis of a business involves analyzing its financial statements and

health, its management and competitive advantages, and its competitors andmarkets.

When applied to futures and forex, it focuses on the overall state of the economy,

interest rates, production, earnings, and management. When analyzing a stock, futures

contract, or currency using fundamental analysis there are two basic approaches one

can use; bottom up analysis and top down analysis.[1]The term is used to distinguish

such analysis from other types ofinvestment analysis, such as quantitative

analysis and technical analysis.
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Fundamental analysis is performed on historical and present data, but with the goal of

making financial forecasts. There are several possible objectives:

to conduct a company stock valuation and predict its probable price evolution, to make a projection on its business performance, to evaluate its management and make internal business decisions,

Two analytical models

When the objective of the analysis is to determine what stock to buy and at what

price, there are two basic methodologies

1. Fundamental analysis maintains that markets may misprice a security in theshort run but that the "correct" price will eventually be reached. Profits can be

made by purchasing the mispriced security and then waiting for the market to

recognize its "mistake" and reprice the security.

2. Technical analysis maintains that all information is reflected already in thestock price. Trends 'are your friend' and sentiment changes predate and predict

trend changes. Investors' emotional responses to price movements lead to

recognizable price chart patterns. Technical analysis does not care what the

'value' of a stock is. Their price predictions are only extrapolations from

historical price patterns.

Investors can use any or all of these different but somewhat complementary methods

for stock picking. For example many fundamental investors use technicals for

deciding entry and exit points. Many technical investors use fundamentals to limittheir universe of possible stock to 'good' companies.

The choice of stock analysis is determined by the investor's belief in the different

paradigms for "how the stock market works". See the discussions at efficient-market

hypothesis, random walk hypothesis, capital asset pricing model, Fed model Theory

of Equity Valuation, market-based valuation, and behavioral finance.
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Fundamental analysis includes:

1. Economic analysis

2.

Industry analysis

3. Company analysisOn the basis of these three analyses the intrinsic value of the shares are determined.

This is considered as the true value of the share. If the intrinsic value is higher than

the market price it is recommended to buy the share . If it is equal to market price

hold the share and if it is less than the market price sell the shares.

Use by different portfolio styles

Investors may use fundamental analysis within different portfolio management styles.

Buy and holdinvestors believe that latching onto good businesses allows theinvestor's asset to grow with the business. Fundamental analysis lets them find

'good' companies, so they lower their risk and probability of wipe-out.

Managers may use fundamental analysis to correctly value 'good' and 'bad'companies. Eventually 'bad' companies' stock goes up and down, creating

opportunities for profits.

Managers may also consider the economic cycle in determining whetherconditions are 'right' to buy fundamentally suitable companies.

Contrarian investors distinguish "in the short run, the market is a votingmachine, not a weighing machine".

[2]

Fundamental analysis allows you tomake your own decision on value, and ignore the market.

Value investorsrestrict their attention to under-valued companies, believingthat 'it's hard to fall out of a ditch'. The value comes from fundamental

analysis.

Managers may use fundamental analysis to determine future growth rates forbuying high priced growth stocks.
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Managers may also include fundamental factors along with technical factorsinto computer models (quantitative analysis).

Top-down and bottom-up

Investors can use either a top-down or bottom-up approach.

The top-down investor starts his or her analysis with global economics,including both international and national economic indicators, such

as GDP growth rates, inflation, interest rates,exchange rates, productivity, and

energy prices. He or she narrows his or her search down to regional/industry

analysis of total sales, price levels, the effects of competing products, foreign

competition, and entry or exit from the industry. Only then does he or she

narrow his or her search to the best business in that area.

The bottom-up investor starts with specific businesses, regardless of theirindustry/region.

Procedures

The analysis of a business' health starts with financial statement analysis thatincludes ratios. It looks at dividends paid, operating cash flow, new equity issues and

capital financing. The earnings estimates and growth rate projections published

widely by Thomson Reuters and others can be considered either 'fundamental' (they

are facts) or 'technical' (they are investor sentiment) based on your perception of their

validity.

The determined growth rates (of income and cash) and risk levels (to determine

the discount rate) are used in various valuation models. The foremost is

the discounted cash flow model, which calculates the present value of the future

dividends received by the investor, along with the eventual sale price. (Gordonmodel)

earnings of the company, or

cash flows of the company.
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The amount of debt is also a major consideration in determining a company's health.

It can be quickly assessed using the debt-to-equity ratio and the current ratio (current

assets/current liabilities).

The simple model commonly used is the Price/Earnings ratio. Implicit in this model

of a perpetual annuity (Time value of money) is that the 'flip' of the P/E is the

discount rate appropriate to the risk of the business. The multiple accepted is adjusted

for expected growth (that is not built into the model).

Growth estimates are incorporated into the PEG ratio, but the math does not hold up

to analysis.[citation needed] Its validity depends on the length of time you think the growth

will continue. IGAR models can be used to impute expected changes in growth from

current P/E and historical growth rates for the stocks relative to a comparison index.

Computer modelling of stock prices has now replaced much of the subjective

interpretation of fundamental data (along with technical data) in the industry. Since

about year 2000, with the power of computers to crunch vast quantities of data, a new

career has been invented. At some funds (called Quant Funds) the manager's decisions

have been replaced by proprietary mathematical models.

Criticisms

Economists such as Burton Malkiel suggest that neither fundamental analysisnortechnical analysis is useful in outperforming the markets[4]

FUNDAMENTAL FACTORS

economic growth (gross domestic product, industrial production, etc.); money growth in the domestic market; inflation and inflation expectations; interest rate; solvency of the country and confidence in the currency in the world market; speculation in the foreign exchange market; the degree of development of other sectors of the global financial market, such

as the securities market, competing with the foreign exchange market.
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Exports and imports

The stronger the desire for foreign goods and services used abroad, the higher the

price has to offer for foreign currency. With the growth of national income increases

the demand for imported goods. This causes a tendency to reduce the cost of the

national currency. On the other hand, the higher the national income abroad reduces

the price of foreign currency. All this happens because of "the country's propensity to

import": the growth of national income leads to increased imports of almost the same

extent that the increased domestic consumption.

capital flows

If investors are seeking more foreign debt, bonds, stocks, bank deposits or cash, they

bid up the price of foreign currency. In contrast, payments to other countries in a

particular state contributed to the increasing rate of its currency.

This factor, which determines the movement of capital, which is closely related to

currency speculation. If it were only on the export of goods and payments for current

transactions, the foreign exchange rate, could have been dull and fluctuated only

slightly.

Thus, small fluctuations in the exchange rate is often exacerbated by spontaneous

movements of "hot money" that move from one country to another at any hearing of

the impending problems, change of political direction or currency fluctuations. When

this "capital flight" begins on a large scale in one direction, it can lead to sharp

movements in exchange rates and even a financial crisis. The output data and the

expectation

On the concept of "data" may include the following events: exit (publication)

economic indicators of host countries traded currencies, the reported changes in

interest rates in these countries, reviews the state of economies and other events that

have a significant impact on the foreign exchange market (for example, the end of the

financial in Japan on March 31, presentation of the Minister of Finance to Parliament

the draft state budget, etc.).


17/31

Waiting for an event and the onset of this event are powerful engines of exchange

rates. Hard to say, which has a strong influence on the market, the event itself, or its

expectation, but we can say with confidence that the output of major data can lead to

significant and lasting movements in exchange rates. These include: Nonfarm

payrolls, GDP, Industrial production, CPI, PPI, and others.

Date and time of release of an indicator known in advance. There are so-called

calendar of economic indicators and the most important events in the life of the

individual states (with specific dates or approximate time of their release). For these

events, the market is prepared. There are expectations and forecasts of the value of an

indicator can go and how it can be interpreted.

The output data can lead to sharp fluctuations in exchange rates. Depending on how

market participants apostrophe and interprets a given indicator, the rate can go as one

and the other side. This movement of course can lead to a strengthening of an existing

trend, it correction or the beginning of a new trend. Or that the outcome depends on

several factors: market conditions, economic conditions of host countries examined

rates, preliminary expectations and sentiment, and, finally, the values of a particular

indicator.

For example, after a series of increasing values of indicators: GDP, Nonfarm payrolls,

CPI, PPI may appear on the market talk of a possible increase in U.S. interest rates.

Even if this change occurs within a few months now actively start to buy U.S. dollars

against other currencies. Thus, the up-trend begins in the U.S. dollar - a steady

strengthening of the dollar against other currencies. After the release of posts about

changing rates could begin the correction in this movement.

With the release of any data (or any information affecting the market) are related to

the following proverb: "Sell the good data on exit (sell good news), and "buy on

rumor, sell on fact (buy on rumor, sell on fact .) These sayings are suitable for

situations when the market expects of an event.

Even before the release of information about the event there is a movement of the

course in a certain direction (the direction of the interpretation of future events), ie

market is "laid." So often after the data (if the information meets expectations) ismoving in the opposite direction. This is due to the fact that expectations were open


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position and when there was something waiting for - is the closure of these positions.

There is a so-called profit taking (removal of profits). Situations where these events

occur, characterized by the expression priced in (ie the onset of this event is already

built into the price - which means a rate of one currency against another). Activity

Funds

The first place for its effect on long-term trends in the movement of exchange rates

hold funds (hedge funds, investment, insurance, pension). One of the directions of

their activity - it is investing in certain currencies. With its huge resources, they are

able to make the course a long time to move in a certain direction. Management of the

funds involved in fund managers (fund managers). They are true professionals.

The largest and most active are American funds, which have assets in the hundreds of

billions of dollars. In order to maximize the benefits of asset allocation from time to

time they change the structure of the investment portfolio, investing in various

investment vehicles - stocks of corporations, government and private bonds, bank

deposits, etc. If it turns out that the profitability of foreign bonds is higher than

domestic, this leads to massive sale of the latter, transfer of funds from the national

currency in foreign money and investing in foreign securities. The national currency

at the same time decreases.

A more thorough study of this factor can be reduced to the level of interest rates and

the overall profitability of investment in the economy, which is a root cause of these

changes, while the movement of capital - is a direct process that leads to a medium of

exchange rate changes.

Quotes from politicians

The statements that may affect the movement of exchange rates, appear during the

various reports, summits, meetings, press conferences, etc. (For example, the G7

leaders meeting or a press conference after a discussion of interest rates).

The journalists of news agencies (Reuters, Bloomberg, etc.) are closely monitoring

such speeches, and in real-time hottest insert statements in the news columns of their

agencies (so-called hot lines or hot news). By the force of impact on the market these

statements can be compared to economic indicators.


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Most often, the date and time of a speech known. For these events, the market is

prepared, so shortly before the onset of their predictions or rumors emerge that can be

said and how it can be interpreted. However, there are times when it happens

suddenly on the market. Then the market could start strong movements in exchange

rates, which are not always predictable.

Thus, after the sensational reports of the resignation of Finance Minister Oskar

Lafontaine of Germany (Oskar Lafontaine), known for his leftist views, the single

European currency (euro) against the U.S. dollar has risen by almost 400 points in just

two hours.

If these or other statements carry a long-term effects (eg, the ability to change interest

rates, the principles of formation of the state budget, etc.), these movements can

become a long-term trends.

For example, two times a year (winter and summer), all markets are closely watching

the performances of the head of the Federal Reserve Alan Greenspan before the two

banking committees of the U.S. Congress (Humphrey Hawkins testimony). During

these presentations, market participants are attempting to find in his words, even a

small hint at the future direction of changes in interest rates in the United States.

Depending on how market participants apostrophe and interprets the words of

Greenspan may be established or that the trend of the U.S. dollar.

In relation to the political leaders there is such a thing as "ogovarivanie course." This

means that at some point in time when the currency reaches levels that are

unfavorable for a particular state, they begin to say that, in their opinion, the course is

not going on that they will not allow further movement is possible that the

intervention and so n And because these people are afraid to trust, or their powers and

knowledge, then their words are beginning to have a direct impact on the market.

When the course is truly at a critical level, then the following statements may be

followed by interventions by central banks. And this is a very strong event - the

course can take more than one hundred points towards the direction of intervention in

a short time (sometimes minutes). In addition, the intervention may cause market

participants wary of open positions in the old direction. This, in turn, could lead to alandslide movements of the exchange rate.


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FUNDAMENTAL ANALYSIS TOOLS

PEG

So is a stock with a high P/E ratio always overvalued? Not necessarily. The stockcould have a high P/E ratio because investors are convinced that it will have strong

earnings growth in the future and so they bid up the stocks price now. Fortunately,

there is another ratio that you can use that takes into consideration a stocks projected

earnings growth: its called the PEG. PEG is calculated by taking a stocks P/E ratio

and dividing by its expected percentage earnings growth for the next year. So, a stock

with a P/E ratio of 40 that is expected to grow its earnings by 20% the next year

would have a PEG of 2. In general, the lower the PEG, the better the value, because

you would be paying less for each unit of earnings growth.

Dividend Yield

The dividend yield measures what percentage return a company pays out to its

shareholders in the form of dividends . It is calculated by taking the amount of

dividends paid per share over the course of a year and dividing by the stocks price.

For example, if a stock pays out $2 in dividends over the course of a year and trades

at $40, then it has a dividend yield of 5%.

Dividend Payout Ratio

The dividend payout ratio shows what percentage of a companys earnings it is

paying out to investors in the form of dividends. It is calculated by taking the

companys annual dividends per share and dividing by its annual earnings per share

(EPS). So, if a company pays out $1 per share annually in dividends and it has an EPS

of $2 for the year, then that company has a dividend payout ratio of 50%; in other

words, the company paid out 50% of its earnings in dividends. Companies that

distribute dividends typically use about 25% to 50% of their earnings for dividend

payments. The higher the payout ratio, the less confidence the company has that it

wouldve been able to find better uses for the money it earned. This is not necessarily

either good or bad; companies that are still growing will tend to have lower dividend

payout ratios than very large companies, because they are more likely to have other

productive uses for the earnings.


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Book Value

The book value of a company is the companys net worth, as measured by its total

assets minus its total liabilities. This is how much the company would have left over

in assets if it went out of business immediately. Since companies are usually expected

to grow and generate more profits in the future, most companies end up being worth

far more in the marketplace than their book value would suggest. For this reason,

book value is of more interest to value investors than growth investors. In order to

compare book values across companies, you should use book value per share, which

is simply the companys last quarterly book value divided by the number of shares of

stock it has outstanding.

Price / Book

A companys price-to-book ratio (P/B ratio) is determined by taking the companys

per share stock price and dividing by the companys book value per share. For

instance, if a company currently trades at $100 and has a book value per share of $5,

then that company has a P/B ratio of 20. The higher the ratio, the higher the premium

the market is willing to pay for the company above its hard assets. Price-to-book ratio

is of more interest to value investors than growth investors.

Price / Sales Ratio

As with earnings and book value, you can find out how much the market is valuing a

company by comparing the companys price to its annual sales. This measure is

known as the price-to-sales ratio (P/S or PSR). You can calculate the P/S by taking

the stocks currentprice and dividing by the companys total sales per share for the

past year (or equivalently, by dividing the entire companys market cap by its total

sales). That means that a company whose stock trades at $1 per share and which had

$2 per share in sales last year will have a P/S of 0.5. Low P/S ratios (below one) are

usually thought to be the better investment since their sales are priced cheaply.

However, P/S, like P/E ratios and P/B ratios, are numbers that are subject to much

interpretation and debate. Sales obviously dont reveal the whole picture: a company

could be selling dollar bills for 90 cents each, and have huge sales but be terribly

unprofitable. Because of the limitations, P/S ratios are usually used only forunprofitable companies, since such companies dont have a P/E ratio .


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Return on Equity

Return on equity (ROE) shows you how much profit a company generates in

comparison to its book value . The ratio is calculated by taking a companys after-tax

income (after preferred stock dividends but before common stock dividends) and

dividing by its book value (which is equal to its assets minus its liabilities). It is used

as a general indication of the companys efficiency; in other words, how much profit

it is able to generate given the resources provided by its stockholders. Investors

usually look for companies with ROEs that are high and growing.

FACTORS AFFECTING SHARE PRICES

A company has a number of stocks available for investors to purchase via the stock

market. If the stock becomes popular with investors, they buy the stock. Thats an

increase in demand. That results in less supply (less stocks available for purchasing).

This causes the stock price to go up. If there are less stocks available to be purchased,

then whatever shares are left in circulation, are worth more.

So, the buying causes the stock price to go up. Rising stocks tend to attract more

buyers. Everybody wants a piece of the action.

If a particular stock becomes unpopular with investors the stock gets sold. More

stocks become available for purchase on the stock market. So, demand goes down,

supply goes up. There are more stocks available in the market, causing the value of

the stock price to go down.

Selling tends to attract more sellers. The stock price goes down.

FACTORS AFFECTING SHARE PRICES

Investor sentiment

In the short-term, stock prices move according to investor sentiment. Investor

sentiment is a collective term that represents the expectations of the majority of stock

market participants.

People buy a stock because they expect its price to rise. People sell a stock becausethey expect its price to fall.


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Investor sentiment can be either positive (rising stock prices) or negative (falling

stock prices).

Note: We are not considering short selling in this article. Short selling is selling a

borrowed asset with the intention of buying it back later at a lower price. Youll here

investors talk about going short or taking a short position. For the purposes of this

discussion, we are only interested in going long buying low and selling higher.

Company announcements

News regarding a company whether good or bad can affect a stocks price.

Favourable news such as positive guidance from a companys management can cause

a stocks price to rise.

Guidance is when the management of a company make an official statement about the

likely future prospects of their company. Usually its in the form of an estimate of

what the likely sales or earnings should be for the next reporting period. Providing

that managements guidance has been accurate in the past, this can be useful

information (we look at how to do this in the Stock Market Tutorial Management

Assessment).

Guidance can also be negative with a corresponding effect on the stock price.

Some announcements tend to be profoundly negative from an investor sentiment point

of view. Certain events, more than often, cause a negative effect on a stocks price.

Things such as:

dividends being cut or reduced negative growth estimates from management, or management or major shareholders selling the stocks they ownThe major stock exchange websites and commercial finance websites such as Yahoo

Finance (finance.yahoo.com) and MSN Money (moneycentral.msn.com) have a

company announcement section for all publicly listed companies.


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Analysts earnings estimates

When a company fails to meet analyst earnings estimates, the share price usually

stumbles. For companies that are followed closely by analysts this is quite often the

case.

For stocks that dont receive much analyst coverage, the earnings forecasts might not

have any effect. This is quite often the case with deep value stocks that have the bad

news already built into the share price.

Economic data

Economic statistics released by the relevant authorities can be favourable ordetrimental.

Certain economic indicators such as interest rates, inflation, and unemployed figures

may affect the whole market.

Or, a particular industry or business might be affected by the release of a specific

piece of economic information, relevant to its specific business dynamics.

The long-term

Over the long-term, earnings drive share prices. Thats why most investment

analysis revolves around profits and factors that affect them.

One of the most important things to consider when analysing a company as a potential

investment is whether the company has a history of making money.

We look at times in a companys history when it was exceedingly profitable. We are

looking for the factors that caused the company to flourish. This gives us clues about

what we might be looking for at this point in time.

As investors, we need to realize that stocks represent ownership in real companies.

When we buy stocks we become business owners. We need to think like business

owners. We arent merely buying stocks, we are buying businesses. We want to buy a

good business selling at a cheap price.


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The Stock Market Tutorialprovides an effective step-by-step method for analysing

companies for their investment potential. Learn how to buy good businesses at the

right price.

Market sentiment

The price of the stock of a company is affected most of the time by the general market

direction during a session. In a bull market, the stock price of most companies will

rise and in a bear market the stock price of most companies will fall. One can gauge

the market sentiment by looking at stock indexes or its future price movement. The

stock indexes are S&P 500, Dow Jones Industrial Index, Nasdaq (USA), ASX100,

ASX (Australia), Nikkei 225 (Japan), Euronext 100, Euronext 150 (Europe Union),

DAX, TECDAX (Germany), FTSE 100, FTSE All Shares, FTSE Techmark (United

Kingdom.

The performance of the industry

The performance of the sector or industry that the company is in also plays in part in

determining the stock price of the company. Most of the times, the stock price of the

companies in the same industry will move in tandem with each other. This is because

market conditions will generally affects the companies in the same industry the same

way. Of course, there are exceptions to this. Sometimes, the stock price of a company

will benefit from a piece of bad news in its competitor if the companies are competing

for the same target market.

Demand and Supply

This is the first factor that affects share prices. When you get to see that more people

are buying stocks, then there is an increase in the price of that particular stock. On the

other hand price of stock falls when more people are selling their stocks. So it is very

difficult to predict the Indian stock market. This is the main reason why you need to

get in touch with a good stock market consultant. There is consultancy for you which

can help you a lot on choosing the right stocks for you.
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26/31

Market cap

It is a verybig mistake when you try to guess a companys worth from the price of a

stock. You should know that the more important is the market capitalization of the

particular company. This helps to determine the worth of a company. So market cap

serves as an important use to determine share prices.

The earning results and earning guidance

The main objective of a company is to make profit. Therefore, investors and traders

always assess a company based on its Earning Per Share (bottom line) and Revenue

(top line) and its future earning potential. In US, companies generally report the

earnings results every quarter-yearly. A company that achieves good earning results

(EPS and Revenue) expects a boost in its share price and one that delivers poor

earning result shall see a beating in its share price. Sometimes, besides reporting the

EPS and Revenue for the past quarter, a company may also issue guidance (expected

value) for the EPS and Revenue in coming quarter or coming years. This is also

closely monitored by investors and is an important factor that will affect the company

stock price.

Take-over or merger.

In general, a company being taken-over is anticipated to get a stock price boost and

the company taking over another company shall experience a drop in its share price.

This is assuming that the company is being taken over at a premium, meaning it is

being bought over at a higher price than its last traded stock price. Depends on the

agreed term, a company can be bought over by cash or stock (of the acquirer) or a

combination of the two. In some minority cases, the stock price of the acquirer may

get a boost if it is perceived that the acquisition shall contribute to its earning or

revenue in the near future.

New product introduction to markets or introduction of an existing product to

new markets.

The introduction of new product to market is seen as a revenue enhancer for a

company. This also applies to an existing product that breaks into new markets.


27/31

Sometimes, the prospect of a new product introduction suffices to improve the stock

price of a company, this is often observed in surges in stock prices of pharmaceuticals

companies after the announcement of successful clinical trials, or FDA approvals for

new drugs.

New major contracts or major Government Orders

A company that is able to obtain new major contracts or major government order is

expected to see a bull run in its stock price. Those companies that fail in the contract

bidding normally experience the fate of sell-off in its stocks.

Share buy-back

The act of share buy-back by a company will reduce the number of share available in

the open market. Due to the law of supply and demand, a reduction in share available

for trading in this case will cause a drop in supply, this will normally help increase the

share price. Also, the continuing buying back of share of a company will also acts as a

support for the share price that helps to maintain or increase the share price. The

investors may also see the share buy-back by company as a confidence booster for

them in the company itself. Therefore, share buy-back is quite often used as a tool to

deliver value to the investors.

Dividend

After the announcement of a dividend. The stock price may increase by an amount

close to the dividend per share value. However, the stock price may drop on the ex-

dividend date by the dividend per share amount. This is because anyone buying a

stock on or after the ex-dividend date are not entitled to the corresponding dividend

payment.

Stock splits

Stock split in theory, should not have an impact to the stock price. However, it is

generally observed that the stock price increases (after taking into account the

increase in the number of share) after a stock split. Some attributed to the better

affordability of the stock after stock split, some attributed this to the perception of

cheap stock due to the lower stock price after the stock split. Some however believes


28/31

that stock split has no real impact on the stock price (effective stock price, taking into

account the change in number of shares), as the stock price will increase regardless of

stock split.

Insider trading

Insiders include CEO, COO, CFO, Chairman, board directors etc, who has first hand

information about the operations and the financial status of a company. Therefore, the

buying or selling of stocks by these insiders may herald some good or bad news about

the company. This is being watched closely by savvy stock investors/traders.

However, do be aware that due to compensation package that comes in the form of

stock or stock options, the insiders may sell their stocks/stock options to cash-in their

compensation benefits. So in this case, it may not signal anything significant about the

company. A savvy investor should know how to observe and filter out this piece of

information from your investment or trading decisions.

Investment Gurus / Hedge Funds trading

The investment decision of highly revered investment gurus like Warren Buffett,

George Soros, Carl Icahn are closely monitored by investors and therefore will move

the market. Hedge fund stock buying and selling are another source of information

regarding the flow of "smart money".

Analyst upgrade / downgrades

Analyst upgrade and downgrade to a stock may have positive or negative impact to

the stock prices. However, one needs to be wary of the fact that quite often analysts'

upgrades or downgrades happen "after" some important news about a company. For

example following a extremely disappointing earning result, many analysts will likely

to downgrade the company stock. So, it is very likely that by then the stock price of

that company has already priced-in the poor earning result, and analyst downgrade

may not have further impact to the stock price.

Addition/Removal to/from Stock Index

Stock Index Fund are those funds that invest in those company stocks that are

included in a particular stock index (e.g. S&P 500, Nasdaq-100, Dow Jones U.S.


29/31

Large Cap etc.) . Therefore, an inclusion of a company stock to a stock index will

generate buying interest in the stock for these stock index fund managers. The stock

index fund managers will dispose of the stock that has been removed from the stock

index.

Earning per share

Now when it comes to the term, earning per share, it means the profit that a

particular company has made per share and that too on the last quarter. If you need to

know the health of the company then this is the most important factor. Whats more

earning per share also influences the buying tendency in the market that results in the

increase of the particular stock price. This is the reason why it is very important for

every public company to bring out the quarterly report. So when you wish to make a

profitable investment, then the best thing for you would be to keep a good watch on

the quarterly reports of different companies. This is very important before you wish to

invest your hard earned money in the share market.

Impact of news

News is another factor that affects the share price. When there is positive news about

a particular stock or company, people try to invest all their money in that particular

stock or market. This leads to increase in the interest of buying the stock. But there

are many circumstances where news could also bring a negative effect where it could

ruin the prospect of the particular stock. So it is very important to know the overall

news of a stock or company where you can invest your money so that it grows within

a very short period of time.

There are many things that you need to consider when you go for investing your hard

earned money in the stock market. You should never be in a haste to invest your

money in the stock market. You should always get in touch with a goodstock market

consultancywhere it can give you some share tips. They are the one who can give

you advice where to invest your money and where not to. They know to distinguish

the good stock from the bad ones.
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30/31

Price/Earning Ratio

Price/Earning ratio or the P/E ratio gives you fair idea of how a companys share price

compares to its earnings. If the price of the share is too much lower than the earning

of the company, the stock is undervalued and it has the potential to rise in the near

future. On the other hand, if the price is way too much higher than the actual earning

of the company and then the stockis said to overvalued and the price can fall at any

point.

Inflation

Inflation means higher consumer prices. This often slows sales and reduces profits.

Higher prices will also often lead to higher interest rates. For example, the Bank of

Canadamay raise interest rates to slow down inflation. These changes will tend to

bring down stock prices. Commodities however, may do better with inflation, so their

prices may rise.

4. Deflation

Falling prices tend to mean lower profits for companies and decreased economic

activity. Stock prices may go down, and investors may start selling their shares and

move to fixed-income investments likebonds. Interest rates may be lowered to

encourage people to borrow more. The goal is increased spending and economic

activity. The Great Depression (1929-1939) was one of the worst periods of deflation

ever.

Economic and political shocks

Changes around the world can affect both the economy and stock prices. For example,

a rise in energy costs can lead to lower sales, lower profits and lower stock prices. An

act of terrorism can also lead to a downturn in economic activity and a fall in stock

prices.

Changes in economic policy

If a new government comes into power, it may decide to make new policies.

Sometimes these changes can be seen as good for business, and sometimes not. They
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31/31

may lead to changes in inflation and interest rates, which in turn may affect stock

prices.

The value of the Canadian dollar

Many Canadian companies sell products to buyers in other countries. If the Canadian

dollar rises, their customers will have to spend more to buy Canadian goods. This can

drive down sales, which in turn can lead to lower stock prices. When the price of the

Canadian dollar falls, it makes it cheaper for others to buy our products. This can

make stock prices rise.

Others

These include news about new technology, patent approval, war, natural disaster,

product recalls and lawsuits that shall have positive and negative impact to the

relevant company stocks. The health or mishap of a key leader in a company may also

affect the stock price of the company. Take a look at the recent news about Apple

Computer.

impact of financial decisions on share price

Documents